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BUSH TOUTS FAKE PROSPERITY
By Dave Chaddock
is no way to regulate them, and that any attempt to do
so is likely to make matters worse. Right, these new synthetic assets that
Countrywide has been selling worldwide have confused a lot of people, and have
thrown them off the scent. But as Adam Bryant points out, it is like a card
trick. Financial wizards have taken the joker- "the risk that certain
borrowers might default"- and have hidden it in the deck. Next
"they shuffled all those risky subprime mortgages into much bigger
investment pools, then cut the deck twice, fanned the cards and presto, it
disappeared."( NYT, 8-19 ) But really, the joker was still there. And
now a suspicion is arising that there is a malaise "deeper than anyone
realized: "The U.S. may have been paying for a lot of its imports in recent
years with mortgage securities of dubious value." ( NYT, 8-17 )
Though the trick may be a bit difficult to fathom, surely there are
people in the U.S. who have the smarts to do so. Some of them, in fact,
could and should have been hired by the government to do just that. Complexities
may magnify the problem, may tend to obscure it, but at its root, it is a real
instability, caused, not by financial intricacy, but by big business outlaws who
are not being controlled by the American people. As we near contract time,
we have to keep our minds clear and our powder ready!
It
was not so very long ago that President Bush was raving about the high rate of
home ownership in the U.S., and bragging about how the rapidly-increasing number
of home owners was proof that the American dream was being fulfilled on his
watch. But in reality, as the prices of houses soared far beyond the reach of
mainstream Americans, vast numbers of people were victimized by what savvy
insiders described as "neutron loans"- loans which eliminated the
people and left behind their houses. Why did this happen? Why were
lenders allowed to make so many loans that were doomed from the start to be
unrecoverable? The leading player in all of this, the Enron of the affair, is
Countrywide Financial Corporation. As Bush looked the other way, Countrywide
fought very hard in state after state to defeat responsible lending laws. 45% of
its loans were set to reprice at a higher level this fall, sending countless
houses onto the auction block. Until very recently, you could get a home
loan from Countrywide without putting down any money of your own. You could get
a loan worth more than 95% of the value of a house without having to document
any source of income whatsoever. Even if you had been 90 days late on a
mortgage payment twice in the last twelve months, even if you had filed for
bankruptcy or were facing foreclosure, Countrywide would make you a deal. In
the short run, these loans were
immensely profitable. As it quickly turned around and
sold these junk loans to investors, Countrywide generated profit margins of
1.84%, nearly twice as high as the 1.07% it made on prime loans. If
borrowers tried to reduce their debt, they would be slapped with three-year
prepayment penalties requiring them to pay six months worth of interest at a
rate 3% higher than the prevailing market rate. Such prepayment penalties
generated $268 million last year for Countrywide, up from $212 million in 2005.
Again, if borrowers had difficulty making payments, Countrywide made out like a
bandit. It made $285 million from late charges alone last year. No
wonder its sales representatives were given greater commissions when they
bamboozled people into getting these adjustable rate mortgages.( See NYT 8-26-07
)
Inevitably, this Ponzi-like scheme is running out of gas. Those who
purchased Countrywide mortgage securities are paying the piper. Washington
Mutual has taken a big loss. The Bank of America has had to eliminate 3,000
jobs. Citigroup has admitted so far to a loss of $5.9 billion. Merrill
Lynch has written off $7.9 billion, which is $3 billion more than it owned up to
just two weeks previous. Banks in Britain, Switzerland,
Australia and Japan are suffering from these tainted securities which had been
given AAA ratings by Moody's and Standard and Poors, only to be suddenly downgraded. And
this may
be
only the tip of the iceberg. One analyst estimates a $400 billion loss
altogether before we are through ( which is considerably more than the $240
billion lost in the Savings and Loan debacle) and another compares it to the
Panic of 1907.
Even Countrywide itself is now gasping for air as it reaches the higher
elevations of its pyramiding scheme. Though it made a profit of $665
million in the second quarter of this year, in the third quarter it suffered a
loss of $1.97 billion, and it recently borrowed $11.5 billion from 40 banks. Now
it is promising to extend its initial rate for 5 years for certain select
borrowers on a case by case basis. And it would also bring some of the
already-adjusted interest rates back to initial levels. The stone
wall they have run into is forcing them to compromise a bit, but the damage has
already been done. Even the $75 billion fund recently put forward by the
big banks, if it comes to fruition, is itself infected by the same virus it is
trying to fight. As one analyst describes it, it is not a rescue operation
but merely "hospice care" or ( using another analogy ) it would be
nothing but "a tow line to get them to the scrap yard." ( NYT, 11-1
)
Meantime the Ken Lay of this operation, Angelo R.
Mozilo, has not bought a share of his company's stock since 1987, and recently,
he has been a huge seller of this stock, with such sales conveniently timed to
occur while the company was still flying high. Since 1984 he has made $406
million selling Countrywide shares, with $129 million of that taking place in
the last twelve months. It is not exactly a case of "insider
trading" in that it was not done with privy information indicating a
specific onset of a major profit loss. It was part of a pre-planned stock sale
arrangement specifically designed to protect an executive from being accused of
trading on inside information. But on the other hand, only an idiot in his
position could not have foreseen, in general, that his policies were creating a
bubble that was bound to burst. If the exact moment of its occurrence could
not be predicted, if the particular straw that was going to break the camel's
back could not be singled out, still it was obvious that the thing was going to
tank. Moreover, the pace of his sales had begun to increase in October of
2006, and again in December, when he increased the amount of shares he intended
to sell each month to 465,000 from 350,000. Then on Feb 2nd he upped the
ante again, announcing he would start selling 580,000 shares a month, getting
rid of almost all his remaining shares just before
announcing the big third quarter loss. Mozilo's
declaration that his stock sales "should in no way be viewed as any
indication of my future outlook for Countrywide" ( NYT, 10-19 ) is just
about as convincing as Bush's periodic claims of progress in Iraq.
One final point. I must take issue with a statement
made in a book I just bought about finance. The book is called A DEMON OF
OUR OWN DESIGN, and it is written by the director of a hedge fund, Richard
Bookstaber. It is a very entertaining book, and I would grant his
contention that the "brave new world" of "synthetic financial
instruments created on the fly", their complexity, the speed with which
they operate, and their integration into a global marketplace, has certainly
caused a lot of confusion. Yes, he is right that "even minor events
can have catastrophic consequences." That the number of hedge funds
has increased from the 130 that existed in 1996 to the more than 9,000 present
today is certainly mind boggling.
That it takes some diligence even to understand these sliced and diced
artificial assets, these options and swaps and "swaptions", these
exotic off-the-books "conduits" with an alphabet-soup of acronyms like
CDO's , is not to be denied. But when Bookstaber argues that the real
economy we live in has actually grown more stable, and that "virtually all
mishaps over the past decades have had their roots in the complex structure of
the financial markets themselves", he parts company with me. He would
have it that hedge funds are so complicated that there
is no way to regulate them, and that any attempt to do
so is likely to make matters worse. Right, these new synthetic assets that
Countrywide has been selling worldwide have confused a lot of people, and have
thrown them off the scent. But as Adam Bryant points out, it is like a card
trick. Financial wizards have taken the joker- "the risk that certain
borrowers might default"- and have hidden it in the deck. Next
"they shuffled all those risky subprime mortgages into much bigger
investment pools, then cut the deck twice, fanned the cards and presto, it
disappeared."( NYT, 8-19 ) But really, the joker was still there. And
now a suspicion is arising that there is a malaise "deeper than anyone
realized: "The U.S. may have been paying for a lot of its imports in recent
years with mortgage securities of dubious value." ( NYT, 8-17 )
Though the trick may be a bit difficult to fathom, surely there are
people in the U.S. who have the smarts to do so. Some of them, in fact,
could and should have been hired by the government to do just that. Complexities
may magnify the problem, may tend to obscure it, but at its root, it is a real
instability, caused, not by financial intricacy, but by big business outlaws who
are not being controlled by the American people. As we near contract time,
we have to keep our minds clear and our powder ready!
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