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The Jehoshua Novels


Most Clueless Banker of the Year Award

Bank of America announced this morning that virtually all of its quarterly profit was wiped out by write-offs of Collateralized Debt Obligations and related mortgage securities. The bank set aside reserves for further losses in its consumer mortgage and credit card portfolio, in line with large increases in defaults and delayed payments in the fourth quarter of last year.

Several weeks ago the bank had alerted markets to the charge-offs, but the amount written down in the CDO portfolio of $5.28 billion was $2.0 billion more than anticipated. At that time, CEO and Chairman Kenneth Lewis said “There’s been a change in social attitudes toward default …. We’re seeing people who are current on their credit cards but are defaulting on their mortgages….I’m astonished that people would walk away from their homes.”

It’s even more astonishing that an executive of a U.S. bank would expect Americans to continue paying on their mortgages after the way the banking industry has treated borrowers. Let’s review the tape:

* Banks invent a product in the 1990s called the home equity line of credit. Consumers can now borrow money against the equity built up in their home. The home becomes “liquified” or “commoditized” – a veritable cash machine for consumers.

* Banks continue to sell first mortgages to Fannie Mae and Freddie Mac, or get guaranties from these agencies for the mortgages they keep on their books. When Congress suggests reining in these mortgage agencies, banks set their lobbying machine in motion and Congress backs off.

* To book even more mortgages, and escape the impediments that their own capital imposes on growth in their balance sheets, banks invent third-party conduits called Structured Investment Vehicles, which they don’t own but do control. These SIVs package the bank mortgages into securities and sell them into the market to investors around the globe.

* Bank mortgage lending takes off in the late 1990s. Mortgages and consumer loans exceed 50% of bank assets by the end of the decade, for the first time ever.

* The mortgage market, and home equity lines of credit kick into high gear in 2002 when the Fed engineers ultra-low interest rates of 1%.

* When Fannie and Freddie run into accounting difficulties with their mortgage hedges in 2002, the banks team up with Wall Street to replace these agencies with a securitization process that uses SIVs and Wall Street brokerages to peddle mortgage securities as fast as the banks can process them.

* Credit standards collapse after 2002 in the mortgage business since banks no longer own the mortgages they are booking. Consumers with no income, no job, no assets, no credit experience, and no business borrowing money are handed mortgages for half a million dollars or more.

* Home owners with equity in their home are encouraged to “cash it out”. No mention is ever made that the “cash” is only paper profit not earned by the consumer unless they sell their home and move into a smaller one. No mention is ever made of the total amount of new debt the consumer will be taking on. The only thing mentioned is the low monthly payment, made possible by historically low interest rates. Mortgage loan advertisements take over as the largest form of advertising on radio, daytime television, and the internet.

* Traditional loan to value ratios are abandoned; loans in excess of the property value become the norm. Loans are predicated solely on FICO scores, but “no score is too low” to qualify a borrower, according to many advertisements. Appraisers are put under pressure to “meet the number” necessary to give loans to the increasing list of deadbeats who quality for jumbo mortgages. Massive amounts of fraud creep into the process, but the banks don’t care to look because they don’t own the loans.

* Banks successfully petition Congress to change the bankruptcy laws to make it much more difficult for consumers to keep their homes in bankruptcy.

* By 2005, housing values are increasing at double digit annual rates in most parts of the country, and two standard deviations beyond the historic growth rate. Warnings are issued regarding a bubble in housing, but banks deny or ignore them. Consumers have no problem taking out five or six consecutive refinancings, and withdrawing all equity built up in the frenzied market appreciation. Mortgages for second homes are easy to get, as are mortgages for investment purposes. In some states nearly 50% of all new mortgages are for borrowers who will not live in the homes, but banks turn a blind eye to this phenomenon.

* Like the real estate industry in general, banks believe and tell their customers that home values never go down. Their internal models are predicated on this assumption. Everything communicated to the consumer tells them that their home is a piggy bank of ever-increasing value. Withdrawing cash from the piggy bank is made as easy as possible. Consumers are given loans allowing them not to pay any interest at all and build up a balloon balance, which will assuredly be taken care of down the road by market appreciation. These option characteristics allow the banks to charge even higher points up front and stick penalty clauses into mortgages forbidding the homeowner from paying off the loan until the bank receives all fees due them.

——
Given this chronicle, why should Mr. Lewis be “astonished” that people who can pay their mortgage refuse to do so when the home value is less than the mortgage? This behavior is nothing more than the same behavior during the bubble, only in reverse. During the bubble consumers were encouraged not to pay down their mortgage. They were sold products specifically for this purpose. The bank loans officers were marketing mortgages on the premise that future appreciation in the home would pay off the debt – the consumer could refinance in two or three years.

It worked for awhile, but now it doesn’t. Now home values are declining and millions of homeowners are underwater. If they weren’t expected to pay down their mortgage when values were appreciating, why should they suddenly be expected to do so now that values are going down? Their home is a commodity and can be walked away from like any bad investment. The underwater mortgage is the bank problem; there are other homes of similar size now much cheaper to buy anyway, or rent is an option as long as the consumer has a job.

Mr. Lewis’s obtuseness is the only astonishing thing here. He trained his customers to behave this way and he should at least have the sense not to imply that there is some moral failing when consumers walk away from their mortgages. A moral failing has occurred, to be sure, but it was ten or so years ago, in the executive suites of banks all around the country.

30 comments to Most Clueless Banker of the Year Award

  • jbaspen

    Numerian – You’ve done an excellent job connecting the dots. What if the pessimists (e.g. Tanta at Calculated Risk) are correct in their estimates that 10-20 million American Homeowners will be “underwater” in the next few years? Will they persevere and hold on, or, will they mimic our corrupt elites and mail in (i.e., “jingle mail”) the keys?

    I’d love to hear your opinion Numerian (and Ian & Sean Paul).

  • Mr. Flibble

    And even more hysterical is that the harsher bankruptsy law gives homeborrowers added incentive to just leave the keys in the door and walk, thus totally screwing the bank.

  • Scotjen61

    Why should a borrower behave any differently than the lender? In a ‘rational’ market why should a borrower pay back a mortgage that is greater than the asset that backs the mortgage. That it is a bank and not an individual getting screwed should make no difference in a rational market that is simply seeking balance with no ethical underpinning.

    You invest and lose money every day in stocks, in pension funds, in 401ks. Corporations routinely write off pensions from their books when they file bankruptcy, or underpay into the funds based upon false projections of performance. Companies routinely lay off the oldest workers to avoid the health insurance liability of these workers, they routinely write off any number of obligations based upon changes in their internal policy, changing healthcare benefits, etc. Insurance companies routinely cancel an insurance policy with no stated reason, routinely deny care when it is needed by refusing to pay.

    Someone needs to explain to me why a homeowner owes any ethical consideration to a bank, or hedge fund, or company? I would walk in a minute and, hell, I’d take the copper pipes with me.

  • Temujin

    Thanks for the clear and concise rundown of the history of this great debacle. It is always refreshing to read an article that cuts to the chase and casts off the rose-colored lenses.

    Apocalypse Khan

  • Mr. Flibble

    Why not live rent-free for six months or however long it takes the sheriff to actually come by to tell you to leave.

    Then you can take the pipes and fixtures.

  • Ian Welsh

    work Numerian, I’ve pushed it out to various folks.

  • tjfxh

    What goes around, comes around.

  • tjfxh

    The financial crisis took another giant leap this past week. Credit insurer (“financial guarantor”) Ambac lost its AAA rating (from Fitch), in what will mark the onset of a devastating run of downgrades for the likes of Ambac, MBIA and the entire industry.

    The “monoline” insurance business, as we’ve known it, is done and the value of the insurance they’re written is evaporating by the day. The market is now desperate to determine which financial institutions (and there are many) have purchased large amounts of (now suspect) insurance for hedging purposes, as well as other financial companies that have in one way or another participated in the credit reinsurance market.

    Virtually all the major financial players are embroiled in this systemic credit fiasco. Importantly, the mind-blowing demise of the financial guarantors is fomenting a crisis of confidence in credit insurance in all its various forms (certainly including the credit default swap – CDS- and mortgage-backed securities – MBS- guarantee markets). According to Bloomberg news, $2.4 trillion of securities are at risk to the financial guarantor industry downgrades.

    I’m assuming that our policymakers will attempt to throw together some type of industry recapitalization strategy, although the complexity of the issue leaves one perplexed as to how any bailout plan would be structured. I suspect that our federal government will eventually be forced to enter the financial guarantee business, at least to the point of assuming the obligations of municipal bond (from the monolines) and mortgage-backed security (from the government-sponsored enterprises such as mortgage lenders Fannie Mae and Freddie Mac) insurance.

    The credit system is today an incredible mess. Literally trillions of securities, previously valued in the marketplace based upon confidence in the underlying financial guarantees, are now suspect. This has severely impacted marketplace liquidity. And perhaps tens of trillions of credit and other derivative contracts are now subject to very serious counterparty issues. Many players throughout the credit market are now severely impaired and have lost the capacity to hedge against/mitigate further losses.

    To be sure, discontinuous and illiquid markets have wreaked bloody havoc on “dynamic” trading strategies used commonly to hedge various risks. I don’t believe it is hyperbole to suggest that dynamic hedging (in particular shorting credit instruments to provide the necessary cashflows to pay on Credit derivative contracts written) became the critical linchpin of contemporary Wall Street risk intermediation. Yet today the models behind so many strategies that have come to permeate “contemporary finance” have completely broken down; the strategies of thousands of financial institutions – big and small – have turned infeasible.

    Doug Noland — more

  • LJ

    here goes. I have owned several homes and always thought that I signed a contract to pay off the home. So there is no penalty for giving the keys back to the bank?

  • yogi-one

    Before you elect me President, at least let me explain how I would deal with this crises:

    1. Close the banks
    2. All billionaires can take their assets back from the banks and secure them in privately owned institutions.
    3. All people worth 100 million or more can take whatever is left for themselves.
    4. The rich and super rich secure themselves in heavily fortified, nuclear-protected “Geen Zones” throughout the nation. They live, work, eat, and sleep totally separated from the now starving masses that was once the American Middle Class. They fly across the polluted poverty zones back and forth to their enclaves.
    5. A huge gulag system is et up to detain, torture, and execute (publicly) rebels, protesters, or insurgents against the super-wealthy.
    6. Some of the starving masses gain access to the enclaves as carefully monitored “guest workers” who have no civil rights, strict wage ceilings, and cannot socialize or associate at all with the wealthy. The most lucky among them become domestic servants, meaning they are quartered in the Green Zones permanently.
    7. The masses are allowed televisions on which only FOX,NBC,ABC,CBS,and CNN are allowed to broadcast. The programming constantly tells them how free and great they are as Americans, and how well the country is doing in all ways. They also get to watch sports and be distracted by glamorous movie and music stars.

    “I have a dream….” and YOU are not part of it….

    OK now you can vote for me.

  • Synoia

    No the loans are non-recourse.

  • Numerian

    Depending on the state, just walking away from a home could be construed as fraud if it can be established the consumer could have continued to pay down the mortgage. Especially if they trash the home before leaving. The tax laws work against the consumer as well, in that they are still penalized for the difference between the mortgage and the home sale price (I’m not a tax expert here but I have read that the difference is somehow treated as income for the consumer). Right now banks chase after bankrupt people six months after the fact and offer them credit cards, but we can expect this will stop soon now that consumer defaults are spreading beyond the mortgage business.

    This is why a lot of homeowners are exploring some accommodation with their bank, such as a short sale. But even this is difficult, because banks don’t usually own the mortgage, and the mortgage servicer (who doesn’t technically own it either) is often hard to reach or work with. In well-publicized cases, Countrywide has been known to mysteriously add fees and miscalculate the debt owed when they turn up in foreclosure court, and the consumer has no way to fight back. On the other hand, some courts are fed up with this process and penalizing the banks, or demanding physical proof of title to the home before granting foreclosure rights to the bank. It’s a right royal mess with all the securitization that has gone on.

    Mr. Lewis seems to be lamenting the disappearance of the ethic that “I signed a contract and I must abide by my word come hell or high water.” Consumers are now trying to wiggle out of their underwater mortgages as quickly and with as little financial cost as possible. That is what shocks him.

  • Numerian

    This would be a true disaster for the financial system if somehow the ethic spreads that you should just walk away from your underwater mortgage. This is why Mr. Lewis is shocked at the lack of commitment people have to their contracts. But as others point out below, this has always been a one-way street – okay for business to do but not for consumers. Donald Trump has routinely stiffed the bondholders for his casino debt, and walking away from and renegotiating your contract when it suits you is common not only in real estate, but now in the private equity business. It’s an American way of doing business.

    Consumers watch all this go on and they inherently know the banks encouraged them not to pay down the mortgage anyway. So guess what? Millions and millions of Americans are going to walk away from their underwater mortgages. It’s going to cost banks dearly. It may even bankrupt a few of them. Oh, what a wicked, wicked world we live in when debtors no longer have the ethical decency to pay down their debt no matter what happens (I’m being snarky with this comment).

  • Numerian

    No wonder banks are distressed and the Fed is panicking.

  • Numerian

    Ten years ahead of his time. No one paid any attention to him for the longest time, even though he Capitalized Every Noun just to get someone’s attention. He certainly deserves some award for his prescience.

  • Numerian

    A nirvana of dictatorship, where he gets to be dictator.

  • creativelcro

    I’m curious…

  • creativelcro

    the usurious interest associated with some credit cards? I mean, what if millions of people start doing that?

  • VizierVic

    “…It’s going to cost banks dearly. It may even bankrupt a few of them. Oh, what a wicked, wicked world we live in when debtors no longer have the ethical decency to pay down their debt no matter what happens…”

    Ethical decency is not involved. The person paying on the mortgage has sworn to either pay the mortgage or surrender the property. The banks have bet that the property dweller would be emotionally attached to the property and be willing to suffer financial loss as a result. Once the debtors have become savvy enough to understand the economics involved in the exchange, the banks get screwed, deservedly so.

    Incidentally, this situation is not terribly new. I knew several colleagues who worked in Texas back during the great late 1970s/early 1980s oil boom when real estate there and especially in Houston just saw its prices blow-out like a gusher. When massive layoffs occurred in the “awl patch” because of the crash starting in 1982, lots of honest, hard-working Texans just went the “jingle mail” route when housing prices collapsed along with the “awl bidness.” It can happen here.

  • VizierVic

    Welcome to the Republic of Gilead!

  • geoduck

    That’s Cheney’s wet dream. Bush just wants to wear a uniform and be told he’s a great leader. A well-stocked theatrical troup could keep him happy for life…

  • Eric Gen

    I bought my house in Central Texas in 1989. It was a HUD house. The Sunday classifieds always had 4-6 full pages from HUD listing the repossessions. I bought it for about half of what it was selling for in 1979 when I was trying to get into this neighborhood, but couldn’t afford it.

    I had $10K to put down in ’79 and people just laughed at me. I put $1K down in ’89.

    If you have enough cash (with some reasonable way to protect it), and are looking for a house right now, I’d rent and wait for the bust to start to bottom. There’ll likely be some real bargains if you have the patience, and the financial ability, to wait.

  • Mr. Flibble

    How organized your mortgage company is and how busy the sheriff is whenever the mortgage company finally gets around to checking whether the property has actually been vacated. A single mortgage among millions (and thousands of foreclosures) is not going to be a priority.

  • Jonathryn

    Is that although they have the legal means to go after debtors (whether the debt originates in mortgages, home equity loans, personal lines of credit, or credit cards), especially with the 2005 bankruptcy bill, if enough people default at the same time, the banks will be left holding the bag. If people are willing to walk away from their mortgages because they got ill, lost a job, or got burned playing the stock market, the next shoe to drop will be that they just stop paying their credit card bills. If they’ve missed a payment or two, they’ll also be saving themselves the usurious 30% interest. If unemployment goes from 4.7% to 5%, then 5.3% there will be just too many people for the banks to chase down, and if you draw those massive defaults over two or three quarters, the banks will either have to fudge their quarterly reports (whether or not today’s SEC would call that fraud), or take the hit and get crucified on the stock market more than they already have. It would be difficult to roll those losses into the level-3 writeoffs they’re already trying to bleed out bit by bit. I can’t see a scenario where a slowing economy/rising unemployment/falling stock market/rise in defaults and bankruptcies/real estate bubble deflation phenomenon doesn’t create a feedback loop that aggravates and magnifies each symptom in turn. A cut in interest rates? That doesn’t matter–if you’ve lost your job and probably won’t help get your job back for six months. It doesn’t matter–if your credit card company cites universal default and charges 30% interest regardless of prevailing interest rates. And it still hasn’t convinced the banks to take risks and make more loans to businesses and individuals.

  • zot23

    Namely that to evict someone or to get a title to a house you need to prove ownership. As well as if you say in court that someone owes you a mortgage payment, you must be able to prove you own that contract.

    With all the slicing and dicing done in CDOs, who really can prove ownership of many of these loans? Think of it this way: if I write my name on a banana and then puree it in a blender with 20 other bananas, how can I prove that mine was in there? Or how much of the mix belongs to my original named banana?

    The banks would have one hell of a time even proving these people owe them money, much less forcing them to pay it. This is what they are scared s*tless of IMHO, they’ve gotten so clever with their repackaged loans and spreading risk that they can’t even prove they own them anymore.

    Get ready for a bumpy ride. Maybe I should open an account with my loacal Bank of Mattress? There will be bank runs by 2009.

  • sillydog

    How your home became a brand item, aka “a banking crisis in the making – banker pleads ignorance.” He is forgetting that men like this can be ignorant. There are people who are the face, that’s how shit works at higher levels. Rest assured, people have seen this coming, but people who make such decisions don’t always accurately predict what people will do — it’s part of the contempt.

    Believe me, if people in media can get jobs helping to create Hollywood-style pitches for the Pentagon hardware, it can work the other way around, too. People can fail upwards for no other reason than looking good or throwing the right parties. The problem, I suspect as it’s always been, is where banking and industry collide with government. That includes business now, too, because the styles became one and the same with influx of young bukcs into the practice during the 1980s. This created the banking monsters seen then and today; v2.0, you will.

    Sub-prime crisis happens when you apply “free market fundamentalism” to money — loosening up the rules, as they did. They took sknanky business practices to the masses in the form of their money, and yes, as they say, people are now treating their homes as a bad investment. As they fucking should. They’re the ones that sold the masses on the idea that they were just like the wealthy in their ability to work the system. It has, of course, never been set up that way.

    That can’t be good for neighbourhoods or the American psyche. People need gardens and trees of their very own, but I digress.

    Now, the good (or bad, depending on ho it plays out) news is that money is sort of a game anyhow. We all decide it’s worth stuff and fourtunes are won and lost every day by people who invent rules. It’s rather like inventing the rules for how to be a vampire or some other ficticious vehicle for storytelling. Anyhow, incremental changes are usually allowed, but the natives get restless if you do too much at once — some kids start calling, “unfair,” and then everything is called into question.

    Whee! Apparently the US has put its faith in Bernake – are you feeling lucky? What’s the right thing to do? Cut rates? Raise rates? Radically alter the way business is done, once again, to respect the lives of human beings as the prime goal of any sane species? Civilizations have a tendency to act like addicts, so one has to wonder what would have to happen to let such a radical shift to take place. I’m quite sure I wouldn’t like the answer, in fact.

    Could a man running a bank be so clueless? In the business or entertainment world, yes. Though you’d think anyone in an entry-level economics class might put those points together — or is that only the domain of the conspiratorialy-minded? That’s the problem with the seemingly endless possiblilities that are created when dealing with people who are loyal only to themselves and apparently capable of doing anything to get ahead. The problem becomes to complex to solve for normal people on the conscious level. What that leaves, I don’t know, perhaps Charles Fort collected something useful in his travels.

    Thing is, one is pelted by so many outrageous lies on a daily basis from people such as this fellow from banking or someone at a White House Press Conference(tm). It’s hard to know what to be outraged at next. This article is a very good start and true as I know it.

    -sillydog

    sillydogmeida.com

  • tjfxh

    There are companies now forming that offer to represent the aggrieved for an upfront fee (of about $K). Some “mortgage holders” are going to get stiffed on this when they can’t come up with the paperwork in court.

  • Tonsure Wimple

    Lots of sold & resold mortgages have unclear title. One report was that one out of 10 who contested a foreclosure won because the mortgage holder could not prove title.

    I recently did bank software and I can see why. Packaging big loans brings big bonuses. Executing these deals does not. Spending on IT does not. I can see exactly how the paperwork fell in the cracks.

    The financial system runs on software that is appallingly scragged.

    Forget it, Jake – it’s AmnesiaTown

  • Raja

    Merriam-Webster:

    scragged
    scrag[2,transitive verb]

    Date: 1752

    1 a: to execute by hanging or garroting b: to wring the neck of
    2 a: choke b: manhandle 1 c: kill, murder

    The Free Dictionary

    Scrag´ged
    1. Rough with irregular points, or a broken surface; scraggy; as, a scragged backbone.
    2. Lean and rough; scraggy.

    Urban Dictionary Definition: Scragged.


    “Vanity, Vanity, all is Vanity.”

  • LJ

    can be bailed out as currently being prayer for planned? The stakes are pretty high.

    One way in which underwriters entice investors to buy lower rated bonds is by having them ‘wrapped’ by financial insurers like Ambac and MBIA. Insurers take on the first chunk of potential losses a bond may take, effectively increasing its credit rating. Underwriters pay the insurer a fee to protect the risky bonds, but this credit enhancement allows them to more easily market and sell the riskiest pieces of a security to investors.

    Underwriters can no longer wrap low-rated securities because investors no longer trust the insurers whose protection boost the credit ratings, nor do they trust the ratings themselves. While much of the dislocation in the mortgage securities market is due to concerns over increased delinquencies and falling home prices, some of the fundamental dynamics in the market for securitizing assets of all kinds no longer function.

    In the coming months, it is likely that we will find out more about how the arcane market for structured debt works, as a $500 trillion market for financial derivatives may in fact be “too big to fail.”

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