Opinion

Felix Salmon

Why banks are self-defeating on housing

Felix Salmon
Jun 30, 2010 19:24 UTC

Why are banks so bad at short sales, even when such things are clearly in the banks’ interest? Cynic has a spectacularly good comment which is worth elevating to a blog entry of its own:

It’s tempting to lay the blame on servicers’ lack of incentive to process these short-sales speedily. Or to suspect that banks aren’t eager to speed the process, because they’d like to wait to recognize the losses until their balance sheets are a little more robust, even if that ends up costing them more in the long run. And those are real problems, but they’re not the whole picture.

The bigger problem here is Milton Friedman. There is an absolute refusal to recognize the possibility that, for a variety of reasons, the lenders will not act in their own best interests unless forced to do so. That runs directly contrary to the axiomatic tenets of neoclassical economics – surely sophisticated businesses will always pursue their own economic self-interests, and have the ability to discern it.

But, alas, not. Banks are also bureaucracies; Weber is as relevant as Friedman. Speeding this process would involve massive hiring. Since there aren’t enough qualified people – short-sales used to be comparatively uncommon – that means that there will be a substantial lag as staff is trained. Moreover, banks are both loath to hire staff for what they perceive to be a short-term problem, and reluctant to expand payroll at this moment in time. And it goes beyond hiring. Few banks view restructuring, short-selling, or foreclosure processing as core to their missions. These are unglamorous areas of the bank. The executives in charge rank low on the totem poll, and are poorly positioned to press for the necessary changes. Finally, there’s outright denial. Executives are never interested in recognizing their own failures. That’s painful. They’d rather avert their eyes, even if that proves costly. Every short-sale is an admission of error, and forces the bank to pay the piper. No one is going to make a performance-related bonus for completing transactions faster that cost the bank huge amounts of money – even though that’s precisely the sort of performance that the bank ought to reward, because it results in long-term relative savings.

This is precisely where regulatory pressure is most useful – in compelling businesses to do things that are in everyone’s interest that they might not otherwise be willing to do themselves. But admitting that a free market might not produce such an outcome is simply too painful for leading economic policy makers, let along Congressional Republicans. And so we watch.

Dan Ariely loves to talk about how as individuals we’re incredibly bad at doing things which involve short-term pain for long-term gain: going on a diet, or quitting smoking, or reducing carbon emissions. He even has a great first-person story about this, dating to a time when he was diagnosed with hepatitis C:

The initial protocol called for self-injections of interferon three times a week. The doctors advised me that after each injection I would experience flu-like symptoms, including fever, nausea, headaches and vomiting. But I was determined to kick the disease, so every Monday, Wednesday, and Friday evening for 18 months I plunged the needle deep into my thigh. About an hour later the nausea, shivering and headache would set in.

Every injection day was miserable. I had to face giving myself a shot followed by a 16-hour bout of sickness in the hope that the treatment would cure me in the long run. I had to endure what psychologists call a “negative immediate effect” for the sake of a “positive long-term effect”.

At the end of the 18-month trial, the doctors told me that the treatment was successful and that I was the only patient in the protocol who had always taken the interferon on schedule.

Bank executives, it’s worth remembering, are human. Every time you do a short sale, you take a substantial loss on your loan. And no one likes doing that: it’s painful. So it’s understandable, from a psychological perspective, that they will drag out the process as much as possible, putting off until tomorrow the pain they know has to come at some point. They might even prefer a foreclosure to a short sale, on the grounds that it’s theoretically possible that they’ll end up getting more money for the house in the end, even though they know that in aggregate the bank’s losses on foreclosures are always going to be bigger than its losses on short sales.

Can the government do anything to nudge banks in the right direction, here, to the benefit of all concerned? And if so, what? Intuitively I find it hard to believe that extra layers of regulation are going to be able to improve anything. And Cynic’s points about the lack of qualified staff, and the existing staff’s lack of status within the bank, are well taken. These are deeply ingrained problems, which don’t have easy solutions. Which in turn is yet another reason to be bearish on the housing market over the medium term.

COMMENT

I invest in pre-foreclosure houses via short sales and some banks are better at the big picture than others. I just had an offer turned down last month by a Suntrust Bank Short Sale Negotiator. The loan had PMI (25% coverage). The bank determined through a BPO (broker price opinion) that the property was worth $90,000 and had a loan exposure of $104,000. The house has been on the market since Jan.2010 at a range from $98k down to $93k, and my 70,000 net,net offer has been the only serious offer in 6 months. So if they accepted it, they would only be out $8,000 at the end of the day, yet they prefer to take their chances with a foreclosure, incur holding costs, maintenance, winterization, risk vandalism & theft, plus attorneys fee’s and court costs. All the metrics I’ve reviewed point to a short sale as the least risky solution for all parties. Their decision is going to cost them alot more in the long run.

Posted by RDJ511 | Report as abusive

Investing in loopholes, MLP ETF edition

Felix Salmon
Jun 30, 2010 17:10 UTC

Remember the Master Limited Partnership tax loophole? Well it turns out that a lot of investment companies seem to be trying to take full advantage of it. Tadas Viskanta notes that everybody and their mother seems to be trying to roll out stock-market-traded funds structured as MLPs, some with valuations north of $1 billion. Essentially, if you list a pipeline corporation directly, there’s much more tax to be paid than if you set it up as an MLP and then list the MLP in ETF form.

Tadas says that investors should be cautious here: “You should be more discerning in your approach to MLPs now that they have been discovered by the crowd”. That makes sense: there’s a very real risk, now that everybody knows about this loophole, that it will be closed. I hope it will be, anyway.

COMMENT

However, it appears that by putting MLPs inside an ETF (a corporation), the ETF is obligated to pay income tax on the income from the MLP. (see Tadas’ links to the IndexUniverse articles on MLP ETFs which include such statements from the ETF creator)

So sure, the MLP itself doesn’t pay income tax, and if an individual owns the LP units then the income is only taxed once, at the LP owner level (a individual).

However, if the LP owner is an ETF (a corporation) then the ETF must pay income tax on the MLP distributions the ETF receives before distributing those proceeds to the ETF owners – and you’re back to double taxation, defeating one of the main upsides of the MLP structure to begin with.

Posted by SteveHamlin | Report as abusive

Cassano comes out swinging

Felix Salmon
Jun 30, 2010 16:07 UTC

AIG FP’s Joe Cassano is coming out swinging in his testimony to the FCIC:

Often repeated are my words during an earnings call in August 2007 that I did not expect any realized, economic losses (as opposed to unrealized accounting losses) on this portfolio. I meant exactly what I said in August 2007. The underlying loans in the CDOs were diversified, and we insured only the super-senior tranche, which always had a AAA layer of loans below it. I did not expect actual, economic losses on the portfolio…

As I look at the performance of some of these same CDOs in Maiden Lane III, I think there would have been few, if any, realized losses on the CDS contracts had they not been unwound in the bailout.

This is something which should be able to be cleared up empirically quite easily, no? How many of the super-senior CDO tranches that AIG FP insured have ended up defaulting by now?

More generally, of course, the question is moot because AIG simply didn’t have the liquidity to survive as a going concern after putting up all the collateral which its insurance contracts required it to post during the crisis. It’s not enough that your credit default swap ends up suffering no losses in the end; you also have to be able to survive until the end. And no one, least of all Cassano, seemed to worry about that.

Update: In his live testimony, Cassano is reiterating that “I think the portfolios are withstanding the test of time in extremely difficult circumstances.” Chairman Angelides is not convinced, saying that projections are for very big losses. But he does seem to be conceding that there aren’t any cash losses on the AIG credit default swaps yet.

COMMENT

Good grief Cassano simply pulled an Enron and instead of putting the risk inside the company, ie putting it on books off the balance sheet, they externalized the risk to the whole market. Smart in a very sad way, but we all pay the price and they make money. I will be in a different mood when the first Goldman Sach’s employee, or any major investment banker, goes to jail.

I mean if Jeff Skilling goes to jail why not LB?

As to Cassano and the belief that all the loans were backed in the other tranches, what world is he living in? Read what happened at Lehman Brothers in that Archstone was good on paper and would have been ok if the rental market had not tanked. The key issue there, of course, is that CDS would have been called in and the devil’s candy would have been revealed for what it was (an empty promise).

The whole logic was that at the end of all the promises something tangible has to exist. Not simply a promise to pay the actual ability to pay either by having cash in hand or converting something into cash. It really is that simply. What Casson is missing, and does not want to know about, is that beneath those layers the quality went down hill so that there was no there there. In other words, he was selling whipping cream on s***.

To put it directly, Cassano and his ilk were not worrying about what the companies beneath the top tiers did or where those bonds were, or where the money was supposed to come from as long as the top tiers looked good.

My god, it is so simple it is shocking. Forget the mathematical BS (wizard of oz suddenly arrives forget about that man behind the curtain) this boils down to a basic transaction, it is about selling a product. For someone to make a profit, someone has to make a loss. (In other words you cannot make something from nothing) What was being sold was some illusion (the devils candy) that I can make us both money or better yet “I can always return %15 year on year.” How long can an investment fund manager and his clients ignore that siren song? Once they are hooked, they have to keep the process working.

Give me the building society and the manufacturing sector any day of the week, or the agricultural sector (at least you can eat your mistakes).

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The inexplicable AIG waiver

Felix Salmon
Jun 30, 2010 15:16 UTC

Louise Story and Gretchen Morgenson have another huge AIG/Goldman story today, which centers on one new and interesting piece of information: when AIG paid off its bank creditors in full, with the help of that monster government bailout, it also signed a waiver forfeiting its right to sue those banks, including Goldman.

The waiver is buried on page 385 of the 823 pages of documents that the NYT has, wonderfully, put online in a very easy-to-read form. (It’s also linked to the full 250,000-page document dump from the House Committee on Oversight and Government Reform, if you want to go trawling through the documents yourself.) I was rude about the NYT putting source documents online a couple of weeks ago; this is the best possible way of the NYT proving that I was wrong.

The waiver itself is interesting. Taking out some of the legal blather, it comes down to this:

Each of AIG-FP and AIG Inc, for good and valuable consideration, the sufficiency of which it hereby acknowledges, forever releases the Counterparty from any and all Claims of any nature whatsoever that AIG-FP or AIG Inc ever had, now has or can, shall or may have, by reason of any matter, cause or thing occurring from the beginning for the world to the Termination Date that arises out of or in any way relates to the CDS Transactions.

Yes, it really says “from the beginning for the world.” But more interesting to me is the bit about “good and valuable consideration.” It seems to me that AIG paid off Goldman and its other counterparties in full — it essentially gave them everything they could possibly want. So what good and valuable consideration did Goldman give to AIG in return for this waiver? Why would AIG agree to this?

The answer of course is that it was not in AIG’s interest to agree to this waiver, and it really didn’t get much if anything in the way of good and valuable consideration from Goldman or anybody else. But the waiver was forced on AIG by the government, and specifically by Treasury and the New York Fed. Treasury was full of old Goldman hands, including Hank Paulson and Dan Jester; the Fed, too, was and is much closer to Goldman than to AIG.

The whole thing is very smelly, and I’d love to see a better reason for the waiver’s existence than this:

David Moss, the Harvard professor, said the government might have been concerned that the insurer would use taxpayer money to sue banks. “The question is: was this legitimate?” he asked. “The answer depends on the motivation. If the reason was to avoid a slew of lawsuits that could have further destabilized the financial system in the short term, this may have been reasonable.”

But the fact is that wasn’t the reason: since AIG was being nationalized, if the government wanted to avoid any lawsuits in the short term it could simply tell AIG not to sue Goldman. The point of the waiver was clearly to enjoin AIG from ever suing Goldman even after it emerged from government control. And there’s no good reason for that.

COMMENT

pardon me..that’s Dewey, Cheatum and Howell…

Posted by justanotherjoe | Report as abusive

Short-sale datapoint of the day

Felix Salmon
Jun 29, 2010 21:47 UTC

How long does it take to complete a short sale? If you have a prime loan from GMAC, it takes a full six months: painful. But what’s much worse is that GMAC is by far the fastest mortgage servicer of the lot: prime loans from Countrywide take, on average, 13 months. Subprime loans from Morgan Stanley’s Saxon unit are even worse, at 17 months. And then there’s the subprime loans from Equicredit and Ocwen, which take a mind-boggling 29 months to go through, on average.

Jorge Newberry has some common-sense ideas about how to speed things up a bit, but the fact is that these servicers have demonstrated their inability to do their jobs multiple times over the past few years: they’re simply overloaded. Too few staff, with too few qualifications, are trying to do too many things at once.

The result is predictably depressing: more foreclosures, less money for servicers, more distressed sales, more empty homes, lower house prices. Treasury has done nothing to alter this situation to date, and neither has Congress. So expect more of the same going forward, for years and years to come.

COMMENT

13 months and 17 months? from when? I’m guessing this is from delinquency?

Short sales take some time, but not that long. And, banks have become much quicker in the last 6 months or so by applying REO technology to the short sale process.

Just last week, I got approval on a GMAC short sale about 6 weeks after submitting the file.

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Finding the Journolist archive

Felix Salmon
Jun 29, 2010 20:28 UTC

There are non-trivial technical problems which would need to be overcome were anybody tempted to take Andrew Breitbart up on his offer to buy the Journolist archives for $100,000. Juli Weiner writes:

The one kink in Breitbart’s plan is that we now live in a post-6/25 world, and JournoList is no longer a functioning entity. To access the archive, members would had to have chosen a Google Groups setting that forwards discussions to their inboxes. JournoListees would also have to now be willing to relinquish control of their e-mail accounts to Andrew Breitbart, which, ew.

In fact, it’s harder than that. I think that most Journolist members had discussions forwarded to their inboxes — it was the only practicable way of keeping on top of conversations. But the only conversations they would have received were the ones which took place after they joined. Journolist didn’t spring fully formed out of Ezra Klein’s contact list with 400 members: it grew organically over time. And once you were a member, you had access to the complete archives. But those archives have now been taken down, as Weiner notes.

So in order to give the full archive to Breitbart, one of two things I think would have to be the case. Either you would have to be in the small group of founding members, who have received all of the emails since inception. Or else, while Journolist was still up, you would have to have somehow mirrored or copied the entire archives onto your own hard drive.

I don’t know how easy or difficult that would have been, but I’m quite sure that it’s beyond the technical ability of most of Journolist’s membership. It does however look as though Ezra Klein killed Journolist just in time: if it was still up today, I’m sure Breitbart would be publishing detailed instructions on how to generate a full archive from a Google Group. For the time being, though, I hold out hope that Breitbart’s fishing expedition will come up empty. Although it seems that one of Journolist’s members was malevolent enough to leak Dave Weigel’s emails, there’s also a very good chance that wasn’t smart enough to store a full local archive of the group’s history.

Update: Dsquared adds in the comments that Breitbart can’t credibly promise to keep the leaker’s identity secret:

Offering to pay $100k for someone else’s private email is not protected journalism even in the USA, as far as I’m aware, and there was at least one EU citizen on that list who might be tempted to assert his Article 8 right to privacy (cf: the News of the World phone-hacking scam). This would be the stupidest thing Breitbart or anyone else could do, given that a) $100k doesn’t necessarily go all that far in the English courts and b) the identity of the person who leaked it (and the person who leaked Weigel’s original email) would certainly come out during discovery. Breitbart really needs to get a new lawyer if he thinks he’s able to make that guarantee of “protection” to someone selling an archive of other peoples’ mail for a hundred grand.

COMMENT

“If I were a member, I would ask for $250,000 and stipulate that the money had to be donated, publicly, to Planned Parenthood and NARAL.” – Do you really think that it could be better to ask for this big amount of money?
pdf viewer

Posted by hazelgranger | Report as abusive

Will fiduciary responsibility be weakened?

Felix Salmon
Jun 29, 2010 19:22 UTC

One of the best pieces of news to come out of the financial regulatory reform bill (assuming it goes through) is that stockbrokers will finally have a fiduciary duty to their clients. It’s long overdue — but already, before the bill is even passed, brokers are trying to find ways to weaken it. Joe Giannone spoke to brokerage executive John Taft:

Taft contends that when the SEC gets to work on drafting the actual rules of the road — and Taft says there is no question a fiduciary standard is coming — it ought to take into account the different ways clients work with brokers.

“You’ve got to change” the standard, Taft said. “It’s got to be different.”

Er, no, you don’t have to change the standard at all — especially since by “change”, Taft clearly means “weaken”.

I suspect that one of the key problems here is that brokers are desperate to be able to privilege their own shop’s products over their competitors’. But if they have a fiduciary duty to their clients, and a competitor is offering an identical-yet-cheaper product, then they might well have to steer their clients to their competitors. I don’t have a problem with that. But enforcing it is going to be a nightmare — assuming that the rule even survives in its present form, and the SEC doesn’t chip away at it before it’s implemented.

COMMENT

I wonder when they will force investment advisors to have a proper fiduciary responsibility to their investors? After all most of people’s money is siphoned up through these vehicles rather than a bank selling the product directly. Or we could have the insane idea that people should be responsible for their own money… but that would be far far far too radical.

Posted by Danny_Black | Report as abusive

Financial regulatory reform: Not over yet

Felix Salmon
Jun 29, 2010 17:45 UTC

It seems that financial regulatory reform is not a done deal after all: Paul Kanjorski says that the reconciliation negotiations might be reopened, Chris Dodd is looking to possibly beef up the FDIC enormously, and Democrats are wondering whether they need to remove $19 billion in new bank taxes in order to pass Republican procedural hurdles in the Senate.

It would be a fiasco of tragic proportions if the banks managed to remove these taxes from the final bill, essentially absolving themselves from cleaning up after their own mess. The arguments against the taxes are weak indeed: either you simply oppose all taxes on principle (which seems to be the Scott Brown stance, and which is fiscally disastrous), or else you’re forced into John Carney’s corner.

Carney is worried that we don’t know exactly where the tax will be applied — but that’s a feature, not a bug. Setting up the tax in great deal ex ante is essentially just asking banks to spend millions of dollars on tax consultants who can help them skirt the new levies. And as the risks in the system evolve and change, so to should the way that they’re taxed. It’s right and proper that the newly created Council for Financial Stability will be charged with taxing systemic risk, rather than having a bunch of politicians try to do so at the beginning and then watch as the banks and other financial institutions nimbly sidestep the new taxes.

An increase in the FDIC premium would be a gift on a platter to banks like Goldman Sachs and Morgan Stanley which don’t have insured deposits — not to mention non-bank players like Citadel which are systemically very important. I’m unclear on what exactly this Republican “procedural hurdle” is — I thought that after reconciliation, you just needed a simple majority to pass a bill. But I’m getting very annoyed about it.

COMMENT

You’re right about the mealy-mouthed bipartisanship involved, Dan (Hess, not the weirdo). It’s the same chickenspit mentality that dare say nothing about the cost to the American taxpayer of Pentagon excess to the tune for 2011 of over $1.6Trillion, incl. $400Billion in interest for past profligacy. It’s the biggest thing giving Government a bad name, making even this failed financial regulatory Bill look uproariously successful by comparison.

Of course, when s’orlrightreally-ists like that other Dan (the excitable one) say they only feel like they spent $600Billion on war games, it just goes to show that they’re really getting nowhere near their money’s worth.

America has a military problem. But you’re right to point out that it also has a bipartisan problem when it comes to asking and telling what the military and the so-called banks of Wall Street keep costing this country. It’s almost as if they really want you to know how much they’re capable of wasting.

Posted by HBC | Report as abusive

U.S. banks still very involved in money laundering

Felix Salmon
Jun 29, 2010 14:59 UTC

In the olden days, drug smugglers would launder their money the old-fashioned way: by starting up a bank. Today, it seems, they have no need to do so: they just use Wachovia and Bank of America instead. Michael Smith has the story, which includes the tale of money launderer Pedro Alatorre:

In May 2008, the Justice Department sought extradition of the suspects, saying they used shell firms to launder $720 million through U.S. banks…

During the period in which Wachovia admitted to moving money out of Mexico for Puebla, couriers carrying clear plastic bags stuffed with cash went to the branch Alatorre ran at the Mexico City airport, according to surveillance reports by Mexican police…

Puebla executives used the stolen identities of 74 people to launder money through Wachovia accounts, Mexican prosecutors say in court-filed reports.

“Wachovia handled all the transfers, and they never reported any as suspicious,” says Jose Luis Marmolejo, a former head of the Mexican attorney general’s financial crimes unit who is now in private practice…

“I am sure Wachovia knew what was going on,” says Marmolejo, who oversaw the criminal investigation into Wachovia’s customers. “It went on too long and they made too much money not to have known.”

At Wachovia’s anti-money-laundering unit in London, Woods and his colleague Jim DeFazio, in Charlotte, say they suspected that drug dealers were using the bank to move funds.

Woods, a former Scotland Yard investigator, spotted illegible signatures and other suspicious markings on traveler’s checks from Mexican exchange companies, he said in a September 2008 letter to the U.K. Financial Services Authority. He sent copies of the letter to the DEA and Treasury Department in the U.S.

Woods, 45, says his bosses instructed him to keep quiet and tried to have him fired, according to his letter to the FSA. In one meeting, a bank official insisted Woods shouldn’t have filed suspicious activity reports to the government, as both U.S. and U.K. laws require.

“I was shocked by the content and outcome of the meeting and genuinely traumatized,” Woods wrote.

And that’s just one of many stories: I particularly also like the bit about how drug smuggler Oscar Oropeza’s wife and daughter would literally launder their banknotes before depositing stacks of cash at a Bank of America branch on Boca Chica Boulevard in Brownsville, Texas, where everybody knew who they were.

“I asked the tellers what they were talking about, and they said the money had this sweet smell like Bounce, those sheets you throw into the dryer,” Salazar says. “They told me that when they opened the vault, the smell of Bounce just poured out.”

How do the Mexican drug smugglers persuade U.S. banks to turn a blind eye to this kind of thing? Smith implies that it all comes down to the inherent profitability of the business, but I’m not fully convinced by that: I don’t think that bank managers’ bonuses are going to be so much bigger for allowing the money to pass through their bank that they would risk their own careers and their employer’s franchise to do so. My guess is that there are direct kickbacks somewhere along the line, and that bank employees are being paid directly, or threatened, or both, by the drug smugglers. I’d certainly love to find out what Martin Woods’ bosses told the authorities when they were asked why they told him not to report the suspicious activity; let’s hope Smith continues to report this story. It’s not over yet — not by a long shot.

(HT: IKN)

COMMENT

I can show you N.W. Indiana cartel distributors who are state government employees, i.e judge and attorney who are involved with casinos, cocaine distribution and money laundering. They steal money from estates of cancer victims and their heirs and seal all the financial records so that no one can see the embezzled funds that are used to fund the distribution business that involves aircraft and multi state cocaine sales. The local federal agencies in Chicago and N.W. Indiana refuse to investigate even though court documents show felony crimes and refusal of judges to reprimand or process filed formal charges against government workers.
They literally find victims and gain power of attorney through estates and clean out bank accounts and never report funds which they funnel to Cayman accounts.

Posted by Whistleblower1 | Report as abusive
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