An on-going question I keep asking as I watch powerful people make bad decisions in politics and business is this: Do they understand the consequences of what they are doing? In the case of former Countrywide Finance CEO Angelo Mozilo some commentators I came across months ago claimed Mozilo was a populist believer in what he was doing. In this theory Mozilo thought he was extending credit to deserving borrowers who just weren't able to get credit from staid racist mortgage companies and banks. But emails released as part of criminal charges against Mozilo show in 2006 Mozilo knew Countrywide was issuing terrible toxic loans.
In March 2006, Mozilo wrote that the lender’s program of granting subprime loans for 100% of the value of a borrower’s home was "the most dangerous product in existence and there can be nothing more toxic and therefore requires that no deviation from [underwriting] guidelines be permitted irrespective of the circumstances."
He was using the term privately before the term toxic entered the mainstream lexicon for talking about loan quality.
Furthermore, in an April 7, 2006 email to Sambol concerning Countrywide’s subprime 80/20 loans, Mozilo fumed: “In all my years in the business I have never seen a more toxic prduct. [sic] It’s not only subordinated to the first, but the first is subprime. In addition, the FICOs are below 600, below 500 and some below 400[.] With real estate values coming down …the product will become increasingly worse. There has [sic] to be major changes in this program, including substantial increases in the minimum FICO…. Whether you consider the business milk or not, I am prepared to go without milk irrespective of the consequences to our production.”
So why didn't Mozilo just order a stop to the issuance of such loans?
Irresponsible loans to folks lying about their income, toxic zero-down deals, pay-option loans with exploding payments: All the misdeeds that brought the mortgage industry down are cataloged in Mozilo's own e-mails. You would think that with all this coming straight from the top, Countrywide would have been racing to change its practices. But the stunning thing is that this is in no way the case. What's most striking about the Mozilo e-mails is not that he continued to present a rosy picture of Countrywide's prospects to investors. That's dishonest but easy to understand. It's that all those complaints didn't actually change how Countrywide did business.
Gimein advances a few theories. Did Mozilo just want to sell (which he did) a couple hundred million dollars worth of Countrywide stock without spooking the market with a bit cut-back in lending? Were the memoes a form of cover-your-ass where he went on record stating his opposition as if somehow he didn't have the power to stop them? The board of directors made him do it? Whatever his motives, he can't honestly claim ignorance as Countrywide's lending practices contributed to the huge and disastrously damaging housing bubble.
Writing in MarketWatch David Weidner points to banking executives who avoided the loan debacle including Comerica CEO Ralph Babb.
But if there's anything that recommends him, it is this: Comerica is the biggest bank in Michigan. Knowing what's happening to the auto industry, how it lost tens of thousands of jobs, is there anyone who isn't impressed that Comerica made nearly $200 million during the last 12 months?
Here's another reason to bring him to Washington: the bank only had $133 million in charge offs in the fourth quarter on a balance sheet of more than $65 billion, and that was double the rate of a year ago.
Analysts, such as Peter Winter at Bank of Montreal, note with a hint of astonishment that credit has held better at Comerica than many of its competitors. Consider that unemployment in Michigan is now about 10% and the state lost 30,000 jobs in October and November alone, according to the Bureau of Labor Statistics.
I am very interested in people who make accurate predictions and wise decisions. Can you point to financial industry executives who managed to implement policies that avoided reckless lending and reckless purchase of dodgy collateralized mortgage obligations and the like? Can you point to economists or traders who publically and accurately predicted much of the financial disaster years in advance? I'd like to build up a collection of links to people who made correct decisions so we can find out what they think now.
Weidner points to others:
It's a group that includes people like Christopher Wood, a chief strategist a Credit Lyonaisse's Asia brokerage who told investors to get out of the U.S. mortgage securities market in 2005 and to sell U.S. and European banks in 2007.
It includes Peter Schiff, a regular on business TV shows, who warned against a real estate collapse. Alone, that prediction was hardly unique, but what set Schiff apart was what he forecast as the fallout: deep recession, credit crunch and bank failures. Yes, that sounds familiar.
I do not know whether Nouriel Roubini will continue making correct predictions. He spent several years predicting premature financial disaster before finally being vindicated. But if Roubini is correct this is going to be a long deep recession.
Jan. 27 (Bloomberg) -- Global stock market declines are increasingly correlated and emerging economies will follow developed nations into a “severe recession,” according to New York University Professor Nouriel Roubini.
Roubini said economic growth in China will slow to less than 5 percent and the U.S. will lose 6 million jobs. The American economy will expand 1 percent at most in 2010 as private spending falls and unemployment climbs to at least 9 percent, he added.
Who should we listen to now? Who has the track record that makes them worthy of our time?
What is one question you would ask Alan Greenspan?
What did you do to get the job? Because nothing in your record seems to justify it.
Have you ever talked to him?
No, and I'm happy to leave it that way.
What would you ask Ben Bernanke?
How did you possibly miss the housing bubble? How could you say at the peak of this three-Sigma event--a one in 1,000 year event at the top of 2006--how could you say the U.S. housing market merely reflects a strong U.S. economy? Surrounded as you are by all this statistical help, and with your experience with the Great Depression, how could you miss it? I simply don't get it.
The housing ratios for housing prices-to-income and housing prices-to-rental prices were so far out of whack from historical trends that the housing bubble was extremely easy to call for people whose jobs ought to involve looking at financial ratios.
Reminds me of descriptions of penny stock brokerage firms selling misrepresented stocks in boiler room atmosphere. But this was a huge FDIC-insured bank.
On another occasion, Ms. Zaback asked a loan officer for verification of an applicant’s assets. The officer sent a letter from a bank showing a balance of about $150,000 in the borrower’s account, she recalled. But when Ms. Zaback called the bank to confirm, she was told the balance was only $5,000.
The loan officer yelled at her, Ms. Zaback recalled. “She said, ‘We don’t call the bank to verify.’ ” Ms. Zaback said she told Mr. Parsons that she no longer wanted to work with that loan officer, but he replied: “Too bad.”
Shortly thereafter, Mr. Parsons disappeared from the office. Ms. Zaback later learned of his arrest for burglary and drug possession.
The sheer workload at WaMu ensured that loan reviews were limited. Ms. Zaback’s office had 108 people, and several hundred new files a day. She was required to process at least 10 files daily.
“I’d typically spend a maximum of 35 minutes per file,” she said. “It was just disheartening. Just spit it out and get it done. That’s what they wanted us to do. Garbage in, and garbage out.”
Massive numbers of taxpayer-insured dollars got shoveled out the door. Many of the loans were packaged up and sold off. Washington Mutual just didn't package up enough of them to avoid holding the bag when the music stopped.
As housing prices went above the levels that buyers could afford WaMu responded by lowering standards and selling mortgages that the buyers wouldn't be able to afford once they reset.
WaMu’s boiler room culture flourished in Southern California, where housing prices rose so rapidly during the bubble that creative financing was needed to attract buyers.
To that end, WaMu embraced so-called option ARMs, adjustable rate mortgages that enticed borrowers with a selection of low initial rates and allowed them to decide how much to pay each month. But people who opted for minimum payments were underpaying the interest due and adding to their principal, eventually causing loan payments to balloon.
Customers were often left with the impression that low payments would continue long term, according to former WaMu sales agents.
For WaMu, variable-rate loans — option ARMs, in particular — were especially attractive because they carried higher fees than other loans, and allowed WaMu to book profits on interest payments that borrowers deferred. Because WaMu was selling many of its loans to investors, it did not worry about defaults: by the time loans went bad, they were often in other hands.
WaMu’s adjustable-rate mortgages expanded from about one-fourth of new home loans in 2003 to 70 percent by 2006. In 2005 and 2006 — when WaMu pushed option ARMs most aggressively — Mr. Killinger received pay of $19 million and $24 million respectively.
The FDIC ought to sue to recover some of that executive compensation. The financial executives of America should come to know some fear.
The average 30-year fixed jumbo loan rate was 7.32 percent on Dec. 22, compared with 5.38 percent for a conforming loan, according to BanxQuote of White Plains, New York.
The difference between the two averaged 2.13 percentage points in December, 10 times the spread from 2000 to 2006 and above last month’s 1.95 percentage points that was the highest on record. If current rates reflected the historical difference of 0.2 percentage points, jumbo borrowers with an $800,000 mortgage would save $913 a month.
This provides a measure of how much Freddie Mac and Fannie Mae lower the cost of mortgages. Freddie and Fannie will only buy mortgages worth $417,000 or less (actually, there are exceptions that range as high as $729,750 depending on local housing costs). That higher cost for mortgages on more expensive houses is causing them to fall more in price than houses that qualify for cheaper mortgages. Note, however, that the more expensive market of California saw much more housing price inflation than most of the US. So these housing price declines are bringing houses down to a less distorted level.
The elite expert response continues to be that we should reflate the housing bubble.
“The real elephant in the room is falling house prices,” Glenn Hubbard, former chairman of the Council of Economic Advisers under President George W. Bush who is now dean of the Columbia University Graduate Business School, said in an interview Dec. 22. “We can fix this by lowering mortgage interest rates.”
Any dumb idea worth doing once is worth doing twice? Why is that? Let me bore you with repetition: The housing price-to-rent ratio and price-to-income ratio have to return to historical trends.
Some people took exception to a recent post about how alt-A and option ARM mortgages will be the next financial disaster. The argument in the comments of that post is that interest rates are so low that resetting of interest rates won't make the monthly payments higher but rather lower. But a lot of option ARM mortgage holders were not even paying enough per month to cover interest in the first place.
Known as an option ARM — and named “Pick-A-Pay” by World Savings — it is now seen by an array of housing analysts and regulators as the Typhoid Mary of the mortgage industry.
Pick-A-Pay allowed homeowners to make monthly mortgage payments that were so small they did not cover their interest charges. That meant the total principal owed would actually grow over time, not shrink as is normally the case.
Now held by an estimated two million homeowners, the option adjustable rate mortgage will be at the forefront of a further wave of homeowner distress that could greatly delay or even derail an economic recovery, mortgage industry analysts say.
Option ARM is yet another financial weapon of mass destruction.
“This product is the most destructive financial weapon ever deployed against the American middle class,” said William J. Purdy III, a housing lawyer in California who is representing elderly World Savings customers struggling to repay their loans. “People who have this loan are now trapped, and they can’t get another loan.”
People become less willing to make their suddenly higher payments as the price of their house drops and they find themselves financially under water - owing more than their house is worth. In some cases they never would have been able to make the higher monthly payments once the mortgage readjusted to cover interest costs. Some were probably counting on flipping and moving on to another home at that point. But in the game of housing musical chairs when the game stops it is those who are sitting in chairs who lose. These mortgage holders and their banks and the American taxpayers all became losers.
Once upon a time in a distant era regulators didn't think federally insured financial institutions should offer such risky loans.
When Reagan era deregulation arrived, the Sandlers and two other competitors were able to market option ARMs for the first time in 1981. Before that, lawmakers balked at the loan because of its potential peril to borrowers.
World Savings initially attracted borrowers whose incomes fluctuated, like professionals with big year-end bonuses. In the recent housing boom, when World Savings started calling the loan Pick-A-Pay, they began marketing it to a much broader audience, including people with financial troubles, like deeply indebted blue-collar workers.
The risky loans didn't just pull in people who had no business buying houses. These loans so boosted demand for housing that they had the macroeconomic effect of driving up the prices of houses. The rising prices pulled in more fools and so when the bubble inevitably popped it caused the deep long recession and big costs for the net taxpayers.
Legendary investor Jim Rogers, who co-founded the Quantum Fund with George Soros, says most American banks are bankrupt.
"Without giving specific names, most of the significant American banks, the larger banks, are bankrupt, totally bankrupt," he said.
"What is outrageous economically and is outrageous morally is that normally in times like this, people who are competent and who saw it coming and who kept their powder dry go and take over the assets from the incompetent.
"What's happening this time is that the government is taking the assets from the competent people and giving them to the incompetent people and saying, now you can compete with the competent people. It is horrible economics."
Given that the mortgage default rate is going to surge along with rising unemployment it seems to me most of the losses of the banks still lie in the future. So Rogers sounds plausible. Rogers is a dollar bear.
"I plan to get out of all of my U.S. dollars at some time throughout this rally," he said. "The dollar is a terribly flawed currency, and perhaps a doomed currency."
We are doomed! Well, not all of us. Some people will prosper even during decay.
"With half of modified loans defaulting, many modifications are only kicking the can further down the road and not solving the root problem," said Greg McBride, senior analyst with Bankrate.com, an online consumer finance Web site. "The fact is that with a lot of properties, you won't be able to move to an affordable modification because the borrower took out a lot of equity at the top of the market or the initial loan was taken at an extremely low teaser rate," he said.
The three largest U.S. card issuers are J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc. Those three banks had nearly 60 percent of the $724.44 billion in outstanding loans at the 10 biggest card issuers in the U.S. as of June 30, according to the Nilson Report, a Carpinteria, Calif., newsletter that follows the industry.
These banks are going to get hammered by rising mortgage defaults and rising credit card defaults. We are in the mother of all deleveragings.
Not only are at least half of modified loans failing even after modification. But Stanford University prof Robert Hall says 70% of subprime foreclosures aren't eligible for mortgage modification programs.
“Something like 70 percent of subprime foreclosures are beyond the reach of modification programs because the owners are investors, because the owner is in default for the second time on the property, or because the owner has disappeared,” Hall said.
People who never should have gotten credit in the first place do not magically become good borrowers. These redefault rates will get even worse as unemployment rises.
Consider the first quarter of 2008. After three months, 36 percent of borrowers with mortgages modified in this quarter had re-defaulted (with payments more than 30 days past due). At six months, this re-default rate had risen to 53 percent. And after eight months, it had reached 58 percent. The data is almost identical for mortgages modified in the second quarter of 2008. For those arguing that 60 days past due is a better predictor of ultimate default and foreclosure, the numbers are hardly better, with re-defaults in excess of 35 percent after six months.
Then there's the auto industry. Some see another acute credit crisis if the car companies go bankrupt.
The threat is so serious that "Credit Crisis Part II" looms if the government doesn't come to the aid of GM and Ford, said J.P. Morgan analyst Eric Selle, author of a research report that pro-bailout Democrats like Levin are citing.
While the threat of a GM bankruptcy gets lots of attention the equally real threat of a GMAC bankruptcy promises to slash the size of GM's dealer network.
“There’s so many dealers on the edge, if GMAC goes out of business 30 to 40 percent of dealers won’t be able to get financing from anywhere else,” Martin NeSmith, a liaison to the lender as a member of GM’s National Dealer Council, said in an interview yesterday. “They’ll go out of business.”
Some people (Jim Rogers included) warn that we may be headed into a lost decade ala Japan in the 1990s where the economy stagnated for a decade. I think this risk is real and made worse by attempts to prop up housing prices with low mortgage interest rates. At the end of a bubble trying to patch the holes in the bubble in order to reinflate it is equivalent to what the Japanese government did when it tried to keep unhealthy companies solvent. Prevent a needed correction and the causes of the downturn will persist and therefore economic growth will be stunted.