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By Scores

I am in New York this afternoon attending and speaking at the Bank Credit Analyst Conference. I have to say that the panel on emerging markets gave me some real food for thought and an idea or two for a future e-letter. I have been a fan of emerging markets in general (with some exceptions) for some time but I should become even more so I think.

For today’s Outside the Box I have something a little different. Michael Hudson has written a book called The Monster about the Mortgage industry, and specifically Ameriquest and Lehman. Someone sent me his introduction and I read it on the plane. I will buy the book. It made me angry. And the new financial regulations don’t address some of the real problem here.

It is an easy read, well written and lots of great quotes and stories. I won’t say enjoy but do take the tine to read and then think about what you just read and about the culture in our country.

You ready for the World Series analyst,

John Mauldin, Editor

Outside the Box

The Monster : How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America–and Spawned a Global Crisis

Michael W. Hudson

Introduction:
Bait and Switch

A few weeks after he started working at Ameriquest Mortgage, Mark Glover looked up from his cubicle and saw a coworker do something odd. The guy stood at his desk on the twenty-third floor of downtown Los Angeles’s Union Bank Building. He placed two sheets of paper against the window. Then he used the light streaming through the window to trace something from one piece of paper to another. Somebody’s signature.

Glover was new to the mortgage business. He was twenty-nine and hadn’t held a steady job in years. But he wasn’t stupid. He knew about financial sleight of hand—at that time, he had a check-fraud charge hanging over his head in the L.A. courthouse a few blocks away. Watching his coworker, Glover’s first thought was: How can I get away with that? As a loan officer at Ameriquest, Glover worked on commission. He knew the only way to earn the six-figure income Ameriquest had promised him was to come up with tricks for pushing deals through the mortgage-financing pipeline that began with Ameriquest and extended through Wall Street’s most respected investment houses.

Glover and the other twentysomethings who filled the sales force at the downtown L.A. branch worked the phones hour after hour, calling strangers and trying to talk them into refinancing their homes with high-priced “subprime” mortgages. It was 2003, subprime was on the rise, and Ameriquest was leading the way. The company’s owner, Roland Arnall, had in many ways been the founding father of subprime, the business of lending money to home owners with modest incomes or blemished credit histories. He had pioneered this risky segment of the mortgage market amid the wreckage of the savings and loan disaster and helped transform his company’s headquarters, Orange County, California, into the capital of the subprime industry. Now, with the housing market booming and Wall Street clamoring to invest in subprime, Ameriquest was growing with startling velocity.

Up and down the line, from loan officers to regional managers and vice presidents, Ameriquest’s employees scrambled at the end of each month to push through as many loans as possible, to pad their monthly production numbers, boost their commissions, and meet Roland Arnall’s expectations. Arnall was a man “obsessed with loan volume,” former aides recalled, a mortgage entrepreneur who believed “volume solved all problems.” Whenever an underling suggested a goal for loan production over a particular time span, Arnall’s favorite reply was: “We can do twice that.” Close to midnight Pacific time on the last business day of each month, the phone would ring at Arnall’s home in Los Angeles’s exclusive Holmby Hills neighborhood, a $30 million estate that once had been home to Sonny and Cher.On the other end of the telephone line, a vice president in Orange County would report the month’s production numbers for his lending empire. Even as the totals grew to $3 billion or $6 billion or $7 billion a month—figures never before imagined in the subprime business—Arnall wasn’t satisfied. He wanted more. “He would just try to make you stretch beyond what you thought possible,” one former Ameriquest executive recalled. “Whatever you did, no matter how good you did, it wasn’t good enough.”

Inside Glover’s branch, loan officers kept up with the demand to produce by guzzling Red Bull energy drinks, a favorite caffeine pick-me-up for hardworking salesmen throughout the mortgage industry. Government investigators would later joke that they could gauge how dirty a home-loan location was by the number of empty Red Bull cans in the Dumpster out back. Some of the crew in the L.A. branch, Glover said, also relied on cocaine to keep themselves going, snorting lines in washrooms and, on occasion, in their cubicles.

The wayward behavior didn’t stop with drugs. Glover learned that his colleague’s art work wasn’t a matter of saving a borrower the hassle of coming in to supply a missed signature. The guy was forging borrowers’ signatures on government-required disclosure forms, the ones that were supposed to help consumers understand how much cash they’d be getting out of the loan and how much they’d be paying in interest and fees. Ameriquest’s deals were so overpriced and loaded with nasty surprises that getting customers to sign often required an elaborate web of psychological ploys, outright lies, and falsified papers. “Every closing that we had really was a bait and switch,” a loan officer who worked for Ameriquest in Tampa, Florida, recalled. ” ‘Cause you could never get them to the table if you were honest.” At companywide gatherings, Ameriquest’s managers and sales reps loosened up with free alcohol and swapped tips for fooling borrowers and cooking up phony paperwork. What if a customer insisted he wanted a fixed-rate loan, but you could make more money by selling him an adjustable-rate one? No problem. Many Ameriquest salespeople learned to position a few fixed-rate loan documents at the top of the stack of paperwork to be signed by the borrower. They buried the real documents—the ones indicating the loan had an adjustable rate that would rocket upward in two or three years—near the bottom of the pile. Then, after the borrower had flipped from signature line to signature line, scribbling his consent across the entire stack, and gone home, it was easy enough to peel the fixed-rate documents off the top and throw them in the trash.

At the downtown L.A. branch, some of Glover’s coworkers had a flair for creative documentation. They used scissors, tape, Wite-Out, and a photocopier to fabricate W-2s, the tax forms that indicate how much a wage earner makes each year. It was easy: Paste the name of a low-earning borrower onto a W-2 belonging to a higher-earning borrower and, like magic, a bad loan prospect suddenly looked much better. Workers in the branch equipped the office’s break room with all the tools they needed to manufacture and manipulate official documents. They dubbed it the “Art Department.”

At first, Glover thought the branch might be a rogue office struggling to keep up with the goals set by Ameriquest’s headquarters. He discovered that wasn’t the case when he transferred to the company’s Santa Monica branch. A few of his new colleagues invited him on a field trip to Staples, where everyone chipped in their own money to buy a state-of-the-art scanner-printer, a trusty piece of equipment that would allow them to do a better job of creating phony paperwork and trapping American home owners in a cycle of crushing debt.

Carolyn Pittman was an easy target. She’d dropped out of high school to go to work, and had never learned to read or write very well. She worked for decades as a nursing assistant. Her husband, Charlie, was a longshoreman.In 1993 she and Charlie borrowed $58,850 to buy a one-story, concrete block house on Irex Street in a working-class neighborhood of Atlantic Beach, a community of thirteen thousand near Jacksonville, Florida. Their mortgage was government-insured by the Federal Housing Administration, so they got a good deal on the loan. They paid about $500 a month on the FHA loan, including the money to cover their home insurance and property taxes.

Even after Charlie died in 1998, Pittman kept up with her house payments. But things were tough for her. Financial matters weren’t something she knew much about. Charlie had always handled what little money they had. Her health wasn’t good either. She had a heart attack in 2001, and was back and forth to hospitals with congestive heart failure and kidney problems.

Like many older black women who owned their homes but had modest incomes, Pittman was deluged almost every day, by mail and by phone, with sales pitches offering money to fix up her house or pay off her bills. A few months after her heart attack, a salesman from Ameriquest Mortgage’s Coral Springs office caught her on the phone and assured her he could ease her worries. He said Ameriquest would help her out by lowering her interest rate and her monthly payments.

She signed the papers in August 2001. Only later did she discover that the loan wasn’t what she’d been promised. Her interest rate jumped from a fixed 8.43 percent on the FHA loan to a variable rate that started at nearly 11 percent and could climb much higher. The loan was also packed with more than $7,000 in up-front fees, roughly 10 percent of the loan amount.

Pittman’s mortgage payment climbed to $644 a month. Even worse, the new mortgage didn’t include an escrow for real-estate taxes and insurance. Most mortgage agreements require home owners to pay a bit extra—often about $100 to $300 a month—which is set aside in an escrow account to cover these expenses. But many subprime lenders obscured the true costs of their loans by excluding the escrow from their deals, which made the monthly payments appear lower. Many borrowers didn’t learn they had been tricked until they got a big bill for unpaid taxes or insurance a year down the road.

That was just the start of Pittman’s mortgage problems. Her new mortgage was a matter of public record, and by taking out a loan from Ameriquest, she’d signaled to other subprime lenders that she was vulnerable—that she was financially unsophisticated and was struggling to pay an unaffordable loan. In 2003, she heard from one of Ameriquest’s competitors, Long Beach Mortgage Company.

Pittman had no idea that Long Beach and Ameriquest shared the same corporate DNA. Roland Arnall’s first subprime lender had been Long Beach Savings and Loan, a company he had morphed into Long Beach Mortgage. He had sold off most of Long Beach Mortgage in 1997, but hung on to a portion of the company that he rechristened Ameriquest. Though Long Beach and Ameriquest were no longer connected, both were still staffed with employees who had learned the business under Arnall.

A salesman from Long Beach Mortgage, Pittman said, told her that he could help her solve the problems created by her Ameriquest loan. Once again, she signed the papers. The new loan from Long Beach cost her thousands in up-front fees and boosted her mortgage payments to $672 a month.

Ameriquest reclaimed her as a customer less than a year later. A salesman from Ameriquest’s Jacksonville branch got her on the phone in the spring of 2004. He promised, once again, that refinancing would lower her interest rate and her monthly payments. Pittman wasn’t sure what to do. She knew she’d been burned before, but she desperately wanted to find a way to pay off the Long Beach loan and regain her financial bearings. She was still pondering whether to take the loan when two Ameriquest representatives appeared at the house on Irex Street. They brought a stack of documents with them. They told her, she later recalled, that it was preliminary paperwork, simply to get the process started. She could make up her mind later. The men said, “sign here,” “sign here,” “sign here,” as they flipped through the stack. Pittman didn’t understand these were final loan papers and her signatures were binding her to Ameriquest. “They just said sign some papers and we’ll help you,” she recalled.

To push the deal through and make it look better to investors on Wall Street, consumer attorneys later alleged, someone at Ameriquest falsified Pittman’s income on the mortgage application. At best, she had an income of $1,600 a month—roughly $1,000 from Social Security and, when he could afford to pay, another $600 a month in rent from her son. Ameriquest’s paperwork claimed she brought in more than twice that much—$3,700 a month.

The new deal left her with a house payment of $1,069 a month—nearly all of her monthly income and twice what she’d been paying on the FHA loan before Ameriquest and Long Beach hustled her through the series of refinancings. She was shocked when she realized she was required to pay more than $1,000 a month on her mortgage. “That broke my heart,” she said.

For Ameriquest, the fact that Pittman couldn’t afford the payments was of little consequence. Her loan was quickly pooled, with more than fifteen thousand other Ameriquest loans from around the country, into a $2.4 billion “mortgage-backed securities” deal known as Ameriquest Mortgage Securities, Inc. Mortgage Pass-Through Certificates 2004-R7. The deal had been put together by a trio of the world’s largest investment banks: UBS, JPMorgan, and Citigroup. These banks oversaw the accounting wizardry that transformed Pittman’s mortgage and thousands of other subprime loans into investments sought after by some of the world’s biggest investors. Slices of 2004-R7 got snapped up by giants such as the insurer MassMutual and Legg Mason, a mutual fund manager with clients in more than seventy-five countries. Also among the buyers was the investment bank Morgan Stanley, which purchased some of the securities and placed them in its Limited Duration Investment Fund, mixing them with investments in General Mills, FedEx, JC Penney, Harley-Davidson, and other household names.

It was the new way of Wall Street. The loan on Carolyn Pittman’s one-story house in Atlantic Beach was now part of the great global mortgage machine. It helped swell the portfolios of big-time speculators and middle-class investors looking to build a nest egg for retirement. And, in doing so, it helped fuel the mortgage empire that in 2004 produced $1.3 billion in profits for Roland Arnall.

In the first years of the twenty-first century, Ameriquest Mortgage unleashed an army of salespeople on America. They numbered in the thousands. They were young, hungry, and relentless in their drive to sell loans and earn big commissions. One Ameriquest manager summed things up in an e-mail to his sales force: “We are all here to make as much fucking money as possible. Bottom line. Nothing else matters.” Home owners like Carolyn Pittman were caught up in Ameriquest’s push to become the nation’s biggest subprime lender.

The pressure to produce an ever-growing volume of loans came from the top. Executives at Ameriquest’s home office in Orange County leaned on the regional and area managers; the regional and area managers leaned on the branch managers. And the branch managers leaned on the salesmen who worked the phones and hunted for borrowers willing to sign on to Ameriquest loans. Men usually ran things, and a frat-house mentality ruled, with plenty of partying and testosterone-fueled swagger. “It was like college, but with lots of money and power,” Travis Paules, a former Ameriquest executive, said. Paules liked to hire strippers to reward his sales reps for working well after midnight to get loan deals processed during the end-of-the-month rush. At Ameriquest branches around the nation, loan officers worked ten- and twelve-hour days punctuated by “Power Hours”—do-or-die telemarketing sessions aimed at sniffing out borrowers and separating the real salesmen from the washouts. At the branch where Mark Bomchill worked in suburban Minneapolis, management expected Bomchill and other loan officers to make one hundred to two hundred sales calls a day. One manager, Bomchill said, prowled the aisles between desks like “a little Hitler,” hounding salesmen to make more calls and sell more loans and bragging he hired and fired people so fast that one peon would be cleaning out his desk as his replacement came through the door.As with Mark Glover in Los Angeles, experience in the mortgage business wasn’t a prerequisite for getting hired. Former employees said the company preferred to hire younger, inexperienced workers because it was easier to train them to do things the Ameriquest way. A former loan officer who worked for Ameriquest in Michigan described the company’s business model this way: “People entrusting their entire home and everything they’ve worked for in their life to people who have just walked in off the street and don’t know anything about mortgages and are trying to do anything they can to take advantage of them.”

Ameriquest was not alone. Other companies, eager to get a piece of the market for high-profit loans, copied its methods, setting up shop in Orange County and helping to transform the county into the Silicon Valley of subprime lending. With big investors willing to pay top dollar for assets backed by this new breed of mortgages, the push to make more and more loans reached a frenzy among the county’s subprime loan shops. “The atmosphere was like this giant cocaine party you see on TV,” said Sylvia Vega-Sutfin, who worked as an account executive at BNC Mortgage, a fast-growing operation headquartered in Orange County just down the Costa Mesa Freeway from Ameriquest’s headquarters. “It was like this giant rush of urgency.” One manager told Vega-Sutfin and her coworkers that there was no turning back; he had no choice but to push for mind-blowing production numbers. “I have to close thirty loans a month,” he said, “because that’s what my family’s lifestyle demands.”

Michelle Seymour, one of Vega-Sutfin’s colleagues, spotted her first suspect loan days after she began working as a mortgage underwriter at BNC’s Sacramento branch in early 2005. The documents in the file indicated the borrower was making a six-figure salary coordinating dances at a Mexican restaurant. All the numbers on the borrower’s W-2 tax form ended in zeros—an unlikely happenstance—and the Social Security and tax bite didn’t match the borrower’s income. When Seymour complained to a manager, she said, he was blasé, telling her, “It takes a lot to have a loan declined.”

BNC was no fly-by-night operation. It was owned by one of Wall Street’s most storied investment banks, Lehman Brothers. The bank had made a big bet on housing and mortgages, styling itself as a player in commercial real estate and, especially, subprime lending. “In the mortgage business, we used to say, ‘All roads lead to Lehman,’ ” one industry veteran recalled.Lehman had bought a stake in BNC in 2000 and had taken full ownership in 2004, figuring it could earn even more money in the subprime business by cutting out the middleman. Wall Street bankers and investors flocked to the loans produced by BNC, Ameriquest, and other subprime operators; the steep fees and interest rates extracted from borrowers allowed the bankers to charge fat commissions for packaging the securities and provided generous yields for investors who purchased them. Up-front fees on subprime loans totaled thousands of dollars. Interest rates often started out deceptively low—perhaps at 7 or 8 percent—but they almost always adjusted upward, rising to 10 percent, 12 percent, and beyond. When their rates spiked, borrowers’ monthly payments increased, too, often climbing by hundreds of dollars. Borrowers who tried to escape overpriced loans by refinancing into another mortgage usually found themselves paying thousands of dollars more in backend fees—”prepayment penalties” that punished them for paying off their loans early. Millions of these loans—tied to modest homes in places like Atlantic Beach, Florida; Saginaw, Michigan; and East San Jose, California—helped generate great fortunes for financiers and investors. They also helped lay America’s economy low and sparked a worldwide financial crisis.

The subprime market did not cause the U.S. and global financial meltdowns by itself. Other varieties of home loans and a host of arcane financial innovations—such as collateralized debt obligations and credit default swaps—also came into play. Nevertheless, subprime played a central role in the debacle. It served as an early proving ground for financial engineers who sold investors and regulators alike on the idea that it was possible, through accounting alchemy, to turn risky assets into “Triple-A-rated” securities that were nearly as safe as government bonds. In turn, financial wizards making bets with CDOs and credit default swaps used subprime mortgages as the raw material for their speculations. Subprime, as one market watcher said, was “the leading edge of a financial hurricane.”

This book tells the story of the rise and fall of subprime by chronicling the rise and fall of two corporate empires: Ameriquest and Lehman Brothers. It is a story about the melding of two financial cultures separated by a continent: Orange County and Wall Street.

Ameriquest and its strongest competitors in subprime had their roots in Orange County, a sunny land of beauty and wealth that has a history as a breeding ground for white-collar crime: boiler rooms, S&L frauds, real-estate swindles. That history made it an ideal setting for launching the subprime industry, which grew in large measure thanks to bait-and-switch salesmanship and garden-variety deception. By the height of the nation’s mortgage boom, Orange County was home to four of the nation’s six biggest subprime lenders. Together, these four lenders—Ameriquest, Option One, Fremont Investment & Loan, and New Century—accounted for nearly a third of the subprime market. Other subprime shops, too, sprung up throughout the county, many of them started by former employees of Ameriquest and its corporate forebears, Long Beach Savings and Long Beach Mortgage.

Lehman Brothers was, of course, one of the most important institutions on Wall Street, a firm with a rich history dating to before the Civil War. Under its pugnacious CEO, Richard Fuld, Lehman helped bankroll many of the nation’s shadiest subprime lenders, including Ameriquest. “Lehman never saw a subprime lender they didn’t like,” one consumer lawyer who fought the industry’s abuses said.Lehman and other Wall Street powers provided the financial backing and sheen of respectability that transformed subprime from a tiny corner of the mortgage market into an economic behemoth capable of triggering the worst economic crisis since the Great Depression.

A long list of mortgage entrepreneurs and Wall Street bankers cultivated the tactics that fueled subprime’s growth and its collapse, and a succession of politicians and regulators looked the other way as abuses flourished and the nation lurched toward disaster: Angelo Mozilo and Countrywide Financial; Bear Stearns, Washington Mutual, Wells Fargo; Alan Greenspan and the Federal Reserve; and many more. Still, no Wall Street firm did more than Lehman to create the subprime monster. And no figure or institution did more to bring subprime’s abuses to life across the nation than Roland Arnall and Ameriquest.

Among his employees, subprime’s founding father was feared and admired. He was a figure of rumor and speculation, a mysterious billionaire with a rags-to-riches backstory, a hardscrabble street vendor who reinvented himself as a big-time real-estate developer, a corporate titan, a friend to many of the nation’s most powerful elected leaders. He was a man driven, according to some who knew him, by a desire to conquer and dominate. “Roland could be the biggest bastard in the world and the most charming guy in the world,” said one executive who worked for Arnall in subprime’s early days. “And it could be minutes apart.”He displayed his charm to people who had the power to help him or hurt him. He cultivated friendships with politicians as well as civil rights advocates and antipoverty crusaders who might be hostile to the unconventional loans his companies sold in minority and working-class neighborhoods. Many people who knew him saw him as a visionary, a humanitarian, a friend to the needy. “Roland was one of the most generous people I have ever met,” a former business partner said.He also left behind, as another former associate put it, “a trail of bodies”—a succession of employees, friends, relatives, and business partners who said he had betrayed them. In summing up his own split with Arnall, his best friend and longtime business partner said, “I was screwed.”Another former colleague, a man who helped Arnall give birth to the modern subprime mortgage industry, said: “Deep down inside he was a good man. But he had an evil side. When he pulled that out, it was bad. He could be extremely cruel.” When they parted ways, he said, Arnall hadn’t paid him all the money he was owed. But, he noted, Arnall hadn’t cheated him as badly as he could have. “He fucked me. But within reason.”

Roland Arnall built a company that became a household name, but shunned the limelight for himself. The business partner who said Arnall had “screwed” him recalled that Arnall fancied himself a puppet master who manipulated great wealth and controlled a network of confederates to perform his bidding. Another former business associate, an underling who admired him, explained that Arnall worked to ingratiate himself to fair-lending activists for a simple reason: “You can take that straight out of The Godfather: ‘Keep your enemies close.’ ”

Excerpted from The Monster by Michael W. Hudson
Copyright 2010 by Michael W. Hudson
Published in 2010 by Times Books/Henry Holt and Company

In what can be considered dated news especially considering the late Sept new round of foreclosure delays, the Aug S&P/CS 20 city home price index fell .28% m/o/m seasonally adjusted vs expectations of -.20% while the y/o/y gain of 1.7% was below the estimate of 2.1%. Of the 20 cities, 8 saw y/o/y gains while Las Vegas again led the declines. On a m/o/m basis, only New York saw a SA gain, albeit modestly of .01%. The overall S&P/CS price level is now 6.7% above the low in April ’09 but still 28% below the record high in July ’06. The late Sept foreclosure halts will distort housing prices into year end as the temporary moratorium can lift home prices in the short term as less supply is put onto the market but would quickly reverse once the supply overhang is inevitably unleashed when things get squared up on the foreclosure side. The faster the foreclosure process, the faster we get to a bottom and the faster our economy can recover.

We’re deep into earnings season, and there’s no better drama than quarterly corporate earnings calls and the “town hall”  meetings  for employees (otherwise known as McKinsey Masterpiece Theater) that goes along with them.  They are chock full of cryptic euphemisms that could easily mislead the novice observer.  So, as a BP Public Service™, we offer the following guide to earnings calls and company town halls.  These comments or references are made by senior management types during the “call or hall.”  Town Halls these days are just about synonymous with “crisis.”  Topics typically discussed include management changes (i.e. “spending more time with his family/pursue other interests, we thank him for a long and distinguished career”), a new comp structure (involving “enhancements” that in reality result in lower compensation; how does that work?), suspension of a dividend and/or massive writedown or loss, damage control of one or more messes caused by either lack of oversight or pure greed, or a face-saving, reorganizing-the-deck-chairs-on-the-Titanic restructuring that allows Peter Principle managers to keep their jobs a while longer while the boat takes on more water.

That said, keep your ears open for any of the following:

1. “I don’t look at the stock price, and suggest you don’t, either.” I don’t look at the stock price because my stewardship of the company currently has it in the crapper, and if I did look I’d have no choice but to resign.  And if you look, you’d agree.

2. “Look at our stock price.” A true Unicorn of a phrase heard very rarely on earnings calls or in town hall meetings.  Uttered almost exclusively by Steve Jobs.

3. Anything having to do with “right-sizing” the company. At current staffing levels, the company might have difficulty paying its senior management the outlandishly egregious salaries and bonuses we’re currently receiving.  Consequently, we have to cut staff by X percent so our gravy train can keep on chugging.  This phrase is usually a favorite of CEOs who like to give the pretense of knowing what’s going on, but actually have no clue whatsoever (queue Stan O’Neal, who right-sized every department except the one that ultimately blew up Merrill Lynch.  Way to go, Stan.  The only thing that should have “right-sized” was O’Neal’s exit package — down to a single-fare MetroCard.).

4. Anything relating to “synergies.” A mythical construct where the whole is greater than the sum of the parts, i.e. that two (or more) businesses that have come together via merger or acquisition actually complement each other.  More often than not, these combinations usually involve forcing a square peg into a round hole.  If there were truly “synergies” instead of absurd overlap in the majority of M&A deals, said deals would not be accompanied by announcements of massive layoffs — each side would continue doing what it does best and the businesses would, in fact, complement each other.  For example, Viagra and Cialis would be a terrible combination.  On the other hand, a Viagra/Red Bull NoonerPak™ would let you do your business and then fight off that drowsy after-effect so you could…do your business.  Perfect!  (Damn, is McKinsey hiring?)

5. “We’re going to focus on our core competencies.” I have no idea how to grow our business outside the realm of what it was when I took the reins, and any attempts I’ve made to do so have failed.  So we will continue to do what we’ve always done and hope that we catch a tailwind.  (Quick, someone get McKinsey on the phone.)

6. “I’m going to ask you all to redouble your efforts.” As with #3, this is a thinly veiled reference implying that the same workforce must increase revenues (top line), and then profits (bottom line), after which senior management salaries and bonuses will skyrocket.  See also: Productivity, Increasing.

7.  “We should discuss that off-line.” Said in response to a question asked during a town hall (very bad form to say to an analyst on an earnings call), this response means that the questioner will likely be given a cardboard box in which to pack his/her personal belongings and be escorted out of the building by security.  Takeaway:  Never ask a challenging question during a town hall.  If you are not going to genuflect before senior management, keep your trap shut.  After all, they ran the company into the ground much better than you ever could.

8. Anything related to “visibility.” In this age of short-termism, “visibility” centers around this or next quarter’s earnings, no further.

9. Any comment mentioning “respect” for a competitor. Simply an outright lie.  No CEO or his/her team has any respect for any competitor.  They have nothing but contempt for them, particularly if said competitor is kicking their ass.

10.  Anything having to do with “circling back.” This response to a question means that the answer is unknown or, if the answer is known but this answer is given regardless, it implies #7 is in effect, which means the question should not have been asked and the questioner is on borrowed time.  In either case, the bottom line is that the answer will never be made public.

11.  Talk about our “best ideas” or our “best thinking.” I would hope that senior management is relaying its “best ideas” and “best thinking” to the rank and file.  If not, why are they being so egregiously overpaid?  Are you kidding me?  Do you think I come to work every day to hear your “worst ideas” or “worst thinking” although, in fact, given what your “best thinking” has done for us, that might not be such a bad idea.

12.  All the things that happen “at the end of the day.” This is little more than verbal celery.  The only thing that actually happens at the end of the day is that everyone goes home wondering WTF senior management was talking about and how they can possibly be so divorced from reality.

13.  Know the difference between “tactical” and “strategic.” “Tactical” refers to grievous errors in decision-making to be made in the short-run.  “Strategic” refers to the slippery slope the company will be on longer term once the “tactical” screw-ups have been executed.  Related: “Strategic alternatives,” which implies that management recognizes the extent to which they’ve destroyed the company and are looking to pull a collective Stephen Slater while the worker bees go about their business, not-so-blissfully unaware.

14.  “We’re going to assess the situation.”  Whatever initiative we undertook was an epic failure (how about adding this to the next corporate tchotchke catalog?),  so now we are going to step back, wait a while, and hope that everyone forgets about it so we don’t have to discuss it on our call next quarter.  In the meantime, we will continue to work on how best to spin this to put it in the best possible light in the event it doesn’t just go away or we can’t sweep it under the rug.

There are dozens — probably hundreds — more.  By all means please contribute in comments.  Keep it pithy.

H/T to Maggie for her help.

The infamous QE trio of the US, UK and Japan may be on the cusp of losing a member. UK Q3 GDP rose twice expectations at a 3.2% annualized rate and combine this with y/o/y CPI gains at 3%+ for 9 straight months and the BoE may have to think twice about pulling a Fed. In response, the 10 yr Gilt yield is rising to a 1 month high and the pound is sharply higher. S&P also raised its AAA UK rating outlook from negative to stable in response to the tough budget cuts announced by the new gov’t. French consumer confidence rose to an 8 month high and Italian confidence went to a 6 month high while German consumer confidence held at the highest level since May ’08. The fly in the ointment in Europe is a sharp selloff in Greek debt after Pimco’s El-Erian said Greece will likely default over the next few yr’s because the debt hurdle is insurmountable without a restructuring. Also, disappointing earnings from UBS and MT are weighing on European stocks.

With just a week before the FOMC announces another round of money printing, which the persistent dissenter Hoenig last night called “a very dangerous gamble going forward,” the 10 yr note yield is quietly rising to the highest level in 4 1/2 weeks and is just a few bps from the level of Aug 27th, the day Bernanke spoke in Jackson Hole and broached the possibility of more action. Because of the inflation concerns derived from Fed policy, the 30 yr yield is rising to 3.94%, 25 bps above the Aug 27th closing level. Rates at shorter maturities are below their Aug 27th close but the action across the longer end highlights the battle the Fed has on its hands if it wants to take on the bond market. An aside, ICSC cut its Oct retail sales comp estimate to a gain of 2-2.5% from 2.5% ex WMT.

Need to hide $40b in losses from view? You can, in one easy step — just change the accounting methodology, and like magic, yo can make the loss disappear!

“The United States Treasury concealed $40 billion in likely taxpayer losses on the bailout of the American International Group earlier this month, when it abandoned its usual method for valuing investments, according to a report by the special inspector general for the Troubled Asset Relief Program . . .

In early October, the Treasury issued a report predicting that the taxpayers would ultimately lose just $5 billion on their investment in A.I.G., a remarkable outcome, since the insurance company was extended $182 billion in taxpayer money in the early months of its rescue. The prediction of a modest loss, widely reported as A.I.G., the Federal Reserve and the Treasury rushed to complete an exit plan, contrasted with an earlier prediction by the Treasury that the taxpayers would lose $45 billion.”

This is my favorite part of the article:

“[SIGTARP Inspector Neil] Barofsky said he had written to the Treasury secretary, Timothy F. Geithner, in mid-October, after widespread reports in the news media about the possibility that the Treasury could wind down its position in A.I.G. with just a $5 billion loss. He recommended that the Treasury correct the October report, perhaps by adding a footnote saying the methodology for calculating its losses had changed.

The Treasury declined. It sent back a letter saying its methodology for calculating losses had not really changed, although its assumptions had . . . “

They refused to add a footnote — if this was a public firm the SEC would be all over their asses! Adding a footnote disclosing the accounting change was too much for Treasury — outrageous.

Yet more reasons why bailouts are a bad idea: Incentivizing the government to lie . . .

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Sources:

SIGTARP October 26, 2010 – Quarterly Report to Congress [PDF]

Treasury Hid A.I.G. Loss, Report Says
MARY WILLIAMS WALSH
NYT, October 26, 2010
http://www.nytimes.com/2010/10/26/business/26tarp.html

Washington’s Blog strives to provide real-time, well-researched and actionable information.  George – the head writer at Washington’s Blog – is a busy professional and a former adjunct professor.

~~~

You’ve heard the name Mortgage Electronic Registration Systems or “MERS” mentioned in relation to the foreclosure problems in the residential real estate market.

But what is MERS?

It is the company created and owned by all of the big banks to process title to property in the U.S. Approximately 60% of the nation’s residential mortgages are recorded in the name of MERS.

MERS is a shell corporation with no employees, but thousands of officers.

As the treasurer and secretary of MERS admitted in a deposition:

Q Does MERS have any salaried employees?
A No.
Q Does MERS have any employees?
A Did they ever have any? I couldn’t hear you.
Q Does MERS have any employees currently?
A No.
Q In the last five years has MERS had any
employees?
A No.
Q To whom do the officers of MERS report?
A The Board of Directors.

***

A That’s correct.
Q And in what capacity would they report to you?
A As a corporate officer. I’m the secretary.
Q As a corporate officer of what?
Of MERS.
Q So you are the secretary of MERS, but are not
an employee of MERS?
A That’s correct.

***

How many assistant secretaries have you
appointed pursuant to the April 9, 1998 resolution; how
many assistant secretaries of MERS have you appointed?
A I don’t know that number.
Q Approximately?
A I wouldn’t even begin to be able to tell you
right now.
Q Is it in the thousands?
A Yes.
Q Have you been doing this all around the
country in every state in the country?
A Yes.
Q And all these officers I understand are unpaid
officers of MERS?
A Yes.
Q And there’s no live person who is an employee
of MERS that they report to, is that correct, who is an
employee?
[Objection]
A There are no employees of MERS.

(page 70, line 1 through page 72, line 8)

In another deposition, a legal assistant at a law firm initiating 4000 to 7000 foreclosures per month in Florida held herself out as “vice president” and “assistant secretary” of MERS. She testified:

Q: The question was you have no job duties as an assistant secretary of MERS, correct?
A: I do not have any job duties other than signing the assignments and mortgage. Does that help?
Q: Yes. Here, I’ll try to rephrase this. Do you attend any board meetings at MERS?
A: No, sir.
Q: Do you attend any meetings at all at MERS?
A: No, sir.
Q: Do you report to the secretary of MERS?
A: No, sir.
Q: Who is the secretary of MERS?
A: I have no idea.

***

Q: Where are the MERS offices located?
A: I can’t remember.
Q: How many offices do they have?
A: I have no idea.
Q: Do you know where their headquarters are?
A: Nope.
Q: Have you ever been there?
A: No.
Q: How many employees do they have?
A: I have no idea.

(pages 11 & 12)

She further testified that her signatures on “these assignments,” which from all indications were and are at least several thousand in number, were in no way attestations that the statements contained therein were accurate or truthful. She further testified that she was the person with the most knowledge about the subject assignment.

For example, she testified:

Q: It says, ‘but effective as of the 19th day of February, 2008.” Do you see that?
A: Yes.
Q: Where did you get that date from?
A: I did not pick that date. That date was put in by the processor that prepared the
assignment.
Q: And who was that?
A: Off the top-of-my-head, I do not know who actually typed this assignment.
Q: Okay. But you are signing on behalf of MERS, and you are stating here that it is effective as of the 19th day of February, 2008, correct?
A: Correct.
Q: At the time you signed this, what reason did you have, as agent for MERS, to make it
effective as of the 19th day of February, 2008?
A: I did not pick that date. And I do not recall this document.
Q: Sitting here today, you have no idea why it is that it says, “effective as of the 19th day of February, 2008.” Is that correct?
A: Looking at this one particular piece of paper, I do not recall or know the answer to that question, no.
Q: Is there some general practice, of which you are aware, that would give us information as to why this particular date was inserted?
A: That information was determined by the people that review the file prior to me.
Q: And what would they base that on, as a general practice?
A: I do not know.
Q: You don’t know? Were, to your knowledge, any physical documents transferred on February 19, 2008?
A: I do not know.
Q: To your knowledge, does the 19th day of February, 2008 have any significance?
A: I do not know.
Q: Ma’am, if you signed this document on behalf of MERS, picking this date, this effective
date – -
A: I did not pick the effective date.
Q: But you ratified it by signing this; didn’t you?
[objection]
Q: Didn’t you attest to the accuracy of that date by signing this document?
[objection]
A: I would say, no.
Q: Did you attest to this document, as a whole, by signing it?
[objection]
A: I do not think that in my capacity of signing these assignments, it was my position to attest. My role was to be given a document that had been reviewed by an attorney, had been reviewed by a title examiner, had instructions from the client, and I was to sign the assignment as secretary on behalf of MERS.
Q: Right. And when you signed it as secretary on behalf of MERS, were you approving and agreeing with the terms contained therein for MERS?
A: I believe I was approving and agreeing to the fact that the mortgage needed to be assigned from MERS to another entity.

(pages 13 and 14)

In other words, assignments of title were never actually created, notarized and recorded, as required by state law. The “vice president” and “assistant secretary” MERS signing sworn statements under penalty perjury was simply making it up and doing what she was told.

In that light, Yves Smith’s report that “no one in the industry transferred the paper” makes perfect sense.

Why MERS?

But why was MERS created in the first place?

MERS, the banks and the mainstream financial press all say that it was simply to save fees by digitizing mortgage electronic.

But as Ellen Brown notes, there is in reality a very different reason that the big banks created MERS:

The rating agencies required that the conduit be “bankruptcy remote,” which meant it could hold title to nothing ….

Indeed, the secretary and treasurer of MERS admitted this in a deposition, stating:

As a requirement for mortgages that were securing loans or promissory notes that were sold to securitize trust, the rating agencies would only allow mortgages MERS — well let me step back. They required that a bankruptcy remote single purpose entity be created in order for transactions holding loans secured by MERS, by mortgages MERS served as mortgagee to be in those pools and receive a rating, an investment grade rating without any changes to the credit enhancement. They required that to be a bankruptcy remote single purpose subsidiary of MERS, of Merscorp.

(page 32, lines 9-20)

Indeed, many commercial mortgages may be held by MERS as well, and for the same reason.

Read the rest of this entry »

Nice set of markups from David Singer:

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click for ginormous chart

Sept Existing Home Sales totaled 4.53mm annualized, much better than expectations of 4.3mm and is up from 4.12mm in Aug. Because of the home buying tax credit distortion though, the level remains below the 2010 average of 4.96mm. Sales gains were seen in all 4 regions. Combining the improvement in sales m/o/m with a 77k decline in available homes for sale, the overall months supply fell to 10.7 from 12.0. The median sales price was $171,700, down 2.4% y/o/y and the cheapest since March. Bottom line, the data is an improvement off a very depressed level but with the robosigner, foreclosure moratorium taking center stage at the very end of Sept which today’s figure didn’t capture and neither will Oct (this # measures closings), the figures towards year end may look much different as distressed homes made up 35% of Sept sales.

QE2: Yabba Dabba Doooooooo!
October 24, 2010
David R. Kotok
The countdown to QE2 continues…

>

For weeks, various members of the Federal Open Market Committee (FOMC) have used the media to discuss their views of quantitative easing. In the first week of November and coincident with the outcome of the elections, they will emerge from a Fed meeting and we may hear a decision. Some pundits argue the electoral outcome is clearer than the 11-voting members, FOMC’s intentions. Senator Shelby is holding up confirmation of voter number 12.

For the financial markets, the FOMC members have definitely introduced uncertainty and thereby raised risk premia in the long-term US Treasury bond market. Yields on the 30-year Treasury bond have risen during this pre-meeting period of publicly debated policy. The Open Market Committee has been nicknamed the “open mouth committee.” As of this writing, no one has a clear expectation of the Fed’s forthcoming policy.

The range of views from FOMC members span from “do nothing” to “we must take significant action.” Estimates of the results of an action are narrowing. The first study we saw attempted to establish that a $100 billion addition of QE would reduce the yield on the ten-year Treasury note by seven basis points. Subsequent analysis lowered the impact to five bps. Another study took the number down to three. At the NABE meeting in Denver, several economists and practitioners engaged in serous discussion of this estimate. The consensus was that the number is closer to two.

Furthermore, there is an expectations component. In Denver, we speculated that about half of the outcome came from the open-mouth activities and preceded the actual open-market implementation of QE.

In the beginning of the QE discourse, there were estimates that a program would be forthcoming and the size of the program might be large. Recent open-mouth pronouncements seemed to have toned down that number. Some FOMC members suggested or implied that this would become a meeting-by-meeting decision.

Wall Street analysts vary but seem to bunch their estimates in a monthly range of $70-120 billion of asset purchases by the Fed. Some firms estimate the total will be as high as $700 billion spread over 6 months. Former Fed Governor Meyer is calling for $1.5 trillion. For reference, the US has about $100 billion a month of net new Treasury issuance. Therefore, if the Fed were to embark on a sequence of monthly purchases on that scale, it would be absorbing the entire federal deficit.

Would anything be accomplished by this plan? Many market practitioners seem to believe that interest rates would be lower than they otherwise would be and the dollar would be weaker than it would otherwise be. We believe that both outcomes seem likely; however, that is not a precise picture.

The US is the largest participant in the global markets but it is not the only one. Of the G4 currency group, one other is also engaged in large-scale asset purchases. That is Japan, and they have much more experience doing it than we do. The United Kingdom bears watching, too. Its monetary policy committee is experiencing an internal debate over QE. At the moment, the QE supporters are in the minority, but some London-based analysts expect them to arrive at a QE program within months. Only the European Central Bank (ECB) is avoiding QE. Nevertheless, President Trichet seems to worry aloud about what the policies of the other major powers are doing to the strengthening of the euro and how that strengthening will hurt an economic recovery in Europe.

Why is the G4 currency block so important? Simply put, the yen, pound, dollar and euro denominate about 90% of the world’s debt. They collectively define the world’s capital markets. All the others are important and nice places to visit but the G4 define global finance.

We expect there will be some form of QE announced at the November Fed meeting. After all this “open-mouth” policy discussion, if the Open Market Committee does nothing, it will have misled the financial markets and lose a great deal of its remaining credibility. Therefore, our conclusion is that something is coming.

If it is small and gradual, there is likely to be little impact. Moreover, what might have been the outcome may already be priced into the market.

If it is large and the announcement is clear, there may be market impact coincident with the announcement. The Fed has had this small vs. large experience in the past. When the Term Auction Facility (TAF) was originally announced (2008), it had little impact. It was too small to mean anything. The Fed’s first moves with the post-Lehman TAF policy were insignificant and tepid. Only when it was enlarged (early 2009) into the hundreds of billions with global swap lines, did the TAF meaningfully reverse the damage done during the Lehman-AIG fiasco phase of the crisis.

The same was true for the $1.25 trillion mortgage purchase program. Within days of the announcement, the mortgage market started to defrost. The Fed was believed and the market functionality resumed even though the Fed’s program spanned over a year to implement. In other words, it takes both large size and credible follow-through for the Fed to have a meaningful impact.

Steve Liesman’s survey on CNBC is one of the tools trying to measure the market’s expectations of QE. If Steve’s results are indicative of market expectations, the Fed will need to surpass the estimates in a decisive and meaningful way. That would mean $1 trillion or more in an announcement.

We will find out soon enough. One thing is certain. With all this talk about QE2, there is no expectation that the short-term interest rate will do anything but remain near zero. That is likely to be the case for a long time. By long time, we mean a period measured in months and maybe years. Cumberland’s portfolio strategy continues to evolve with the basic assumption that the zero boundary in short-term rates is here to stay for a while.

~~~

David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors