Sunday March 22, 2009, Dateline NBCaired a piece called “Inside the Financial Fiasco,” in which Chris Hanson finally takes a break from exposing sexual predators to take a closer look at the current housing mess.
NBC attempts to assign blame for the mortgage meltdown, and also tries to make it seem like they have finally identified the handful people who were the “only ones who knew” what lay in store for the economy when Wall Street embarked on the derivatives end-run that fueled the crisis.
So let’s go down the list of people that are prime candidates in the vicious circle of blame, and what their role where in the making of this fiasco.
Let’s start at the top. Back in the mid ‘90’s, The Government loosened credit guidelines and required lenders to make mortgages available to more to minority buyers.
By doing this, they gave the lenders an open check book to write questionable loans, all the while knowing that they would be able to sell them on the secondary market (Wall Street).
This was the creation of the infamous “Subprime” loans which later morphed into Alt-A and Expanded Approval loans.
Next, let’s look at the Product Managers who wrote the underwriting guidelines for the toxic loans known as SISA’s and NINA’s, which required little or no documentation of income and assets. The SISA loans are highlighted in the Dateline piece.
Do you think that these product managers had no idea that these types of loans may be misused, or did they only see the underlying profit that was possible from billions of dollars of loan fees collected by creating millions of loans that were virtually just ticking time bombs?
Yes, there are some cases where these loans were appropriate, such as for the business owner who had a lot of write offs, or the borrower whose spouse may not have the best of credit, but will nonetheless contribute towards the monthly mortgage payments.
But the types of borrowers who where actually put into these loans were completely unqualified, as mentioned in the NBC piece.
People like Delores Parker Jackson, who took out multiple loans on four condos totaling over $1.3 million with a negative (-$6000) shown on her tax returns.
Mrs. Jackson, who claims to have run a profitable daycare, and says that she is not to blame, but is actually the victim of predatory lending.
REALLY? She took out multiple mortgages on four different properties totaling over a million dollars with a payment of more than $10k a month, and she claims she had no idea that she could not afford the terms. Now she wants to pretend that she is not culpable, and that the mortgage company committed fraud?
Come on, do seem we that stupid?
Thirdly, let’s look at another “innocent” party: The CEO’s of all the banks and mortgage companies.
These people should have overseen the product managers and acted as the final line of defense by looking out for the company’s long term interests by saying “Hey, stop! These loans may be too risky.”
But the CEO’s saw only a “pot of gold” in the form of billions in loan fees, and where slaves to the corporate bottom line.
Do you think that Angelo Mozilo, the former CEO of Countrywide who earned over $400 million during his last five years at the company, had absolutely no idea that SISA and NINA loans with zero money down would backfire?
Chris Hansen attempts to talk to Mr. Mozilo, but to no avail.
Since he quit Countrywide and the mortgage mess started to blow up, Mozilo has been hiding out at his palatial estate in Southern California, ala Howard Hughes. Chris tried to get the guard at Mr. Mozilo’s gate outside his house to let him in, but was turned away.
Also to blame are the former CEO’s at places like Bear Stern’s and Lehman Brothers, who ended up driving their companies into the ground by buying up these toxic securities. And none of these guys saw the writing on the wall?
I think they did, but also saw big dollar signs in the racket, and choose to ignore the hazards.
Next up for their heaping of blame are The Borrowers. I was an LO for 15 yrs, and used Countrywide as a purchaser for many of my loans.
I knew that some of my borrowers were “less than qualified,” but the underwriting said to “make the loan.”
Like when I would be working for a builder, and a borrower would come to me and asked what loan amount they qualified for, my reply often was, “How much can you afford?”
I told them that I could tell them all day how much they can and cannot get approved for, but only they could tell me how much they really afford.
I could tell them on paper or with calculator that you could qualify to pay, but only the borrower could tell me if they could actually maintain that payment.
I cannot tell you how many times I was told by borrowers, “Don’t worry about me affording it. You just write that mortgage.”
This is where I move on to include the next culprit in this mess, The Loan Officers.
How many LO’s wrote loans for people that they knew would end up in foreclosure?
Many borrowers who I turned down for a mortgage would come back to me later to say, “See, I knew I could get approved. Thanks for nothing.”
At the height of the bubble, there were so countless mortgage brokers who were willing to do anything to write a loan and collect a fee.
They would falsify the numbers to make them work if they had to.
In the Dateline piece, they showcase a woman who was employed as a personal trainer, and who claimed to of told the LO at People’s Choice that she only made $1600/mo.
She was approved for a $259k loan.
Even after she was told that the payment would be over $2100/mo, she figured that she would just have her sister move in and help with the payment.
Do you think that the LO at People’s Choice had any idea that she may NOT be able to make the payment on this house? When Chris Hansen looked at the original paperwork, it stated that she made $7300/mo, which surprised the woman.
She claims she never provided that figure to the LO.
How many LO’s committed fraud because the commissions that they were going to make on each loan they closed could be well into the tens-of-thousands of dollars?
Even though my job was commissioned based, I only made loans if I had some degree of certainty that the borrower had both the ability to pay the mortgage payment and that they completely understood why I was giving them a SISA or NINA loan product.
I did not want a former borrower hunting me down in the parking lot some night after work because I put them in a loan that that left them flat broke.
Next in line is a major player, one who no one seems to put much blame on or even mention much, The Appraiser’s. I believe these guys had a huge impact on the housing explosion, and no one seems to want to bring them up.
As the appraisers continued to inflate the values of the properties, the mortgage companies continued to write mortgages to cover the obscene appraisals.
I knew that if a borrower told me that they were short on funds to close, I could call the appraiser and ask him to “bump up” the value of the property a bit, so that I could give the borrower the money cover closing costs.
This was considered a legitimate practice because real estate only increases in value, remember? But in reality, the value of that house did not go up $5k in the 2-3 weeks since they had done the actual appraisal.
I also found out the hard way how much of an “opinion” an appraisal really was.
Prior to working for the builder, I worked for a short time as a mortgage broker. I only did one loan at the place. , and it was for a gentleman who was doing some renovations on his house, but did not have enough money to finish the project.
Less than a year earlier, the value of the house came in at $85k. When he wanted to do another cash-out refinance a year later, but the new appraisal came in again at $85k. So when I went to my boss and told him that I did not have the value to support the loan, he handed me a business card and said, “Call him.”
Two weeks later, I had an appraisal for $115k, enough to cover the loan.
Was there that much movement in the values of the house? Did it really go up $20k in three weeks, or did the new appraiser just want more business?
What do you think? I know when I worked for one of the big mortgage companies and did a ton of refi’s, every time I had to put an initial value of a home on an application (which typically came from the borrower) nine times out of ten, the appraisal came back with the exact same value.
Curious.
Another big part of the mess, the people who were supposed to catch any fraud or mistakes, were The Underwriters.
They were the final check points in the mortgage process, and when they were presented with a SISA loan that showed that a “house cleaner” made $12k/mo, they should have sounded the alarm.
Like the appraisers, the underwriters are merely mentioned in the piece on Dateline.
Ilene Lanacano, who worked for “People’s Choice,” says that when she brought up some of these problems with the questionable loans, she was often overruled by the CEO of the company.
She states that she was often offered “incentives” by loan officers (money, jewelry, even a car) to approve loans. Ilene says that she never took any of these incentives.
She also claimed that there was harassment and intimidation if you did not approve loans, such as flattened tires and physical threats.
Ilene finally left “People’s Choice” for a consulting firm whose business was to analyze the loans to be pooled in Mortgage Backed Securities (MBS’s). When she raised some flags, she ended up getting in trouble by management.
Next, let’s look to good old Wall Street. You would think that one of the supposed guru’s of Wall Street could have seen the possibility that at least some of these loans were destine fail. But they too, only saw the bottom line, and they sold these MBS to everyone: investors, pension funds, municipalities and other countries.
And then there is China, who bought up trillions of dollars in MBS in an attempt to control the US. By owning all these MBS, China has a huge stake in our mortgage meltdown.
They were only briefly mentioned in the “Dateline” piece, and no real repsonsibility was levied on them. If China had not been so greedy, there wouldn’t have such a demand for MBS, which would have cut down the toxic loans being written.
And the Chinese are smart, shouldn’t they have seen some of the signs?
Next ones to heap some blame on are the Bond Rating Agencies, such as Standard and Poors, who was also briefly mentioned in NBC’s piece.
As Dateline explained, they were hired to give credit ratings to these MBS, which are supposed to indicate their level of risk to investors. “AAA” was the highest rating that they could give a security, and 80% of MBS received that top stamp of approval.
They suggested that most MBS would perform well, despite the fact that the agencies did not have any historical data to back the ratings up. Richard Gufliota of S&P, stated that they were so over inundated with securities to rate that most were not examined to the extent that they should have been.
It should also be mentioned that they made their money in volume too. More quantity over quality.
Finally, a lesser acknowledged culprit of this financial fiasco is The Media itself.
If it wasn’t for the greed of the media (TV, Radio and Newsprint), rolling out with advertisement after advertisement for these mortgage companies and their products, borrowers would not have been so encouraged to accept some of these toxic loan.
In years leading up to this mess, there wasn’t a commercial break that did not produce a mortgage ad.
Often advertised were the No Closing Cost, Stated Income, No Income Verified, and so forth.
There wasn’t a Radio host in the nation who didn’t have at least one mortgage company in their back pocket paying them to be their spokesperson.
Did any of them look into the products that they were pitching to their listeners? Nope. I think they just laughed all the way to the bank.
And what is strange about the media’s role, is that I have yet to see anyone try to add them into the equation. Now, all you hear out of radio talk show hosts spewed crap about how everyone else is to blame. None have come forward to say, “Hey, I guess I had a hand in it too.”
All in all, it is going to be a vicious circle of blame.
There is plenty of blame to go around, and I think when it comes down to it, we can sum it all up with one little word: “GREED;” the Greed of the Government, the greed of the Product Managers, the greed of the CEO’s, the greed of the borrowers, the greed of the Loan officers, the greed of the Appraisers, the greed of the Underwriters, the greed of Wall Street, the greed of China, the greed of the Bond Raters, and greed of the media.
The plaint that credit default swap-promulgating AIG (AIG) is contractually obligated to pay out millions in bonuses to the same pitted brass that led the company, the industry, and the entire economy off a cliff is a bunch of horse hooey.
If you are on the management team of a company that lays off workers, can’t pay its bills, leaves shareholders holding nothing, and has to take public bailouts, it’s your damn job to make a deal to restructure that company, or wind it down responsibly.
Your bonus is getting to keep porking up to the paycheck trough while other workers are losing salary, severance, and health care.
New York Times: The payments to A.I.G.’s financial products unit are in addition to $121 million in previously scheduled bonuses for the company’s senior executives and 6,400 employees across the sprawling corporation. Mr. Geithner last week pressured A.I.G. to cut the $9.6 million going to the top 50 executives in half and tie the rest to performance.
The payment of so much money at a company at the heart of the financial collapse that sent the broader economy into a tailspin almost certainly will fuel a popular backlash against the government’s efforts to prop up Wall Street. Past bonuses already have prompted President Obama and Congress to impose tough rules on corporate executive compensation at firms bailed out with taxpayer money.
A.I.G., nearly 80 percent of which is now owned by the government, defended its bonuses, arguing that they were promised last year before the crisis and cannot be legally canceled. In a letter to Mr. Geithner, Edward M. Liddy, the government-appointed chairman of A.I.G., said at least some bonuses were needed to keep the most skilled executives.
I sure would like to see those AIG contracts – I’ll bet I can poke a hole in the specious supposition that the company really, really wants to do the right thing, but its little hands are tied. Since the public bailout of AIG, we all have an ownership interest in where the money is going, and are entitled to ask probing questions.
New York Times: “We cannot attract and retain the best and the brightest talent to lead and staff the A.I.G. businesses — which are now being operated principally on behalf of American taxpayers — if employees believe their compensation is subject to continued and arbitrary adjustment by the U.S. Treasury,” he wrote Mr. Geithner on Saturday.
Still, Mr. Liddy seemed stung by his talk with Mr. Geithner, calling their conversation last Wednesday “a difficult one for me,” and noting that he receives no bonus himself.
“Needless to say, in the current circumstances,” Mr. Liddy wrote, “I do not like these arrangements and find it distasteful and difficult to recommend to you that we must proceed with them.”
I know contracts inside and out, at the real-world, down and dirty level, not the black-box, ivory tower, theoretical stratum that gets adjusted as the tectonic plates of business deals crash into each other.
Although I have chosen not to practice law anymore, I am really good at understanding the terms of these agreements, and evaluating when it would appropriate to reward corporate players for their performance.
And, when it is not.
New York Times: Of all the financial institutions that have been propped up by taxpayer dollars, none has received more money than AIG, and none has infuriated lawmakers (and Ben Bernanke per 60 Minutes) more, with practices that policy makers have called “reckless”
The bonuses will be paid to executives at A.I.G.’s financial products division, the unit that wrote trillions of dollars’ worth of credit-default swaps that protected investors from defaults on bonds which were backed in many cases by subprime mortgages.
The bonus plan covers 400 employees, and the bonuses range from as little as $1,000 to as much as $6.5 million. Seven executives at the financial products unit were entitled to receive more than $3 million in bonuses.
Any attorney who advises that these bonuses are appropriate ought to have his or her head checked.
Base salary, maybe, if not outrageous. No bonus. No severance unless everybody else also received proportionate assistance. Don’t care what the contract says – attack it in bankruptcy or wind down – I saw it many times in the Silicon Valley meltdown.
But the official also said the administration will force A.I.G. to eventually repay the cost of the bonuses to the taxpayers as part of the agreement with the firm, which is being restructured.
AIG’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall. AIG had set up a special bonus pool for the financial products unit early in 2008, before the company’s near collapse, and when problems stemming from the mortgage crisis were just becoming clear.
There were concerns that some of the best-informed derivatives specialists might leave.the company. AIG then locked in $450 million for the financial products unit, and prepared to pay it in a series of installments to encourage people to stay.
This poignant issue is near and dear to me, as I have shut down management bonuses before, even when I would have received some of that money, and even when I really needed it.
I also have been lucky enough to work with one of the premier corporate governance experts in the country and with a bankruptcy and wind down expert whom I hope will end up on the federal bench.
In the past, I have known both of these gentlemen to express support for my assertion that it is appalling for a destitute company to pay out management and deal bonuses to the team that took the company under.
New York Times: A.I.G.’s main business is insurance, but the financial products unit sold hundreds of billions of dollars’ worth of derivatives, the notorious credit-default swaps that nearly toppled the entire company last fall.
Under a deal reached last week, A.I.G. agreed that the top 50 executives would get half of the $9.6 million they were supposed to get by March 15. The second half of their bonuses would be paid out in two installments in July and in September. To get those payments, Treasury officials said, A.I.G. would have to show that it had made progress toward its goal of selling off business units and repaying the government.
Nice. You just keep holding that moral compass you got there, guys.
Laura is a business consultant and an advocate for information security, consumer protection, long-term shareholder value, and better management decisions. Her specialty is finding and fixing risks and threats to sensitive data. Her experience includes international banking, credit card, and mortgage companies, venture capital portfolio companies, and software and technology providers. She practiced law in Silicon Valley during the tech boom and meltdown, handling corporate governance and information protection.
The Author gives permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author and to Information-Security-Resources.com
By Anthony M. Freed, Information-Security-Resources.com Financial Editor
Heartland Payment Systems (HPY), one of the largest credit card processors in North America, is finally being called to the carpet for the apparent lapses in Payment Card Industry Data Security Standards (PCI DSS) that contributed to the largest data breach of 2008, perhaps even the largest breach ever considering the full extent of the exposure has yet to be determined.
Called to the carpet sort of, anyway; the sanctions and guidance laid out by Visa (V) seem a little lackluster when weighed against the severity and duration of the breach.
Given that Visa is now considered the most likely of several candidates for inclusion in the Dow Industrial Average, taking up slack from soon to be sidelined Citigroup (C) and Bank of America, (BAC) it is not surprising that they do not want to call too much attention to the situation:
On January 20th of this year, Heartland Payment Systems (HPS) publicly disclosed a large-scale compromise involving account data from all card brands. In light of this event, Visa has taken the following actions to help protect the Visa system:
CAMS Alerts – Between January 18th and February 4th Visa issued a series of Compromised Account Management System (CAMS) alerts (US-2009-046-IC) to financial institutions related to this compromise event. Providing this information can help financial institutions act quickly to minimize fraud on exposed card accounts.
It is worth noting here that Visa and MasterCard (MC) reported anomalies to Heartland in late October, about two and a half months before the CAMS alert was issued.
Data breaches in the financial industry always reignite the debate between those who want full and immediate disclosure, and those who would prefer to subdue the news.
A lot seems to depend on your preferred usage of words like “quick” and “help”.
As for the sanctions Visa has prescribed for Heartland, I believe it’s something akin to when Dean Wormer put the Delta House on Double Secret Probation, or at least that’s how it reads:
Removal from Visa’s List of Compliant Service Providers – Visa has removed Heartland from its online list of Payment Card Industry Data Security Standard (PCI DSS) compliant service providers. HPS has advised, however, that it is aggressively working on remediation and re-validation of its systems to comply with PCI DSS standards. The company will be relisted once it revalidates its PCI DSS compliance using a Qualified Security Assessor and meets other related compliance conditions.
System Participation – HPS is now in a probationary period, during which it is subject to a number of risk conditions including more stringent security assessments, monitoring and reporting. Subject to these conditions, Heartland will continue to serve as a processor in the Visa system.
So Heartland is off of Visa’s Christmas card list for 2009, but they still get a fruitcake.
A breach of unknown scope and impact to consumers, participating banks, their shareholders, merchants, the economy in general, the source of multiple class action lawsuits and untold losses for years to come, and the big smack down is that Heartland has to sit in the back of the bus?
Profits over protocols; some actuary must have crunched the numbers, the underwriters drew the bottom line, and the executives decided to mush on. Damn the torpedo (holes).
And Heartland may not be the whole story.
There are multiple access points in the data chain. Heartland may be where the malware disease did its worst damage, but that does not guarantee that Heartland is also the point of infection.
And as far as being PCI DSS compliant, there has been some confusion as to what that exactly means for security assurance.
PCI DSS compliance is only a momentary measure. Think of it along the lines of a kitchen inspector who gives a restaurant the highest rating after inspection, that is no guarantee the cook will wash his hands well next week, or that the mayonnaise will never get left out.
That is why you will hear a CEO of a breached credit card processor plead “But we were PCI DSS compliant“ and simultaneously you will hear the PCI council (made up of the major payment card brands American Express (AXP), Discover Financial Services (DFS), JCB International, MasterCard Worldwide and Visa) exclaim that “No PCI compliant processor has ever been breached.”
Both of these statements can not be correct.
Also included in Visa’s belated response to the Heartland breach is a fine to be levied against the participating banks – most of whom rightly consider themselves to be victims of the breach as much as their customers are.
This must be like when the mean Drill Sergeant makes everyone march in the rain because one jerk made a goof. I guess the client banks are supposed to exert peer pressure on Heartland to mend their ways, or something:
Fines – In accordance with Visa Operating Regulations, fines will be assessed to Heartland’s sponsoring banks. Such fines are part of the program Visa uses to assure compliance with system rules. Ongoing compliance with PCI DSS helps keep the system more secure for all participants.
I fail to see the purpose of penalizing banks that send their processing business to Heartland unless it can be shown that the bank somehow contributed to the breach in a material manner, otherwise this is just more fodder for the lawyers in the form of damages to recover through litigation.
Another mystery contained in Visa’s announcement is the requirement that all fraud related to the Heartland breach has to be reported by May 19th. This is ridiculous, as it could be a year or two before all fraud cases can be identified and then substantiated; requiring this to happen in the next two months is unrealistic, if not unreasonable:
Account Data Compromise Recovery – Visa has determined that this event qualifies for the Account Data Compromise Recovery (ADCR) program. Subject to its terms, this program provides issuers the ability to recover a portion of their losses related to accounts that are determined to be the subject of a breach, by assessing acquirers for the ADCR financial liability. An acquirer’s ADCR financial liability is determined based on a percentage of magnetic stripe-read counterfeit fraud and specified operating expense liability amounts. Issuers will have until May 19th to report fraud losses related to this event to Visa. Until this reporting window closes, specific recovery amounts cannot be determined. Visa will provide clients with additional information as it becomes available.
Finally we get to that last paragraph, and I can say there is something there that I actually agree with: The PCI DSS is a decent start. What really needs to be fixed is how PCI DSS is implemented and maintained throughout the data access chain:
This recent compromise underscores the importance of all parties maintaining ongoing compliance with the Payment Card Industry Data Security Standard. These standards continue to serve as a robust and critical foundation to protect cardholder data and, when implemented properly, have proven to be highly effective in preventing and mitigating the impact of data compromises. Compromise events are a reminder of the importance for all parties in the payment system to maintain ongoing vigilance when it comes to protecting cardholder data. Each stakeholder in the Visa system has a critical role in our collective fight against the criminals that perpetuate card fraud.
So in summation, Heartland (and others) may be full of holes, and Visa belatedly recommends business as usual until such time as the holes can be found and filled.
On to the next breach.
Anthony is a researcher, analyst and freelance writer who worked as a consultant to senior members of product development, secondary, and capital markets from the largest financial institutions in the country during the height of the credit bubble. Anthony’s work is featured by leading Internet publishers including Reuters, The Chicago Sun-Times, Business Week’s Business Exchange, Seeking Alpha, and ML-Implode.
The Author gives permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author and to Information-Security-Resources.com
By showing the inside workings of a take over, “60 Minutes” (I think) was trying to put our minds at ease by showing how smoothly it goes.
But this is a bank of only 5 branches, with a total 12,000 deposits worth only $200 million. Not pocket change, but not any where in the same ballpark or even league as a big bank like B of A (BAC) or Chase (C).
In the story, they state that when Indy Mac (IDMCQ) went down it held close to $11 billion. The FDIC levies premiums that they charge banks to insure the deposits, and put the funds into a reserve for such failures.
The FDIC states that there were 25 closings in 2008, but as of the first two months 2009, there have already 1been 6 closings. The FDIC estimates that they will need $65 billion to cover closings over the next five years.
Let’s do the math:
-$65 billion over then next five years = $13 billion per year.
-If HCB is an average bank, don’t think that with five branches is that big = $200 million.
-That means they can handle 65 closings a year of these small banks.
So that being said, what happens if another Indy Mac goes down?
According to Sheila Bair (Chairman of the FDIC) the FDIC will never go broke. It will always be backed by the government.
What does Bair think? That the fed will just print some more money and give to her? That doesn’t sound so good.
Now I have done some investigating of my own: According to this piece, there are three things that the FDIC can do when a bank fails:
-They can close the bank and pay the depositors.
-They can close the bank as it was and run it themselves.
-They can sell the bank (as was the case in the HCB in this story.)
In the story, Heritage was sold to MB Financial (MBF) and things went on as normal they next day (Saturday) after the FDIC take over. The FDIC paid MB $3.5 million dollars to take over Heritage. The FDIC also insures that if any loan by HCB that goes bad in the near future will re-reimbursed up to 80% of the loan loss.
Okay, so this situation seems to have a happy ending.
But let’s say that a bank fails and the FDIC fails to get a suitable buyer, what happens if they don’t want to run it and they close it down.
I brought this question to the attention of my banker at Regions Bank (RF). He informed me that the FDIC has up to TWO years to pay depositors their claim. Yes it is insured, but if you don’t have access to your money for up to two years, what good is it going to do you?
What about the people who live pay check to pay check? Or the seniors that have a limited cash flow and everything they own is in that one bank that went under?
Once I heard this from my banker at Regions, my wife and I decided to diversify in three banks. This way if one goes under and no one buys it, I will have a back up. We also took some cash and put it into our safe.
Why, do you say or wonder? Well, lets to some thinking here:
Who, if anybody, remembers what happened during the depression? Who really lived it? Answer: Seniors.
Who has some of the most assets? Answer: Seniors.
If there is a massive scare and there is a run on the banks, who do you think will be the first to come to the bank and withdraw all of their savings? Answer: Seniors.
And last, how many “average Joe” accounts would it take to equal what one senior couple would have in their account? Answer: I don’t know, but I know it is probably at least 10 to 1, probably close to 20 to 1 or higher.
Keeping the confidence in the people who have the most at stake…seniors. If there is a run on the banks, you can bet that the seniors will be the first ones in line to get their cash.
In the “60 Minutes” piece, they in fact show a senior citizen come in with an empty brief case in order to withdraw all his money. Nothing in this story examines how seniors can make or break this mess with run on the banks.
I have never been involved with a bank that was being taken over, but I am sure it is not as nice as the way they show it in this piece.
Heritage had been in business for 45 yrs and probably didn’t take some of the most risky loans such as the Chases (JPM), B of A’s and Well’s (WFC), but they get bailed out where these small banks seem to be just kicked to wayside.
One other thing that is brought up is when Pelley brings to the attention of Bair about what would happen if a big bank goes under and why they get bailed out and the small banks don’t, she suggests that we need to legislate the size of the big banks.
Make it so that they cannot exceed a certain limit to insure the fact that they cannot get too big and fail.
Bair says that the FDIC can and will not fail, what will happen if a Chase or B of A goes under. I think that the FDIC would have a hard time handling one of those.
They won’t be able to just “print money” to clean up the mess without creating another snowball effect on the value of the dollar, let alone the consumer confidence. That is something that Pelley should have investigated instead of how nice it was when this little five branch bank failed.
The euphemism “deleveraging” defines this crisis. A person or bank reduces debt by selling an asset. Deleveraging advances. If there is no asset, and no cash on hand, however, debt must still be reduced. A write-off is taken.
Deleveraging actually re-leverages the asset seller as bad investments destroy good capital. Thus deleveraging is the opposite of its name in a crash. Many write-offs pushes deleveraging into a bankruptcy. A new euphemism is used: “Nationalization”. The state seizes a bankrupt bank. What do you do with a bankrupt bank?
That is the question of the day.
A loan officer qualifying a purchaser for a new mortgage reviews the income of the borrower. He then determines an affordable level of debt. “You can go out and buy a property worth X,” the loan officer says.
If we are to judge the validity of bank assets like mortgage debt, then Gross Domestic Product (GDP) may be a reliable starting place. GDP is suggestive of a nation’s buying power and comparable to income for an individual. GDP broadly defines reasonable debt levels.
Review a history of the ratios of household debt-to-GDP and bank-sector debt-to-GDP. Shrill alarm bells ring out loud. It’s hard to hear anything else. This macroeconomic picture inspires fear. “It cannot possibly be that bad,” one thinks.
If 1980 is a base year, and we hypothesize debt levels at that time were affordable and smart, and that we should return to them, then they suggest the excess of debt which households owe today equals $7 trillion (of a total of $14 trillion).
That’s terrible and unworkable. It is also modest compared to the financial sector. The excess of financial debt is $14 trillion (of a total of $16 trillion) (see graph 1: “US Private Sector Debt”).
Rosetta Stone: Huge increases in debt may be the key issue driving the financial crisis
Meditating on this excess leverage reminds one of watching from the 2nd floor window of your suburban home as a nuclear bomb detonates in the city center. That is where your office is / was. You are still alive, but for how long? One thing we know: You will not be going to work tomorrow.
These gargantuan numbers paint with a very broad brush. All excess debt is not un-payable. Still, while the numbers appear to be impossibly large, they should not be dismissed simply because reason tells us they are impossible. Reason did not guide debt creation.
Set aside for a moment the argument about what is the right level of debt for all banks and all households. Let’s run a fire drill, and assume in 1980 we had it right. Assume GDP is a valid starting place to determine our ability to pay debt. And then assume $7 trillion of household debt and $14 trillion of financial debt is un-payable. All of it is a write off in this scenario. How do we erase this value-less pestilence?
If an individual could sell his house to end a debt burden, he would. If a bank could sell a loan asset to pay down a debt, it would. Unfortunately, if an asset doesn’t cover a bill, they can’t sell unless they admit a loss. The would-be seller waits and hopes and turns to zombie. That’s the difference between a boom and a bust. Selling doesn’t help enough in a bust.
My guess is our deleveraging requires a bankruptcy filing, but not for one homeowner or one bank, but systemically, for many or all money center banks, and for a huge subset of households; maybe something like one of five households. If indeed we have to do this, we should get this work done quickly.
The question is: What is the smart way to start and immediately finish bankruptcy?
The right way forward is simple: Enact Plan Orange.
Convert senior debt holders of commercial banks en masse into equity, and give them control of the banks. Zero the old equity and preferred shares. And employ a highflying kicker: Reduce mortgage debt for any homeowner to at most 80% of the present value of a home (see graph “Plan Orange”).
These actions radically fortify banks and homeowners. They are valid for all countries with excess debt in households and banks, which includes at least Ireland, Spain, and England. A coordinated enactment among nations may bring stable confidence to the markets.
The mortgage plan, which the graph estimates reduces consumer debt by $5 trillion in the United States, accomplishes many things. It’s primary virtue is reawakening a huge number of consumers; the group which accounts for 70% of our economic activity.
The impact would dwarf the recent stimulus package, making it a Mini-Me in comparison. With it we destroy negative equity, unfair loans, and foreclosures. Mortgage investments mutate in an instant from bad to good. The owners of mortgage investments, including banks and insurance companies, may be free again to lend, or they are far less undead.
If you believe time is money, this plan is dirt-cheap medicine. It employs massive simplicity to achieve maximum speed. Should we take such an action, we may even unleash a boom from this terrible crisis. We need the boom to pay off the massive new debts which our government must shoulder as part of this plan.
The first step is the most difficult. We must admit a debt which cannot be repaid is not a debt. We must realize our bubble is superior among bubbles. It is different this time – in the breadth of its magnitude.
Credit spread the bubble here, there and everywhere. Therefore it is a double or triple or an infinite bubble. Wherever borrowed money could purchase a major asset class, contamination permeates that asset class. And the debt used to purchase it is a mirage. Thus double bubble or bankruptcy squared. You choose the name.
Does anyone believe residential real estate and mortgages are the end of our calamity?
Who can predict losses in commercial real estate, leveraged buy outs, and credit cards? What performance in those classes should we anticipate if unemployment hits 12% and GDP contracts 9%? Those are the numbers we have to plan for, while at the same time we elide $21 trillion of extraneous debt.
Let’s review the economic conditions under which the debtor will struggle to repay the obligations. If we are in a severe banking crisis, history says our unemployment of 4.9% in January 2008 will peak at 12% (it is 7.6% as of January 2009) (3. The Aftermath of Financial Crisis).
Gross Domestic Product will fall by 9% from its high; a radical drop compared to consensus estimates. Property values will fall 35%. We can only hope it will stop there for us. Stocks will fall 56% — a number easily believed.
OMINOUS OMNISCIENCE: The best research describing the affect of a bank crisis predicts difficulties far more serious than consensus forecasts by economists and analysts
These terrible things will happen at the same time we must pay the monthly interest expense on a huge possibly excess debt of $21 trillion between households and financial firms. My hypothesis: There’s no way we can make it.
Some of the excess debt is a write-off. But how much of it is excess?
We actually don’t need to answer that question now. What we need is debt destruction and capital creation. We need bankruptcy. Erase un-payable debts the old fashioned way. Take out the old owners. Install the debt holders as owners. Reorient the economy from debt to equity.
Since an un-payable debt is a write-off, and since financial-debt-to-GDP ratios are EIGHT times higher than in 1980, the right question for our banks is not how much their equity is worth. The equity is dead and gone. The right question is: Will bondholders, converted to equity, be destroyed just as their predecessors must be?
Given the excess of leverage, they will likely zero out as well. Even if all bank debt for money-center banks is converted to equity, state-sponsored capital injections will likely be enormous. For Fannie and Freddie, there is no such thing as disposable debt holders. Our credit worthiness depends upon us honoring their debts. All their losses go straight to Uncle Sam.
The losses will be mammoth.
Generally what we need is to build a bon fire and burn to the ground ten or 20 or 30 years of manic lending. Debt must be welshed on in numerous trillions. Alan Greenspan recently approved of bankruptcy for money-center banks (nationalization), but said bond holders of seized banks require a guarantee (4).
The view from the tundra does not support this guarantee. Would Mr. Greenspan support his own position if the banks’ bond holders would be wiped two or three or five times by write offs? Bond investors are adults, and money-center-bank creditors invested poorly. The IMF and Goldman Sachs both predict greater than $2 trillion of loan losses for US-based assets (5). What if the losses are twice that?
Our speed-test ratios of debt-to-GDP hypothesize excess debt of $21 trillion for banks and households as one group. What if the $2 trillion figure is short by half? If banks do convert their debt to equity, and the banks end up stronger than they appear, the new equity holders aka the former bond holders will be paid back by the value of their stock. They can get their money back if there is any money to pay them back with.
We must dramatically reorient a debt-centered boom into an equity-heavy recovery. Start by paying down all mortgages to a reasonable level. Convert bank debt to equity. The bank debt alone represents almost a trillion dollars of new capital for the four majors and more than doubles the equity account (6). We will have begun reducing a vast part of the grotesque imbalances in broad ratios of debt-to-GDP. If adequate capital is our goal, why do we ignore this remedy?
Pumping Up: The money-center banks can radically increase their capacity to withstand losses and to lend if debt holders are converted to equity owners
If new state injections of capital are necessary, and if old injections need to be re-categorized, they should resemble senior debt, which neatly solves the question of government management by giving it to someone else. Since post-orange banks have huge capital accounts and no bad residential mortgages on the books, they have breathing room to make money.
Next up are monstrosities in commercial real estate, buyouts, and credit cards. We must anticipate unprecedented write-downs in these categories. And we must devise the same instant-bankruptcy mechanisms for these assets as is suggested here for mortgages.
Regulators must expand their thinking. They must move beyond their scientist-like role as lender-of-last-resort. They have handled this well, but science is easy. Now they have to do the art work. This will require that they wear different hats which are at first uncomfortable. They are the bankruptcy prosecutor-judge-and-jury of-last-resort and parent-with-checkbook-open of-last-resort.
While they adapt to those roles, we put the lending rules back together again. Make the rules real and make them stick. Regulate leverage for banks as borrowers. Regulate leverage for banks as lenders. It’s a great cure all for our ugly failures.
We don’t have time to play around.
Review the devastating early effects of our crisis. Global equity markets had fallen $21 trillion last year at the market low (7). Fifty million people worldwide are now expected to lose their job (8). How many mouths are now unfed, when even before the disaster 100,000 people starved to death every day (9)? When these innocent bystanders enter our calculus the dictates of moral hazard grow false quickly, and the regulation of leverage now can bar repetition of our most serious errors.
Until the next time.
Poor Souls: The U.S. economy guides the world’s economy
Our decisions make life better or worse for all. Roughly 100,000 people die every day from starvation
Untold masses and markets all over the world depend upon us. We can’t be guided by the hurt feelings of stock and bond holders. We need a bright rebound. We need radical courage, great ambition, and intelligence. Plan Orange has it.
A zombie is a person, bank, or country, which pretends a vast array of un-payable debt has substance.
We are not a zombie country.
We need to get to work, and a radical move into equity will make this possible. We have nothing to fear but debt itself. Just take aim at this ugly beast debt.
Kill it dead with bankruptcy. Write off the debt and burn it to the ground. Good things follow.
1. GDP-to-Debt in major sectors. See graph labeled “US Private Sector Debt”.
2. “Plan Orange” graph.
3. Bank crisis statistics. See “The Aftermath of Financial Crisis”. Dec 19, 2008. Carmen Reinhart & Kenneth Rogoff.
4. Greenspan on bank bondholders: “You would have to be very careful about imposing any loss on senior creditors of any bank taken under government control because it could impact the senior debt of all other banks,” he said. “This is a credit crisis and it is essential to preserve an anchor for the financing of the system. That anchor is the senior debt.” Financial Times. 2/18/09. “Greenspan Backs Bank Nationalization”.
5. Credit-loss projections. IMF & Goldman Sachs. “The fund said that credit losses from bad assets originating in the US would be $2,200bn (€1,662bn, £1,537bn), a sharp increase from its previous $1,400bn estimate.” Financial Times, 1/28/09, “IMF Slashes 2009 Growth Forecasts”. “Analysts at Goldman Sachs were the latest to jack up estimates of potential U.S. loan losses. In a report released late Tuesday night, Goldman economists estimated that losses from delinquent U.S. residential mortgages alone would hit $1.1 trillion as home prices sink, up from an earlier estimate of $780 billion. Add in losses from commercial real estate, credit cards, auto debt and business debt and Goldman’s loan loss estimate hit $2.1 trillion.” Wall Street Journal 1/15/09 “Banks Loan Losses Could Reach $2 Trillion.
6. Long-term debt and equity at money center banks (2007 annual report of BA, Chase, Citi, Wells).
7. $21 trillion lost in equities: “When equities bottomed on 21 November 2008, the MSCI World index had fallen 55 per cent since 31 October 2007. This worked out at a global loss of $21 trillion, or $ 21,000 for every individual in the developed world.” TimesOnline. 2/11/09. “Global Stock Market Losses Total $21 Trillion”.
8. 50 million jobs lost: “Worldwide job losses from the recession that started in the United States in December 2007 could hit a staggering 50 million by the end of 2009, according to the International Labor Organization, a United Nations agency. The slowdown has already claimed 3.6 million American jobs.” New York Times. 2/15/09. “Job Losses Pose a Threat to Stability Nationwide”.
9. 100,000 die of starvation every day: “In 2006, more than 36 million died of hunger or diseases due to deficiencies in micronutrients”[8]. Wikipedia: Entry under Malnutrition. World Health Organization.
The AIG Bailout: It is not about regulation and de-regulation, as Washington lawmakers would like you to believe. It is also not about the inability to control derivative transactions, as self-styled experts are claiming on your television sets.
In fact, if the facts are closely scrutinized, the alarm bells are all ringing the wrong jagged tune.
What we are facing today is the complete lack of comprehension of the very nexus which triggered the most remarkable phase of capital accumulation following the Second World War.
The post-WW II universe was shaped entirely by a capital accumulation process which guaranteed huge surpluses for the United States, Western Europe and Japan, and which was inherently the cause of sustained poverty throughout the developing world.
In the late-1990s, however, the capital equilibrium began shifting; production-cost arbitrage and outsourcing began directing cash to countries like China and India.
But western economies confronted that equilibrium shift by continuing to create huge debt-based wealth, mainly through fundamentally flawed asset valuations, through unrealistic credit ratings and through rampant speculation.
Today, the capacity of large segments of American corporations and consumers to service debt is almost negligible.
Valuations did not lead to cash flows and profits. Credit ratings failed to fully comprehend impairments in business models. And, as if to drive the inevitable final nail in the debt coffin, the risk insurance sector, without which the modern-day capital enterprise is a non-starter, is now destined to walk away from the wealth bubble in a matter of a few short weeks and months.
The nexus of capital, debt and insurance (and militarism, for that matter) is currently in crisis mode.
American International Group (AIG), for example, will need more than US$150 billion as cash margin for its credit default swap contracts to offset the downgrades in its own credit ratings; other risk reinsurance entities, including European majors, are expected to emerge from the woodwork with serious counterparty deficits within this month.
Banks like Washington Mutual (WAMUQ) and Wachovia (WB), as other examples, are still not disclosing the foreclosure-to-sale risk inside their property portfolios.
Elite Wall Street institutions, like Citibank (C) and Morgan Stanley (MS). are reported to be undertaking, as a matter of top priority, worst-case revaluations of all American and foreign assets appearing on their balance sheets.
The evidence is overwhelming: this crisis is like no other in American history. It is not a question of a loss of confidence but that there are no grounds for confidence at all.
As long as the global economy created genuine capital surpluses in the American capitalist structure, valuations were a non-issue, since ongoing and increasing demand for assets invariably generates its own momentum in terms of perceptions of value and future value. And exceptionally high debt levels are not considered prohibitive in the face of valuations being proven, repeatedly, at points of liquidation.
But the unique combination of industrial growth and impoverishment in the emerging markets has rapidly eroded the foundations of the post-WW II capital accumulation process. Cash demand for American assets, as a consequence, has dried up, and debt can no longer underpin over-valuations.
So exactly what credit quality was AIG insuring?
Surely, the underlying nexus propping up the global capitalist economy did not lend itself to actuarial mathematics. Nor did the hopelessly inadequate property valuations, often provided by unqualified appraisers on American main streets, support any credible asset definitions.
By all accounts, default swap prices were predicated on the mere belief that any potential degradation of American assets was both manageable and, at worst, a cyclical phenomenon.
To offer a simplistic explanation, a credit default swap provider is required to make immediate cash reserve provisions in the event that the credit rating (issued and updated by the established credit rating agencies) of the provider is downgraded; quite clearly, the bigger the downgrade, the bigger the cash reserve requirement.
Therefore, in view of the fact that Standard & Poors, Moodys and Fitch have all lowered AIG credit ratings during the last few hours, the American financial system is due for a significant shake-up this week. Similar credit events will then follow in Europe and Japan.
The less said about the impact on the third world, the better.
Rakesh Saxena is a pricing and risk analysis specialist in insurance and derivative products and has extensive deal making in the emerging economies. He can be reached at derivatives@shaw.ca. Home URL: http://www.quoteplatform.com
Lockheed Martin (LMT) may see their stock rebound after being pummeled last week by news the Obama administration was weighing its options in regard to a controversial program to replace the current fleet of Presidential helicopters, commonly referred to as “Marine One.”
What’s the good news? Well, there isn’t any.
There were revelations this weekend that a defense contractor staff member had used a P2P file sharing program on their company computer, which also happened to contain much there is to know about the President’s iconic helicopter.
The information had made its way as far as an ISP address in Tehran, Iran:
ISR News — A Pittsburgh-area company that monitors peer-to-peer networks accessed with file-sharing software like LimeWire and Napster says it has identified a potentially serious security breach involving Marine One and an IP address in Tehran, Iran.
The company found a file detailing the helicopter’s blueprints and avionics package, which it then traced to its original source, TiversaCEO Bob Boback told NBC affiliate WPXI, which reported the story Saturday.
It literally baffles the mind: Billions of dollars are spent on physical and information security every year, and it can be trumped by one bonehead maneuver, by one little lapse in judgment.
That is a tremendous amount of resources and effort committed to security just to have it undermined by the whim of one non-malicious individual, and it underscores the precariousness of even the most secure of systems.
The final bill for this breach may be hard to figure, as this could influence a decision by the Obama administration to continue funding for a Bush initiative to replace the current presidential helicopter fleet:
New York Times — A six-year-old project to build state-of-the-art presidential helicopters has bogged down in a contracting quagmire that will challenge Mr. Obama’s desire to rein in military contracting expenses. The price tag has nearly doubled, production has fallen years behind schedule and much of the program has been frozen until the new administration figures out what to do about it.
Equipped to deflect missile attacks and capable of waging war from the air, the new VH-71 helicopters would fly farther, faster and more safely than the current decades-old craft. But each improvement pushes up the cost. The program’s original $6.1 billion contract has ballooned to $11.2 billion, and the Pentagon notified Congress last month that it was so far over budget that the law required a review. The Obama administration now must determine if the project is essential to national security and if there are alternatives that would cost less.
Now it is up to defense and security experts to decide exactly what threat this exposed information may have.
“If the office of the presidency is vulnerable, then the country is vulnerable,” said Representative Joe Sestak of Pennsylvania, a Democrat and a retired Navy vice admiral. “However, the nation is crying for accountability, from Wall Street to Congress to Iraq.”
Any way this is sliced, it looks as though those in favor of putting an end to the VH-71 program may have a more difficult time making their case after this breach, and iit could bena boon for Lockheed Martin and their British and Italian partners who would provide much of the design.
The program had been criticized as nothing more than a political bone thrown to the UK and Italy as a gratuity for their support for Bush’s War in Iraq.
As the program’s tab ballooned to over $12 billion dollars – about twice the initial bid for the project – and the economy began to fail, support for the program declined sharply:
New York Times — Asked about it in last year’s campaign, Mr. Obama promised to “take a close look” at the program, adding that it was “a lot of money, even in Washington.” The White House had no comment last week, but Geoff Morrell, the Pentagon press secretary, said Defense Secretary Robert M. Gates was rethinking the VH-71 and other projects that were “having execution problems.”
“We’re prepared to make some hard choices,” Mr. Morrell said.
Which brings us back to a point I have been trying to hammer away at this year, that information security breaches have far reaching fiscal and national security repercussions, and they are not getting enough attention of the right kind, or from the right people.
Our team has been predicting that 2009 will be the year that InfoSec moves to the forefront of the economic crisis, and with Homeland Security implications.
This latest security breach further highlights the fact that the failure to secure information is the next major shareholder derivative, director and officer liability, regulatory, consumer product safety, and class-action issue to impact our economy.
(Kudos to the Tiversa team who uncovered the breach through their hard work and dedication – Great Job!)
Author’s Disclosure: No Holdings
Anthony is a researcher, analyst and freelance writer who worked as a consultant to senior members of product development, secondary, and capital markets from the largest financial institutions in the country during the height of the credit bubble. Anthony’s work is featured by leading Internet publishers including Reuters, The Chicago Sun-Times, Business Week’s Business Exchange, Seeking Alpha, and ML-Implode.
The Author gives permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author and to Information-Security-Resources.com
Posted by Anthony M. Freed 
