Tuesday, March 13, 2007

Hold On to Your Hat, if You’re Invested in Mortgages

My old daddy used to say of Wall Street that there are two classes of investors—the sheep and those who shear the sheep. Daddy wasn't always right, but he was seldom wrong. Investors in mortgages and the gazillion derivative investment devices that are the spawn of the mortgage industry are about to get shorn.

Shearthesheep My old daddy used to say of Wall Street that there are two classes of investors—the sheep and those who shear the sheep. Daddy wasn't always right, but he was seldom wrong. Investors in mortgages and the gazillion derivative investment devices that are the spawn of the mortgage industry are about to get shorn.
If they have their way, all early-warning systems suggest a hue and cry for government help. As in the Savings and Loan debacle of John McCain’s bad old days, it’s possible they’ll get Blankfeingoldmansachsit. Lots of power on the lobbying side of this, made up of the likes of Goldman Sachs, various REITs, banks and mortgage houses, all of them lined up nervously on the bad-debt wire, like so many blackbirds.
It’s another of those ‘who-could-have-known?’ moments, following a decade of warning clouds the greedy mistook for sunshine. The Fed looked the other way--Greenspan was on auto-pilot.
Franklinraines There was plenty of greed to go around, from Franklin Raines’s $50 million compensation at Fanny Mae (based on overstated earnings) to the billions in fees sucked off the top of shaky mortgages by the investment community—then made ‘derivative’ and packaged off to the sheep.
Lehman Brothers, as an example, strutted the news that mortgage-related businesses within their firm contributed directly to record revenue and income over the last three years. Gretchen Morgenson of the New York Times reports that
“a Wall Street analyst at Bear Stearns wrote an upbeat report on a company that specializes in making mortgages to cash-poor homebuyers. The company, New Century Financial, had already disclosed that a growing number of borrowers were defaulting, and its stock, at around $15, had lost half its value in three weeks.”
In McCain’s hoped-to-be-forgotten help for Charles Keating’s Lincoln Savings, the failure of that S&L resulted in (Wikipedia)
"the largest and costliest venture in public misfeasance, malfeasance and larceny of all time." The ultimate cost of the crisis is estimated to have totaled around USD$150 billion, about $125 billion of which was consequently and directly subsidized by the U.S. government, which contributed to the large budget deficits of the early 1990s.
Did I say hang on to your hats? Gretchen Morgenson again
Investment manias are nothing new, of course. But the demise of this one has been broadly viewed as troubling, as it involves the nation’s $6.5 trillion mortgage securities market, which is larger even than the United States treasury market.
Subprimelenders Perhaps China will pick up some of the sub-prime slack that’s driving the market into the ash can of mortgage finagling history. The sub-prime market (you may or may not recall) is the loaning of outrageous amounts of money to people who have no credit history or a badly damaged one. Consumers desperate to consume.
Mostly, these were perfectly decent folks, cruising along and paying their bills until a ‘too-good-deal-to-resist’ came knocking on the door. Refinance! Take that pesky old 6% mortgage, trade it in for a 4 percenter and pocket the extra change that an ‘equal’ monthly payment will bring you. Enough to buy a car or a flat-screen TV, maybe both.
Salesman Don’t worry about the small print, something about ‘variable rates’ and default clauses. Many (most) of these good people were too old, too uneducated or too confused by fast-talk to understand they might (would) lose their homes.
Everyone was doing it. Everyone doing it is the excuse of first and last resort when we want things we can’t afford.
The fast-talker at the door didn’t care. His commission was paid by the contract. The lender he purportedly represented didn’t care either. It wasn’t like the crusty old days when lenders cared about the neighborhood and someone you knew sat behind the same desk at the bank for twenty years.
These guys were on the way up.  The way up your pant-leg to your checkbook. 
Those sub-prime (a euphemism for worthless) loans would be repackaged, dispersed, over-valued, attested to and derivated beyond all recognition before the week was out-- and who gave a damn?—the front-end profits were enormous.
There is even a word in the industry for badly documented, over-valued and shaky lending practices—they were (and are) known as “liar loans.” Deutsche Bank reported liar loans as a percentage, rising from a quarter to nearly half of all mortgage derivatives over the past five years.
“I guess we are a bit surprised at how fast this has unraveled,” said Tom Zimmerman, head of asset-backed securities research at UBS, in a recent conference call with investors.
Not surprised that it unraveled, just taken aback at how fast. UBS is a global financial services company (Swiss) which focuses on wealth and asset management. Tom’s ass-et is on the line and I’ll just bet he oozed a certain amount of sweat as well as surprise during that investor call. If not UBS, then certainly firms like UBS are going to have considerably less wealth and fewer assets to manage in the coming months. The bottom has not yet dropped out, but you can hear the creak.
Debt The poor and the marginal are going to lose their homes. The poor and the marginal were the losers in the S&L scandal as well. The greedy, for the most part, got their losses covered back then—a decision that was sold to the public on the very shaky basis that the economy couldn’t possibly survive a $150 billion hit. Domino theory taken from the rationale for war to the rationale for saving the rich man’s bacon.
Don’t get me wrong, I respect rich men. But there’s a vast difference between a rich man and a greedy man and this bubble was built on avarice.
Investment bankers, those paragons of virtue who pay themselves $100 million annually, took good old boring and safe mortgages and turned them into volatile, over-valued investment instruments. They purposefully hid the pea under the shell as they did it and they did it with misrepresentation and malice in a single-minded rush to profit.
Those who lived by those false colors and those who, in a blind grab at the gold ring, followed them—flushing tens of thousands of poor and marginal homeowners down the financial toilet—deserve to take the full loss. No Fed help.
Unless they can sell their snake-oil to China. That might be a bail-out. China has been the enabler of our deficit economy for decades. Might be time (or long past time) for a Chinese landlord.
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