An Open Letter to Tom Brown at

February 22, 2009

February 22, 2009

TO: Thomas K. Brown c/o

RE: Your blog post criticizing 60 Minutes for its piece on Herb and Marion Sandler and their option ARM loans.

Dear Tom,

In the column referenced above, you express great admiration for the Sandlers and you criticize 60 Minutes for its report on their bank, World Savings, which made approximately $120 billion worth of option ARM loans:

Did you see the 60 Minutes report on Herb and Marion Sandler’s World Savings [note to readers: World Savings and Golden West are different names for the same company] on Sunday?  If you did, you saw a travesty. The report managed to get virtually all relevant facts related to World’s marketing and underwriting practices precisely backwards—and in the process unfairly maligned, even libeled, two of the most able, honorable financial services executives of the past half century. The report was essentially a work of fiction masquerading as journalism. The people at CBS News ought to be ashamed of themselves.

Actually, Tom, you should be ashamed of yourself.  For starters, your post makes perfectly clear that you have no idea what you’re talking about.  More irresponsible, you use your faulty analysis as grounds to claim the 60 Minutes report is “libelous.”  It’s one thing to be wrong; quite another to claim journalists should be sued for a story they got right.  As a long-time critic of option ARM loans myself, I feel it necessary to defend 60 Minutes for its report.

There’s one particular paragraph in your post that belies your complete and total misunderstanding of the housing crisis, and the role banks played in bringing it upon themselves:

60 Minutes’ reckless disregard of the facts is a disgrace. Yes, Golden West’s loan portfolio will suffer incredibly high loan losses–not because of shoddy underwriting. Rather, the properties the company lent against are enduring a one-in-100 year event with respect to home prices. In an environment like that, losses will rise, no matter how judicious you are.

But Tom, lenders can’t be the victims of a house price crash they themselves caused!  It was precisely because of their INjudiciousness that house prices got “too high” in the first place.  The cause of the housing bubble was, in fact, the progressively easier lending structures that inflated it.  Let me explain…

The market for houses and the loans used to buy them are not somehow independent of each other as you imply.  For any asset that is bought using credit—houses, commercial real estate, stocks, bonds, companies—the market is the loan.

Ask yourself, what is a housing “bubble” and how is one created?  The term “bubble” suggests that prices were, objectively speaking, “too high.”  Clearly this was the case.  A chart of house prices relative to median income makes it abundantly clear.  House prices can’t continue to expand forever, not unless incomes expand at the same time.  If prices are expanding faster than income, then prices are “too high” relative to what people can actually afford to pay for shelter.  In other words, we have a bubble.

So how is it, that house prices can continue to expand when incomes stagnate?  Easy, let folks borrow more.  The more credit borrowers can get, the more they can bid for the house.  Whether their incomes will allow them to actually pay down the debt incurred is a moot point at closing because they aren’t the ones actually providing the cash to pay for the house.  The lender is.

Do you see where I’m going with this Tom?  Prices got too high precisely because credit got too easy.  The distinction is not academic.  You can’t argue that lenders like World Savings are the victims of the house price crash if their loans are at fault for driving house prices too high in the first place.

It’s rather important that you grasp this so, at the risk of repeating myself, let me connect the dots for you.

There’s only so much buyers can bid for houses when 1) their incomes aren’t growing and 2) a 20% down, 30-year fixed-rate mortgage is the only loan available to them.  How do you get such buyers to bid more?  You give them more credit.

  • You let borrowers put down 10% instead of 20%.  Or you let them finance 100% of the purchase price with piggy-back second-lien mortgages.
  • You charge a low teaser rate so borrowers have lower monthly payments to start.
  • You let borrowers with very low credit scores borrow spectacular sums you know they’ll never be able to pay back.
  • You let debt-to-income ratios increase, allowing borrowers to spend more of their monthly income on their mortgage.
  • If debt-to-income ratios get to high, you let borrowers lie about their income and you look the other way.
  • You let borrowers make a minimum payment each month that doesn’t even pay the full interest on their mortgage, causing the principal balance to grow.

Why would lenders extend credit so recklessly?  And why would borrowers go in for it?  Because house prices never go down! Lenders think borrowers will just refinance.  Borrowers think their house’s price will just keep going up.  Everyone’s making money so let’s keep the party going!

The problem is that the credit cycle is self-reinforcing.  As credit standards become progressively looser, bids become progressively higher relative to borrowers’ incomes.  Easier credit = higher prices. But at a certain point, you can’t loosen lending standards anymore.  You can’t artificially inflate prices by pumping more credit into the market.  Instantly the bubble pops; prices go down and the cycle moves into reverse.  Suddenly our housing bubble has turned into a housing bust.

Now, hopefully, you understand why your argument is precisely backwards.  Yes, we are undergoing a “one-in-100 year” bust.  But you don’t get a bust without first inflating a bubble.  Bankers and borrowers are the ones that inflated it.

Option ARM lenders, along with peddlers of subprime and Alt A, deserve particular scorn because they were the ones that offered the easiest credit structures.  Because they are the ones that inflated the last stages of the bubble, they are the ones most responsible for the ferocity of the ensuing bust.

But don’t take my word for it.  Take the market’s.  Lenders and borrowers that relied on these, the most “toxic” lending structures, are suffering more than anyone.  The biggest Alt A, Subprime and option ARM lenders, for instance, are all either bankrupt or headed in that direction.  IndyMac, BankUnited, Downey Savings, FirstFed.  All bankrupt or headed to $0.  Countrywide, WaMu, GoldenWest are already bankrupt, and they brought BofA, Chase and Wells Fargo down with them.  True, the big banks are still breathing with the help of government life-support.  But everyone knows the truth: these patients, with the possible exception of Chase, are already dead.

(By the way, I recommend you study Minksy’s financial instability hypothesis.  Anyone familiar with Minsky’s work spotted this bubble years before it burst.)

Now that we’ve dismissed the major premise of your argument—that it’s the bust itself that is to blame, not the lenders who blew the bubble—the rest of your argument can simply be disregarded.  Still, for reasons articulated at the bottom, I feel compelled to tear it apart piece by piece…

You have four points of contention with the 60 Minutes piece.

1.  You take issue with their source, Paul Bishop:

Bishop is someone with a career history that ought to arouse some suspicion regarding his credibility. “He’d been a top salesman at IBM and spent years as a stock broker,” the report says. “Most everywhere he went, he had a reputation for speaking his mind and ruffling feathers.” My translation: the guy couldn’t cut it in three different industries, in part because he’s an abrasive jerk.

The best you can come up with against Bishop is that he’s an “abrasive jerk?”  If he were dishonest, or had anything significant to gain by speaking out against his bosses, that would be a legitimate criticism.  He doesn’t appear to be dishonest; the data itself actually confirms everything he says.  And you’ve already admitted as much yourself: “Yes, Golden West’s loan portfolio will suffer incredibly high loan losses.”

Nor does he appear to have gained anything by speaking up to his bosses.  To the contrary, speaking up  got him fired.  He wasn’t down with the program so he got canned.

2. You take issue with 60 Minutes’ contention that World Savings pushed mortgages on folks that couldn’t afford them.

Your argument against this point—that Golden West kept its mortgages on the books exposing itself to credit risk—doesn’t prove that the mortgages were affordable.  It just proves the Sandlers and their management team were stupid for exposing themselves to losses.   Again, in your own words, “Golden West’s loan portfolio will suffer incredibly high loan losses.”  By definition, a loan that defaults is one which the borrower couldn’t afford.  Good underwriters are supposed to know when a particular loan product might make the borrower particularly vulnerable to an external shock.

At best you could argue that the Sandlers and their management team just didn’t understand that house prices would revert to the mean relative to income.   Again, all this proves is that they were stupid.  Since they didn’t understand how loan products like theirs were directly responsible for the spike in house prices relative to incomes, of course they wouldn’t understand that the ensuing bust would hit their product the hardest.

But all of this is moot if you just watch their own training video.  In it, you can see very clearly how World Savings trained its brokers to obscure the true nature of their product.  When the actor role-playing a loan applicant asks clearly if picking a minimum payment would cause the loan’s balance to grow—the key feature of negatively amortizing option ARMs as I’m sure you’d agree—the actor role-playing the loan officer dodges the question:  “It’s optional,” he says.  The answer, of course, is yes!

By the way, it’s worth noting that World Saving’s option ARMs were the most toxic brand available.  The typical option ARM allows negative amortization to grow for five years or until the loan balance reaches 115% of its original amount.  But the Sandlers’ option ARMs allow the loan balance to grow for 10 years or to 125% of the original amount.  As I’ve said before on my blog, in allowing negatively amortizing minimum payments, option ARM lenders effectively gave borrowers rope to hang themselves with.  Understood this way, World Savings was giving its borrowers a noose tied to the end of a bungee cord…

3.  You argue, contrary to the 60 Minutes piece, that option ARMs weren’t a bad product for consumers.

To support this claim, you point to charge off rates through 2005 only, which is the data Herb Sandler provided to 60 Minutes.

That’s awfully convenient.  As everyone knows, charge-off rates began their trip to the moon starting shortly thereafter.

My first question…you claim in your bio on to be a “thought leader” in the banking industry and also a superlative analyst.  Really?  Do good analysts simply ignore data that is contrary to their argument?  Are post 2005 charge-off rates somehow unrelated to loans extended in prior years?

It seems to me you’re not so much interested in good analysis as you are in carrying water for Herb and Marion. (“…two of the most able, honorable financial executives of the past half century.”)

Incidentally, in your bio you also note that you’re currently running “a hedge fund that invests solely in financial services companies.”  Would you be willing to publish the returns you’ve achieved over the past few years?  If you’ve invested along the lines of the analysis in this particular post, then your fund has likely gotten slaughtered.  If you invested correctly, and went short, well then you’re blog posts are intellectually dishonest at best.

4.  World Savings, you say, didn’t change its underwriting policy as 60 Minutes claims, forsaking loan quality in favor of loan volume.

What data do you use to support this?  Again, a table that shows the declining percentage of loan applications that were funded…provided by Herb Sandler.

First of all, the decline is hardly notable.  From 68% in 1992 down to 58% in 2005?  Not much to write home about.

But if your argument is about loan volume, why not actually dig up those numbers?  What was the volume of loans written in each year between 1992 and 2005?  If you bothered to look it up, I’m sure you’d find that it was growing.

See my point above: This is water-carrying, not analysis.

In conclusion:  Tom, I think you should stop masquerading as an analyst.  Reading your stuff, and everything else on, it’s clear that you guys aren’t intellectually-honest analysts.  You’re industry shills.

Is it any surprise that you’re also among the most vociferous opponents of mark-to-market accounting and bank nationalization?  On the latter issue, I don’t see anywhere on your site where you actually discuss, in any sort of substantive fashion, how to deal with the bank insolvency crisis.  You criticize others’ ideas.  Do you propose anything of your own?


Rolfe Winkler, CFA

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Visitor recommendations trackback……

[…]one of our visitors recently recommended the following website[…]………

Posted by dc 28 black Friday | Report as abusive