Friday, December 21, 2007

Faire and lazy

As in laissez faire. See this recent post for explanation of this characterisation.

The market crisis du jour is the credit meltdown, blamed by most, simplistically, on the subprime mortgage market.

For some, the villain here is the slick, cheap trick mortgage salesman/broker/packager/bank/syndicator/etc., and the victim is the unsophisticated "Least sophisticated borrowers".

For others, the villain here is the vile, greedy, wannabe homeowner who tried to shoehorn into a house knowing full well that that was not their rightful due in the pecking order of thisngs, and the victim is the hapless, helpful mortgage salesman/broker/packager/bank/syndicator/ etc.

The WSJ profiles some of the victims and villains today (hint: not including average joe home buyers).

In one article, the Journal tabulates about 2 dozen "Companies [that] Blame
Housing, Credit Problems for Weakness", including AutoNation, FedEx, GE, and Hershey in addition to the usual banking, finance and housing industry suspects.

IN another article, the Journal reports that "Fraud [is] Seen as a Driver
In Wave of Foreclosures". It explained,
Skyrocketing foreclosures are a testament to how easy it was to borrow from mortgage lenders in recent years.

It may also have been easy to steal from them, to judge from a multimillion-dollar fraud scheme that federal prosecutors unraveled here in Atlanta. The criminals obtained $6.8 million in mortgages from Bear Stearns Cos., including a $1.8 million mortgage to Calvin Wright, a New Yorker who told the investment bank that he and his wife earned more than $50,000 a month as the top officers of a marketing firm. Mr. Wright submitted statements showing assets of $3 million, a federal indictment alleged.

In fact, Mr. Wright was a phone technician earning only $105,000 a year, with assets of only $35,000, and his wife was a homemaker.

Suspicious Activity Reports, which many lenders are required to file with the Treasury Department's Financial Crimes Enforcement Network when they suspect fraud, shot up nearly 700% between 2000 and 2006.

In 2006, losses from fraud could total a record $4.5 billion, a 100% increase from the previous year, says Arthur Prieston, chairman of the Prieston Group, which provides lenders with mortgage-fraud insurance and training. The surge ranges from one-off cases of fudging and fibbing to organized criminal rings.

"We've created a culture where a great many people know how to take advantage of the system," says Mr. Prieston.

Yet the system itself bears blame. The evolution of mortgages into a securities instrument turned loan origination into a competition. Caution gave way to a push for speed and volume. Embroiled in an all-out war for market share, issuers reduced barriers to credit, for example, by offering so-called "stated-income" loans, which require no proof of income. "The stated-income loan deserves the nickname used by many in the industry, the 'liar's loan,' " says the Mortgage Asset Research Institute, which works with lenders to prevent fraud. A recent review of a sampling of about 100 stated-income loans revealed that almost 60% of the stated amounts were exaggerated by more than 50%, MARI says.

Bear Stearns says the scheme evaded its antifraud efforts by supplying false information at every step of the application process. "We as an industry cannot eliminate fraud entirely," Tom Marano, head of mortgages and asset-backed securities for Bear Sterns, said in a statement about the Atlanta ring. "We can and do continue to develop systems and detection techniques that evolve with the complexity of criminal schemes.'"

But others contend that the Atlanta case illustrates the recklessness with which lenders were issuing mortgages in recent years. "This case should have been an indictment of the mortgage industry," says Patrick Deering, an Atlanta defense attorney involved in the case.

In an eye-opening setback for prosecutors, Mr. Deering and other defense attorneys successfully defended three home builders against charges that they had participated in the scheme. Prosecutors had attacked the home builders for failing to raise red flags when they witnessed mortgages being issued far in excess of what the builders were being paid.

But some defense attorneys went on the offensive and attacked lenders for failing to guard against fraud. Particularly illuminating was the testimony of Lucy Lynch, a former vice president of mortgage operations at BankFirst.

"Fraud was not really a consideration in our world," Ms. Lynch testified, according to a trial transcript.

Ms. Lynch said the bank relied on an outside "loan officer" at a reputable mortgage broker to serve as its "eyes and ears" in the real-estate transactions. As it turned out, that person was indicted as part of the fraud ring.

In some cases, the bank gave its blessing to closing documents that showed unexplained payments of hundreds of thousands of dollars to obscure companies that turned out to be owned by the fraudsters. On three different Atlanta-area homes over a three-month period starting in late 2005, closing documents approved by BankFirst showed large payouts to the same companies.

Ms. Lynch said the bank assumed that the cash was going to subcontractors for construction work. But the bank never asked for invoices. In an interview, Ms. Lynch says the bank was primarily checking to make sure the borrower wasn't being charged any additional fees or debt. "We didn't do anything different from the rest of the industry,'' she said, adding that she believes her testimony helped convict three perpetrators of the fraud -- two borrowers and a real-estate agent who helped lead the ring.

Asked in court why the pattern of payouts didn't raise any red flags, Ms. Lynch responded: "Do you have any idea how many loans came into BankFirst during that time period?" She said BankFirst typically allowed a "15-minute window" from the time it received closing documents by fax to the time it released the loan proceeds to the borrower.

Ultimately, prosecutors failed to convict any of the three home builders. Charges against one were dropped. Another was the subject of a mistrial. And the third was acquitted before the case went to the jury. "These were the wrong people on trial," says Mr. Deering, whose client, home builder Randall Tharp, was acquitted.

One of the biggest losers in the Atlanta scheme was Bear Stearns. A total of $6.8 million in Bear Stearns loans were used by the enterprise. The fourth-largest mortgage that Bear Stearns originated in 2006 went to a borrower in the Atlanta scheme. That involved a mansion on which Bear Stearns lent nearly $3 million. Today, that mansion is in foreclosure and listed at $1.75 million.

Bear Stearns says falsified income and asset documents are difficult to detect "if they are part of a sophisticated fraud ring." In the case of the $1.8 million loan that Bear Stearns issued to Mr. Wright, the New York telephone worker, the company says it verified Mr. Wright's employment and assets.

But Mr. Wright's attorney, Mr. Secret, says, "Bear Stearns certainly couldn't have verified any of the assets or any of the money. It simply wasn't there."

Some banks victimized by the Atlanta ring say they depended in part on a party called the closing attorney to protect their interests. But often, lenders neither choose nor pay for the closing attorney: The buyer does. In this case, the closing attorney was part of the fraud ring. The 58-year-old lawyer, Raymond Costanzo Jr., known in the ring as "Uncle Joe," signed off on several fraudulent sales, and collected $250,000 from the scheme, the indictment alleges. In 2006, Mr. Costanzo pleaded guilty to bank fraud and is awaiting sentencing.

In the neighborhoods where the Atlanta scheme operated, values have plummeted. Many homes associated with the scheme are now in foreclosure. Some have sold for as low as 50% of what buyers in the fraud ring paid. "The banks are getting more and more aggressive in their pricing because they don't want to own these homes," says Warren Lovett, a real estate agent with Coldwell Banker in Atlanta.

Mr. Lovett has taken listings for about 60 foreclosed properties this year. He estimates that half of the foreclosures he's encountered are due to fraud.

IN yet another article, it looked at the industry's activities in trying to hide/downplay/manage/massage the situation, in "Pricing Probes On Wall Street Gather Steam".
During the past several months, financial firms have announced more than $80 billion in write-downs on mortgage-related assets. This includes a $9.4 billion write-down by Morgan Stanley on Wednesday stemming from bad bets on such securities. Last week, UBS AG took a $10 billion write-down bringing its total for the year to $13.7 billion; Merrill Lynch & Co. has had write-downs of $7.9 billion, and more are expected. In all three cases, the firms added to the write-downs they initially announced.

The credit crunch that has hurt some homeowners and led to the Wall Street write-downs has highlighted an unnerving reality in the financial world: Investors increasingly have no way of knowing with any certainty the value of many of the securities now traded.

The SEC has set up a working group that also is looking at whether firms adequately disclosed the risks of these investments and were timely in announcing stresses on the firms' financial statements. The probes are in early stages.

"The fact that we're investigating does not mean that we have uncovered wrongdoing," said Walter Ricciardi, deputy director of the SEC's enforcement division. "We don't know now that we will be recommending any enforcement actions in the subprime area."

To bring civil charges, the SEC likely would need specific evidence that a firm intended to make itself look better by misstating the value of its assets, says David Meister, a former federal prosecutor who now is a partner in New York at the law firm Clifford Chance LLP.

The SEC is asking questions specifically about whether financial firms were valuing mortgage-related securities differently on their own books compared to the valuations they applied to the holdings of customers such as hedge funds.

The SEC also is asking why securities firms would price the same or similar mortgage securities at higher prices for their in-house trading desks than for their asset-management groups, for instance, or the repurchase desk, where large slugs of securities are sold on a short term basis.

Lastly, the Journal dissected the recent Bear Stearns developments, in "Bear's Woe: Beyond Mortgages".
Bear, the smallest of Wall Street's five big investment banks but one of the worst hit by the mortgage downturn, recorded a net loss of $854 million for its fourth quarter.

Bear Stearns Cos.' loss in the fourth quarter, the first in its 84-year history, is stoking concerns that the Wall Street firm's troubles extend beyond the mortgage market and into once-steady money makers like the firm's stock and asset-management divisions.

"The write-downs are less surprising and less disconcerting than what looks like a loss of franchise," wrote Credit Suisse Group securities analyst Susan Roth Katzke in a research report, noting that revenue in equities, fixed-income, and clearing services all dropped significantly. [See, also, The Bear Flu: How It Spread.]

Guambat noted a parallel to this in a story today, in the Sydney Morning Herald tale of the throttling of shopping centre owner gone all but bust, Centro Properties. The thrust of the tale had to do with the over-leveraging and under-disclosing by Centro's management.

But an aside caught Guambat's eye. It had to do with JP Morgan and its huge fees. Because, in many cases of subprime write-downs we're seeing, the banks are saying this is a one-off confined to bad subprime bets but that the rest of their fee generating business is just hunky dory thank you very much.

This was the part of the story that caught Guambat's eye:
It was a spectacular firestorm surrounding a company that had built the value of its business to a portfolio of funds under management worth $26 billion, including 128 shopping centres in Australia and 682 in the US.

Large in stature, he [Centro CEO Andrew Scott] is said not to tolerate fools gladly. But in his fall, he has dragged some big names with him. These include substantial investors such as UBS and Macquarie Bank. Then there are big names behind the organisations, like the executive chairman of JP Morgan in Australia, Andrew Pridham, who has served as mentor to Scott's ambitious program of expansion. It signals challenging times for what has been a lucrative partnership: in one transaction alone, underwriting a capital raising of $1 billion for Centro Retail Group in March, JP Morgan banked $25 million.

Assuming a not insignificant part of the fees these banks have been earning have been associated with feeding the various aspects of the subprime melt-up, what will become of those fees once the subprime melt-down runs its course?

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