When we wrote about this issue over a year ago, most observers dismissed governments using eminent domain to seize residential mortgages as a tempest in a teapot. Instead, the whole issue has come to the fore in the summer doldrums, just before the coming September Congressional confrontations about sequesters, the budget and debt limits which will really color the 2014 election cycles. Naturally, the first front has been opened in California, home to one of the biggest pots of electoral and popular votes.
On August 7th, Bank of New York Mellon filed a motion for Declaratory and Injunctive Relief against the City of Richmond, California. Here's a link to the complaint.
BNYM calls this "a case about the misuse of public power for private benefit," which in effect "rents out" the City's powers of eminent domain for the private profit of Mortgage Resolution Partners, a for-profit group masquerading as a community action group and funded by well heeled investment banks like Evercore Partners, which was founded by former Clinton administration staffer Roger Altman, who is also a major fundraiser for President Obama.
The "Seizure Program" will purchase mortgages, including current mortgages, at deep discounts to fair market value, refinance the mortgages for the existing homeowners, while generating fees for the City of Richmond and its financiers. The financing investment banks will receive the Federal guarantees for the new mortgages, which will then be packaged and sold, the big paydays for the investment banks.
The trusts which now own the seized mortgages will take their hit, as will investors in pension plans and mutual funds which own MBS. So in part, this is a government sponsored transfer of wealth from one set of investors, public and private, to a selected set of private investors.
As the complaint states, "...the Seizure Program actually targets performing loans and does nothing to help homes in foreclosure." Yet, slide presentations attached as exhibits trumpet the community action nature of the program to save the City of Richmond money by forestalling expensive foreclosures while keeping people in their homes. Well, if the homeowners are current, they were staying in their homes anyway. The propaganda would make a Russian blush.
The document says the the city has offered to initially purchase 624 loans, 85% of which are not in any stage of foreclosure. 81% are current or have not received any notice of default. 90% of BNYM's 105 loans in this initial pool are not in any stage of foreclosure.
The relevant language of the Fifth Amendment reads, "...nor shall private property be taken for public use without just compensation." As Professor Mary Ann Glendon of Harvard Law School points out, what began as a notion of the just compensation being solely for a public use became "silly putty" in the hands of the courts. Glendon cites retired Supreme Court Justice Sandra Day O'Connor who wrote, "where the exercise of eminent domain power is rationally related to a conceivable public purpose, the Court has never held a compensated taking to be proscribed by the Public Use Clause."
"Keeping people in their homes," saving municipal funds and preserving jobs in the local community are all part of the propaganda for the Seizure Program, so MRP and its government enablers have thought this out well. From as early as the 1790's however, jurists recognized that use of the eminent domain clause should never be used to generate "taking" schemes which merely transferred wealth from one group to another. Unfortunately, that is exactly what is coming down now as this scheme begins to be implemented.
Major fixed income investors like PIMCO and BlackRock have awakened out of their slumber, intoxicated and flush from the longest bond bull market in history, to protest the scam.
The stench has returned worse than before.
.
Showing posts with label Mortgages. Show all posts
Showing posts with label Mortgages. Show all posts
Thursday, August 8, 2013
Wednesday, July 25, 2012
The Mortgage Lending Problem in A Nutshell
The New York Times had a quirky story giving notoriety to long-time bank analyst Richard X. Bove. We see him getting upset about not getting good customer service from his bank, Wells Fargo. I think that's like expecting a Big Tofu burger from McDonalds. No big surprise.
The story had this innocuous sidebar:
"He (Bove) decided to write Tuesday’s note when Wells Fargo rejected his application to refinance his mortgage, even though he had already withdrawn the application."
Think about that for a minute. Bove started on Wall Street in 1965, and has been a bank analyst and research director at firms like Shearson and Wertheim, and now Rochdale Securities. He can't get a refi?
All of the talk about record low mortgage rates is just that, talk. On the refinancing side, we've probably had burnout already. Banks are very reluctant to lend to formerly conventional customers. Fees are being added to formerly free services, and existing fee levels are being raised. Lower provisioning for loan losses on the existing portfolio, expense reductions, and share buybacks can help to generate decent earnings without taking risks associated with mundane tasks like lending.
Housing is said to be recovering. There is still a very large shadow inventory of existing homes which have not yet come on to the market, but there will be very few potential buyers who can qualify to absorb them given the disincentive for banks to change their underwriting stance.
This is a by-product of the distortions arising from monetary policy which has lost its rationale and focus.
The story had this innocuous sidebar:
"He (Bove) decided to write Tuesday’s note when Wells Fargo rejected his application to refinance his mortgage, even though he had already withdrawn the application."
Think about that for a minute. Bove started on Wall Street in 1965, and has been a bank analyst and research director at firms like Shearson and Wertheim, and now Rochdale Securities. He can't get a refi?
All of the talk about record low mortgage rates is just that, talk. On the refinancing side, we've probably had burnout already. Banks are very reluctant to lend to formerly conventional customers. Fees are being added to formerly free services, and existing fee levels are being raised. Lower provisioning for loan losses on the existing portfolio, expense reductions, and share buybacks can help to generate decent earnings without taking risks associated with mundane tasks like lending.
Housing is said to be recovering. There is still a very large shadow inventory of existing homes which have not yet come on to the market, but there will be very few potential buyers who can qualify to absorb them given the disincentive for banks to change their underwriting stance.
This is a by-product of the distortions arising from monetary policy which has lost its rationale and focus.
Saturday, July 14, 2012
California Subprime Mortgages: A Bad Dream Won't Go Away
The state that spawned the California Gold Rush and "fool's gold," was the center of the subprime mortgage industry, Although there was a spike in subprime mortgage issuance beginning in 2004, academic researchers have found that some of the worst mortgage products (option ARMs, 80/20 mortgages, and subprime HELOCs) and the absence of documented underwriting standards combined to account for high volumes of toxic products in 2006.
In the second quarter of 2006, 8 of the 10 top subprime mortgage originators were located in California. The top 10 orginators issued a staggering $110 billion of mortgages in the quarter, of which 82% came from the California issuers. Ironically, Wells Fargo Mortgage was the biggest issuer in Q2 2006, with $27 billion, followed by New Century Financial with $14 billion in the quarter; Countrywide was number four with $11 billion in the quarter. These data are contained in Bankruptcy Examiner Michael Missal's report, which we have cited before as required reading for any serious student of the mortgage crisis.
New Century Financial writes in its disclosures, that the company is focused on "lending to individuals whose borrowing needs are generally not fulfilled by traditional lending institutions because they do not satisfy the credit, documentation, or other underwriting standards prescribed by conventional mortgage lenders and loan buyers."
Separately, Professors Mian and Sufi of the University of Chicago Booth School of Business write, "Homeowners with low credit scores in areas with high house price growth from 2002-2006 have seen mortgage default rates climb from almost 4% to almost 15% from 2006-2008."
In June of 2006, Missal cites an internal finance department email at New Century Financial stating that their weighted average loan to value ratio in the borrower portfolio (combining mortgage and home equity lines of credit) had reached 87%! Missal notes that there were three CPA's on the Audit Committee, including the Board Chair. CFO Cathy Dodge was a CPA. New Century had built it's model on a foundation of "originate and distribute." By 2006, loan quality had clearly been falling apart since 2004, and growing "kickbacks" of bad loans from securitized pools by investors threatened the ability to raise cash by unloading the toxic assets to investors, declaring a gain on sale and pumping up earnings. All of the normal processes and reporting were in place, and yet neither internal audit, the audit committee, nor the external auditor raised any red flags. Everything was fine until the company was near death: then nobody knew what hit them.
Were the borrowers all innocent victims? I hardly think so. Most of the mortgages originated by New Century were stated income loans, in other words the borrower gave an annual income number with no verification and the company's independent broker originators did no due diligence. In addition, this kind of market with this kind of lending attracts the professional fraudsters, who plague credit card companies, rent-to-own companies and direct marketers like Fingerhut. It is a Faustian bargain, because why should the homeowner turn down free money, and why should brokers turn down cash commissions, and why should the management turn down bonuses for reported EPS which is economically fraudulent?
Professors Mian, Sufi and Trebbi produced a startling and original scholarly research paper in 2009, "The Political Economy of the Mortgage Crisis." The 2008 "American Homeowner Relief and Foreclosure Prevention Act" passed under President Bush had a "Hope for Homeowners" program which gave strapped mortgagees access to $300 billion in federal agency insurance. The authors show that while defaults rose in both Democratic and Republican districts, support for the Act by Democrats were "near unanimous" whatever the default rates were in their districts, where Republicans tended to vote in favor where they represented high default rate districts. Mortgage defaults draw lots of bipartisan legislative sympathy, as opposed to credit card debt or student loans, at least historically. There are a number of interesting trends in their data which are would take too long to discuss in a post.
Expect the full court press to stay on the Mortgage Resolution Partners California bailout plan for the bad actor homeowners in California. If the executives at the subprime lenders got a free ride, why not them? And now we have the massively incompetent (or worse) managers of San Bernardino adding their two cents,
Be afraid, as this giveaway is not going away.
In the second quarter of 2006, 8 of the 10 top subprime mortgage originators were located in California. The top 10 orginators issued a staggering $110 billion of mortgages in the quarter, of which 82% came from the California issuers. Ironically, Wells Fargo Mortgage was the biggest issuer in Q2 2006, with $27 billion, followed by New Century Financial with $14 billion in the quarter; Countrywide was number four with $11 billion in the quarter. These data are contained in Bankruptcy Examiner Michael Missal's report, which we have cited before as required reading for any serious student of the mortgage crisis.
New Century Financial writes in its disclosures, that the company is focused on "lending to individuals whose borrowing needs are generally not fulfilled by traditional lending institutions because they do not satisfy the credit, documentation, or other underwriting standards prescribed by conventional mortgage lenders and loan buyers."
Separately, Professors Mian and Sufi of the University of Chicago Booth School of Business write, "Homeowners with low credit scores in areas with high house price growth from 2002-2006 have seen mortgage default rates climb from almost 4% to almost 15% from 2006-2008."
In June of 2006, Missal cites an internal finance department email at New Century Financial stating that their weighted average loan to value ratio in the borrower portfolio (combining mortgage and home equity lines of credit) had reached 87%! Missal notes that there were three CPA's on the Audit Committee, including the Board Chair. CFO Cathy Dodge was a CPA. New Century had built it's model on a foundation of "originate and distribute." By 2006, loan quality had clearly been falling apart since 2004, and growing "kickbacks" of bad loans from securitized pools by investors threatened the ability to raise cash by unloading the toxic assets to investors, declaring a gain on sale and pumping up earnings. All of the normal processes and reporting were in place, and yet neither internal audit, the audit committee, nor the external auditor raised any red flags. Everything was fine until the company was near death: then nobody knew what hit them.
Were the borrowers all innocent victims? I hardly think so. Most of the mortgages originated by New Century were stated income loans, in other words the borrower gave an annual income number with no verification and the company's independent broker originators did no due diligence. In addition, this kind of market with this kind of lending attracts the professional fraudsters, who plague credit card companies, rent-to-own companies and direct marketers like Fingerhut. It is a Faustian bargain, because why should the homeowner turn down free money, and why should brokers turn down cash commissions, and why should the management turn down bonuses for reported EPS which is economically fraudulent?
Professors Mian, Sufi and Trebbi produced a startling and original scholarly research paper in 2009, "The Political Economy of the Mortgage Crisis." The 2008 "American Homeowner Relief and Foreclosure Prevention Act" passed under President Bush had a "Hope for Homeowners" program which gave strapped mortgagees access to $300 billion in federal agency insurance. The authors show that while defaults rose in both Democratic and Republican districts, support for the Act by Democrats were "near unanimous" whatever the default rates were in their districts, where Republicans tended to vote in favor where they represented high default rate districts. Mortgage defaults draw lots of bipartisan legislative sympathy, as opposed to credit card debt or student loans, at least historically. There are a number of interesting trends in their data which are would take too long to discuss in a post.
Expect the full court press to stay on the Mortgage Resolution Partners California bailout plan for the bad actor homeowners in California. If the executives at the subprime lenders got a free ride, why not them? And now we have the massively incompetent (or worse) managers of San Bernardino adding their two cents,
"We are intrigued," said Gregory Devereaux, chief executive of San Bernardino County, which is east of Los Angeles and has one of the highest unemployment rates in the state. "Our economy in this county can't be turned around until a large proportion of the mortgage crisis has been addressed."No, Greg, the municapal finance crisis can't be turned around until San Bernardino gets control over its employee salaries and benefits and scales services at a level consistent with an economically sensitive tax base.
Be afraid, as this giveaway is not going away.
Thursday, July 5, 2012
Government Overreaching on Seizing Mortgages
The wicked never rest, and there is no rest for beleaguered citizens who are not fortunate enough to be chosen for government largesse. The Wall Street Journal story about California cities contemplating an absurd, Kafkaesque use of eminent domain powers is truly "appalling," as described by Scott Simon, Managing Director at PIMCO.
Mortgages are private contracts between a homeowner/borrower and a financial institution/lender. Eminent domain is typically used, for example, when a new public highway project requires a right of way which is now occupied by homes and private businesses. The government entity's powers of eminent domain are exercised in order to construct a project which is in the interest of a larger population, including outsiders. In exchange for exercising this right, the government entity must demonstrate need and come to some market driven settlement with the existing property owners exchanging value for giving up their homes and business locations, plus some value for the inconvenience and costs of moving. All of this is subject to negotiation, in theory.
As it is, eminent domain powers are often abused and applied arbitrarily to property owners who don't necessarily want to play ball at the proposed settlement rates. We have some egregious examples here in the Minnesota Nice Midwest. The California proposal brings abuse of government power and eminent domain to levels that should be laughed out of town or struck down in courts.
Cities in the California case would seize individual underwater mortgage loans. After seizing the loan, via the eminent domain subterfuge, a City would use Mortgage Resolution Partners to pay a reduced amount to the lending institution. Mortgage Resolution Partners CEO Graham Williams comes from a background of lending to low income borrowers through a program called "Neighborhood Advantage" and from subprime lender ITT Financial Services and later at Bank of America. The smell testalyzer is flashing red already. Mortgage Resolution Partners would then put the formerly underwater homeowner into a new, low interest mortgage insured by the FHA with equity requirements as low as 2.25% according to the Journal. So, of course, taxpayers are again handing out a subsidy and taking risk. In these transactions is a nice, upfront profit for the wizards who came up with the scheme.
Professors Mian and Sufi of Chicago Booth Business School did an original and well known analysis on the explosion of mortgage lending from 2002-2006 covering a sample of 238 U.S. counties. The top decile counties for the growth in household debt to income are in California and Florida. The single largest growth in debt ratios occurred in Monterrey County, California. The California counties had the frothiest growth in real estate values, and we know from companies like Countrywide and IndyMac, that these Zip codes were precisely the targets for aggressive mortgage origination. Professor John Coffee of Columbia has testified about these abuses before Congress. Now, all taxpayers will be asked to fund a bailout for these homeowners. Why not for homeowners in the Midwest or in Westchester County or in Appalachia?
Did I mention that Roger Altman of Evercore Partners, one of the investment banks backing Mortgage Resolution Partners, served in the Clinton Administration and is raising funds for President Obama's re-election efforts? I have to leave the room now because the smell test is over and the stench is too much.
Mortgages are private contracts between a homeowner/borrower and a financial institution/lender. Eminent domain is typically used, for example, when a new public highway project requires a right of way which is now occupied by homes and private businesses. The government entity's powers of eminent domain are exercised in order to construct a project which is in the interest of a larger population, including outsiders. In exchange for exercising this right, the government entity must demonstrate need and come to some market driven settlement with the existing property owners exchanging value for giving up their homes and business locations, plus some value for the inconvenience and costs of moving. All of this is subject to negotiation, in theory.
As it is, eminent domain powers are often abused and applied arbitrarily to property owners who don't necessarily want to play ball at the proposed settlement rates. We have some egregious examples here in the Minnesota Nice Midwest. The California proposal brings abuse of government power and eminent domain to levels that should be laughed out of town or struck down in courts.
Cities in the California case would seize individual underwater mortgage loans. After seizing the loan, via the eminent domain subterfuge, a City would use Mortgage Resolution Partners to pay a reduced amount to the lending institution. Mortgage Resolution Partners CEO Graham Williams comes from a background of lending to low income borrowers through a program called "Neighborhood Advantage" and from subprime lender ITT Financial Services and later at Bank of America. The smell testalyzer is flashing red already. Mortgage Resolution Partners would then put the formerly underwater homeowner into a new, low interest mortgage insured by the FHA with equity requirements as low as 2.25% according to the Journal. So, of course, taxpayers are again handing out a subsidy and taking risk. In these transactions is a nice, upfront profit for the wizards who came up with the scheme.
Professors Mian and Sufi of Chicago Booth Business School did an original and well known analysis on the explosion of mortgage lending from 2002-2006 covering a sample of 238 U.S. counties. The top decile counties for the growth in household debt to income are in California and Florida. The single largest growth in debt ratios occurred in Monterrey County, California. The California counties had the frothiest growth in real estate values, and we know from companies like Countrywide and IndyMac, that these Zip codes were precisely the targets for aggressive mortgage origination. Professor John Coffee of Columbia has testified about these abuses before Congress. Now, all taxpayers will be asked to fund a bailout for these homeowners. Why not for homeowners in the Midwest or in Westchester County or in Appalachia?
Did I mention that Roger Altman of Evercore Partners, one of the investment banks backing Mortgage Resolution Partners, served in the Clinton Administration and is raising funds for President Obama's re-election efforts? I have to leave the room now because the smell test is over and the stench is too much.
Friday, June 29, 2012
Remembering Countrywide
Fresh off a recent post on foreclosures, I was doing a final read of the Wall Street Journal when I came on their article about Bank of America's $40 billion mistake in acquiring Countrywide Financial.
Here is an excerpt that speaks to the issue of dealing with delinquent mortgages and eventual foreclosures. It is a mind boggling mental picture: "Countrywide saddled Bank of America with hundreds of thousands of delinquent borrowers, thrust it into the middle of a foreclosure-paperwork scandal and exposed the bank to countless lawsuits from mortgage-bond investors and insurers. The number of people handling poor-performing real-estate loans for Bank of America ballooned from 5,000 at the time of the Countrywide purchase to 50,000. Those people occupy at least 4.5 million square feet of office space around the country, the equivalent of 78 football fields."
What's really appalling is that all those horrible collectors and others occupying that 4.5 million square feet are dealing with real people whose lives are being turned upside down. I understand that many of the borrowers were gaming the system too. But none of this should have happened at this scale because Countrwide's underwriting should have been reined in by regulators, and it should never have been acquired by any kind of rational board of directors.
First question: if Raj Rajaratnam has paid millions in clawed back profits from a relatively puny insider trading scheme and been banned from the securities industry while spending eleven years in prison, why on earth is Angelo Mozillo not in the Federal pen on multiple life sentences? I am among millions of Americans who are asking the same question about Mozillo.
Finally, here's a laughable quote from Ken Lewis the former CEO of Bank of America: "The Merrill Lynch and Countrywide integrations are on track and returning value already." (from Wikipedia) His 2007 compensation was $20 million. Shareholders wanted earnings growth and management rewarded themselves for delivering a chimera instead.
Bank of America is the best performing stock in the Standard and Poor's 500 year-to-date! We talk about kleptocracies in a number of other countries, some of which claim decocratic processes. We need to have a serious look at the virus of a crony capitalism which is thriving in our own markets, untouched by any meaningful reform.
Here is an excerpt that speaks to the issue of dealing with delinquent mortgages and eventual foreclosures. It is a mind boggling mental picture: "Countrywide saddled Bank of America with hundreds of thousands of delinquent borrowers, thrust it into the middle of a foreclosure-paperwork scandal and exposed the bank to countless lawsuits from mortgage-bond investors and insurers. The number of people handling poor-performing real-estate loans for Bank of America ballooned from 5,000 at the time of the Countrywide purchase to 50,000. Those people occupy at least 4.5 million square feet of office space around the country, the equivalent of 78 football fields."
What's really appalling is that all those horrible collectors and others occupying that 4.5 million square feet are dealing with real people whose lives are being turned upside down. I understand that many of the borrowers were gaming the system too. But none of this should have happened at this scale because Countrwide's underwriting should have been reined in by regulators, and it should never have been acquired by any kind of rational board of directors.
First question: if Raj Rajaratnam has paid millions in clawed back profits from a relatively puny insider trading scheme and been banned from the securities industry while spending eleven years in prison, why on earth is Angelo Mozillo not in the Federal pen on multiple life sentences? I am among millions of Americans who are asking the same question about Mozillo.
Finally, here's a laughable quote from Ken Lewis the former CEO of Bank of America: "The Merrill Lynch and Countrywide integrations are on track and returning value already." (from Wikipedia) His 2007 compensation was $20 million. Shareholders wanted earnings growth and management rewarded themselves for delivering a chimera instead.
Bank of America is the best performing stock in the Standard and Poor's 500 year-to-date! We talk about kleptocracies in a number of other countries, some of which claim decocratic processes. We need to have a serious look at the virus of a crony capitalism which is thriving in our own markets, untouched by any meaningful reform.
Foreclosures in New York
Bill McBride who blogs at Calculated Risk commented on CoreLogic's 63,000 completed foreclosures in May, flat with April and below the year ago level, with a degree of optimism. Like an iceberg, most of the inventory is below the surface, I suspect. Here in lower Westchester County, New York walking around my old neighborhood, there are many homes at various stages of descending into foreclosure. A flagship Mediterranean home in the neighborhood lay vacant for four years after the owner lost it. It was recently purchased by new owners, not investors. Most of the sales here are distressed, and the neighborhood is filled with homes not yet in the formal process. The inefficiency and incompetence of municipal governments further impedes a resolution process.
As I've said many times before, banks never thought that they would be in the business of foreclosing, especially on such a large scale. Banks can barely deliver core checking and savings accounts efficiently, and they certainly are not humane or efficient about foreclosures. The mortgage servicers as a whole are a fly-by-night group and they weren't built for this either.
CoreLogic does note that foreclosure inventories are still rising in states like New York and Connecticut. Believe it.
As I've said many times before, banks never thought that they would be in the business of foreclosing, especially on such a large scale. Banks can barely deliver core checking and savings accounts efficiently, and they certainly are not humane or efficient about foreclosures. The mortgage servicers as a whole are a fly-by-night group and they weren't built for this either.
CoreLogic does note that foreclosure inventories are still rising in states like New York and Connecticut. Believe it.
Sunday, August 14, 2011
Bank of America: Heavy Clouds, Low Visibility
I finally read through the transcript of Bank of America's conference call, "hosted" by Bruce Berkowitz of the Fairholme Fund. There was really no visibility offered into the very few good questions. There was a discussion about selling "core versus non-core assets." The discussion then turned to Merrill Lynch, at the behest of a questioner.
I was truly flabbergasted by the response of CEO Brian Moynihan, who said that Merrill, to paraphrase, was fully integrated into the culture of Bank of America. No serious institutional investor would have tipped their hand by challenging this assertion, but it is totally implausible.
Ever since the Eighties, when commercial banks first bought asset managers to reduce their earnings cyclicality, the cultures have never meshed, particularly over compensation issues. Over time, the targets for commercial banks became the investment banks, which themselves had wealth management businesses, as well as proprietary trading desks and investment banking. Now, the cultural and compensation issues diverged more sharply from the commercial banks, although bank CEO compensation exploded sharply because they ran bigger balance sheets.
I once worked for Merrill Lynch when they were located in the old US Steel Building on Liberty Street. The idea of costs and internal controls were about as well understood as Mandarin Chinese. There was a complete disconnect between the huge retail brokerage network, "The Thundering Herd," and the institutional business, both of which were totally oblivious to the asset management business located in New Jersey. Fast forward to 2008, Merrill Lynch was being run by a distant, isolated CEO who wasn't excited by either the brokerage business or by the lackluster asset management business. Instead he led it into the world of creating Collateralized Debt Obligations, instruments that the board and the CEO didn't understand. As this out of control empire started to collapse, along came Bank of America to acquire Merrill Lynch.
US Bancorp bought Piper Jaffray in 1997, and dividended it back to shareholders in 2003. USB bought it at the high point of the cycle and divested at the low point, just before the market turn. In the interim, ownership added no value, and Piper subsequently thrived as an independent public company. Citicorp's acquisition of Smith Barney was described as follows by the Wall Street Journal in 2009, "Ever since Smith Barney became part of Citigroup 10 years ago, the brokerage has been whipsawed by integration problems and troubled deals." Smith Barney was eventually disgorged by Citi.
Citi couldn't integrate Smith Barney after ten years, and yet we are to believe that Bank of America has integrated the bigger and more sprawling Merrill Lynch in less than two years? Not likely. I had the misfortune to have some dealings with Merrill Lynch recently, trying to transfer an old account. I ran full tilt into a total lack of communication, record keeping, and computer system issues between Bank of America's systems and those of Merrill Lynch.
Integration in the best possible case might involve computer systems. The cultures can never be integrated. Institutional traders, salespeople, analysts, and capital markets executives are masters of the universe, and brokers are not part of the club. Retail banks can't sell brokerage services effectively. Why did Charles Schwab return to the business he founded? My point is that the Bank of America CEO's assertion about Merrill Lynch's complete integration would represent the first such successful integration in corporate history.
Beyond this point, which is not small, there is the issue of Countrywide Financial. Nothing on the call added any more clarity to the risks associated with this disastrous acquisition. The "see you in court" challenge to AIG was false bravado and would not give me comfort as a shareholder. Bank of America's asking Secretary Geithner for relief against mortgage fraud issues being brought by State Attorneys General has not worked, and this will be a protracted, multi-front battle which probably won't end cheaply.
After all is said and done, Bruce Berkowitz's Fairholme Fund's investment in Bank of America is very hard to understand. In 2009, Forbes Magazine asked Berkowitz why he was avoiding financials. He is quoted as saying, "Well, we don't know how to value them...It's impossible to know what they own...Five years ago, you could read AIG's report on derivatives. Maybe it was a paragraph. It didn't tell you anything. You had to just assume that these people knew what they were doing. Today you can read ten pages on it and still not know what's going on unless you go through the underlying collaterals. Almost impossible."
Fairholme should have followed its own advice, and this conference call shouldn't have made them any more comfortable with their investment.
I was truly flabbergasted by the response of CEO Brian Moynihan, who said that Merrill, to paraphrase, was fully integrated into the culture of Bank of America. No serious institutional investor would have tipped their hand by challenging this assertion, but it is totally implausible.
Ever since the Eighties, when commercial banks first bought asset managers to reduce their earnings cyclicality, the cultures have never meshed, particularly over compensation issues. Over time, the targets for commercial banks became the investment banks, which themselves had wealth management businesses, as well as proprietary trading desks and investment banking. Now, the cultural and compensation issues diverged more sharply from the commercial banks, although bank CEO compensation exploded sharply because they ran bigger balance sheets.
I once worked for Merrill Lynch when they were located in the old US Steel Building on Liberty Street. The idea of costs and internal controls were about as well understood as Mandarin Chinese. There was a complete disconnect between the huge retail brokerage network, "The Thundering Herd," and the institutional business, both of which were totally oblivious to the asset management business located in New Jersey. Fast forward to 2008, Merrill Lynch was being run by a distant, isolated CEO who wasn't excited by either the brokerage business or by the lackluster asset management business. Instead he led it into the world of creating Collateralized Debt Obligations, instruments that the board and the CEO didn't understand. As this out of control empire started to collapse, along came Bank of America to acquire Merrill Lynch.
US Bancorp bought Piper Jaffray in 1997, and dividended it back to shareholders in 2003. USB bought it at the high point of the cycle and divested at the low point, just before the market turn. In the interim, ownership added no value, and Piper subsequently thrived as an independent public company. Citicorp's acquisition of Smith Barney was described as follows by the Wall Street Journal in 2009, "Ever since Smith Barney became part of Citigroup 10 years ago, the brokerage has been whipsawed by integration problems and troubled deals." Smith Barney was eventually disgorged by Citi.
Citi couldn't integrate Smith Barney after ten years, and yet we are to believe that Bank of America has integrated the bigger and more sprawling Merrill Lynch in less than two years? Not likely. I had the misfortune to have some dealings with Merrill Lynch recently, trying to transfer an old account. I ran full tilt into a total lack of communication, record keeping, and computer system issues between Bank of America's systems and those of Merrill Lynch.
Integration in the best possible case might involve computer systems. The cultures can never be integrated. Institutional traders, salespeople, analysts, and capital markets executives are masters of the universe, and brokers are not part of the club. Retail banks can't sell brokerage services effectively. Why did Charles Schwab return to the business he founded? My point is that the Bank of America CEO's assertion about Merrill Lynch's complete integration would represent the first such successful integration in corporate history.
Beyond this point, which is not small, there is the issue of Countrywide Financial. Nothing on the call added any more clarity to the risks associated with this disastrous acquisition. The "see you in court" challenge to AIG was false bravado and would not give me comfort as a shareholder. Bank of America's asking Secretary Geithner for relief against mortgage fraud issues being brought by State Attorneys General has not worked, and this will be a protracted, multi-front battle which probably won't end cheaply.
After all is said and done, Bruce Berkowitz's Fairholme Fund's investment in Bank of America is very hard to understand. In 2009, Forbes Magazine asked Berkowitz why he was avoiding financials. He is quoted as saying, "Well, we don't know how to value them...It's impossible to know what they own...Five years ago, you could read AIG's report on derivatives. Maybe it was a paragraph. It didn't tell you anything. You had to just assume that these people knew what they were doing. Today you can read ten pages on it and still not know what's going on unless you go through the underlying collaterals. Almost impossible."
Fairholme should have followed its own advice, and this conference call shouldn't have made them any more comfortable with their investment.
Wednesday, December 17, 2008
The 4.5% Solution
Again, Professors R. Glenn Hubbard and Christopher Mayer of the Columbia University Graduate School of Business have reiterated their idea for putting a floor under housing stock price declines, avoiding foreclosures, and for enabling consumers who refinance to increase their consumption. We've written about this idea for some time in previous posts, and it sounds as if something like it might be forthcoming.
This would be a much bolder move than the much-ballyhooed but largely symbolic easing announced yesterday. To paraphrase Alan Blinder, "A for effort by the Fed, but an Incomplete for results."
Given that the lateness of the calendar, we're a little concerned about the ability of the Congress,the Bush and incoming Obama administrations to agree on the Hubbard-Mayer plan, but there's always hope.
Here is the link again:
http://www4.gsb.columbia.edu/realestate/research/housingcrisis/mortgagemarket
This would be a much bolder move than the much-ballyhooed but largely symbolic easing announced yesterday. To paraphrase Alan Blinder, "A for effort by the Fed, but an Incomplete for results."
Given that the lateness of the calendar, we're a little concerned about the ability of the Congress,the Bush and incoming Obama administrations to agree on the Hubbard-Mayer plan, but there's always hope.
Here is the link again:
http://www4.gsb.columbia.edu/realestate/research/housingcrisis/mortgagemarket
Thursday, December 4, 2008
The Fed Wakes Up to Foreclosures
Fed Chairman Bernanke expressed concern today about the foreclosure rate which he says is running on track for 2.25 million proceedings this year. Forcing lenders to lower published mortgage rates accomplishes nothing, because if home values are down, credit score requirements are more stringent, a household has a job loss and reduced income, and the lender's margin has risen, mortgages won't actually be closed at those rates to the people who really need help. The banking industry has never been set up to effectively and humanely handle large volumes of foreclosures, because it is something that they're not good at and something that was never anticipated on a large scale. The participants in the foreclosure business are yet another unregulated, unseemly lot. Unleashing this process on a large scale is like introducing termites into a house.
The Hubbard-Mayer plan, which we discussed in an earlier post aims to keep people in their homes, while resetting rates and loan amounts to realistic values. Lenders will have some write down issues, holders of securitized paper will cry foul, and there may be windfall gains to some homeowners. It certainly has some implementation challenges, but no more so than those created by the potpourri of ineffective plans and programs out there now. I believe that a form of this plan will in fact resurface, and hopefully we can decisively address the foreclosure problem in the near future.
Here is the earlier link to their publication:
http://www4.gsb.columbia.edu/realestate/research/mortgagemarket
The Hubbard-Mayer plan, which we discussed in an earlier post aims to keep people in their homes, while resetting rates and loan amounts to realistic values. Lenders will have some write down issues, holders of securitized paper will cry foul, and there may be windfall gains to some homeowners. It certainly has some implementation challenges, but no more so than those created by the potpourri of ineffective plans and programs out there now. I believe that a form of this plan will in fact resurface, and hopefully we can decisively address the foreclosure problem in the near future.
Here is the earlier link to their publication:
http://www4.gsb.columbia.edu/realestate/research/mortgagemarket
Tuesday, November 11, 2008
A Great Idea Lost in the Din
Glen Hubbard, the Dean of the Columbia University Graduate School of Business and Professor Chris Mayer, came up with a bold proposal for the residential mortgage mess back in early October. Here is a link to FAQ about their plan on the Columbia University GSB site:
http://www4.gsb.columbia.edu/realestate/research/mortgagemarket
I look at it this way. 1. Q: What is the home owner's worst nightmare? A: Being foreclosed out of one's home, creating heartache for the family, and losing your credit rating for the future.
2. Q: What is the last thing that banks want? A: To foreclose on a home and to be an owner of residential property. Why? Homes in foreclosure go into a parallel universe with fly-by-night service providers who promise a lot and do nothing. The home sits there and deteriorates through a winter, the grass goes unmowed, and this quickly affects the market value of adjacent homes that might themselves be coming on the market. This process does not work for the bank. It is a remedy that is worse than the disease. So, we come to the conclusion that avoiding foreclosure is not an issue of moral hazard or of bailing out people who made foolish decisions, but something that is really in no one's interest.
The Hubbard-Mayer proposal is the only one I've seen that addresses this reality. Much of the current Wild West buffet of bailout-du-jour strategies serve only to address the balance sheets of the financial institutions. There is much more at stake than this, as the banking system contagion feeds back, through the mechanism of declining GNP and employment,onto home prices. Since this has already begun, the proposal probably needs a bit of tweaking, but this is minor.
Their proposal excludes investors and speculators, and basically resets all interested homeowners to a 5.25% fixed rate mortgage based on a reasonable loan-to-value ratio, provided the homeowner can support the new mortgage. A new SPE would administer the program and write-downs from the current mortgage and value situation would be shared between the originator of the old mortgage and the new Federal SPE. The homeowner would give up 20% of the future home appreciation to the government when the home were sold.
There is a lot to like about the proposal, because it doesn't whittle away at the problem, it cuts the Gordian Knot.
http://www4.gsb.columbia.edu/realestate/research/mortgagemarket
I look at it this way. 1. Q: What is the home owner's worst nightmare? A: Being foreclosed out of one's home, creating heartache for the family, and losing your credit rating for the future.
2. Q: What is the last thing that banks want? A: To foreclose on a home and to be an owner of residential property. Why? Homes in foreclosure go into a parallel universe with fly-by-night service providers who promise a lot and do nothing. The home sits there and deteriorates through a winter, the grass goes unmowed, and this quickly affects the market value of adjacent homes that might themselves be coming on the market. This process does not work for the bank. It is a remedy that is worse than the disease. So, we come to the conclusion that avoiding foreclosure is not an issue of moral hazard or of bailing out people who made foolish decisions, but something that is really in no one's interest.
The Hubbard-Mayer proposal is the only one I've seen that addresses this reality. Much of the current Wild West buffet of bailout-du-jour strategies serve only to address the balance sheets of the financial institutions. There is much more at stake than this, as the banking system contagion feeds back, through the mechanism of declining GNP and employment,onto home prices. Since this has already begun, the proposal probably needs a bit of tweaking, but this is minor.
Their proposal excludes investors and speculators, and basically resets all interested homeowners to a 5.25% fixed rate mortgage based on a reasonable loan-to-value ratio, provided the homeowner can support the new mortgage. A new SPE would administer the program and write-downs from the current mortgage and value situation would be shared between the originator of the old mortgage and the new Federal SPE. The homeowner would give up 20% of the future home appreciation to the government when the home were sold.
There is a lot to like about the proposal, because it doesn't whittle away at the problem, it cuts the Gordian Knot.
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