Thursday, June 30, 2011

The Mortgage Servicing Fiasco

Back in the very early 1990's, a company that I worked for acquired a fairly obviously screwed up mortgage company that the business managers coveted, more for girth than quality it seemed to some(this comment may seem elitist to some but the CEO of the to be acquired company did not know how to hold silverware at dinner, had a caveman grip, and he treated women in his attitude and attempts at jokes, well, poorly is the polite word).

The investment banker and fairness opinion advisor for our company was Lehman. To no avail I called hq from their offices late on a night of prospectus editing a few days before closing and reported some of my serious concerns. Unheeded, but sympathetically understood by some, I got off of the phone and the Lehman securities analyst that covered the mortgage business laughed and said, "there are more ways to lose money in the mortgage business than there are ways to get shot in Beirut" (early 90's remember).

Here we are today and the banks are taking almost all of the blame - not the facilitating regulators, not those customers that were dishonest, not the Government Sponsored institutions like Freddie and Fannie that were mandated by Clinton, Frank, Cuomo and company to expand into subprime, and certainly not the brain trusts at Pimco and other exceptional firms that bought the securities that could have been researched thoroughly before investment. Just the evil banks it seems.

There are two major parts to the business. Origination is sourcing the loans through offices or brokers, with terms decided and evaluated by the originating bank. Countrywide, WAMU, Golden West, and a host of smaller players like the dead IndyMac, Taylor Bean, and others really stretched the imagination and at times legality on origination terms and a few of the bigger firms partially followed in order to compete.

Servicing is the other big aspect of the business. After origination, servicers manage the payment flows and enforce the terms of the mortgage agreement. It's a white collar clerical administrative function primarily, but with a substantive hedging capability needed, through derivatives, to protect the sourced loans from the time of the servicer's acquistion until they can be packaged and sold to investors. This deriviatives function allowed the Congressional oversight committee to pay Fannie and Freddie CEO's at levels only exceeded by Goldman Sachs, even though they were government sponsored and primarily back office functions.

The major origination culprits are well known but many are out of business. So now the deep pockets of the servicers are under attack. Servicing firms did make mistakes. They were in no way prepared for the collapse of the mortgage market in '08 and '09, as they, like almost everyone, considered the subprime issues to be a contained event, of concern but in the larger scheme of things a small part of the mortgage market. Credit default swaps were, at the time, the little known catalyst for the disaster that was coming.

Servicing firms or servicing divisions at major institutions were often run, at the top, by non-tech admin types, trusted colleagues of the CEO's and others who were expected to be able to bridge the gap between the techies and quants and the executive management, and explain in layman's terms what was going on the businesses. When the disaster happened, these managers did not have the skills to manage, and their executive bosses knew next to nothing about the intricacies of this back office function.

Bank of American(Countrywide) and Wachovia now Wells Fargo(Golden West) had made conscious, so to speak, decisions to acquire major poor originators, while JPMorgan(WAMU) had taken a company off of the government's troubled hands with the expectation of some bias toward protection. BofA is getting hit at every turn and all of the major servicers are expected to be the subject of huge penalities at both the federal and state levels, as well as through civil suits as the trial bar gets their teeth into this.

Those are pretty much the facts seen from here. Here are some major problems seen by this admittedly former banker. I've done worse things but they probably have been diminished considerably in the minds of some by my role in my former profession(missed this debacle but left in 2003 after trying to explain the Enron disaster for over a year).

---Bank of America is estimated to be paying $5.5 billion to Fannie and Freddie for selling poor originations to those government backed organizations whose only, sole, primary, mandated, function was to know and understand the mortgage business, and they were under executive order and congressional mandates to broaden their credit standards to the subprime arena. With the precedent set, others will pay as well. This is paying the government for their bad management, private companies following the lead of their government sponsors.

---With the various penalities and with the civil suits on the horizon there will be judgements for not only losses but outsized punitive damages as well. Administrative mistakes in a crisis whose magnitude virtually no one foresaw is neither a crime nor a punishable offense. Many of the mistakes were made as overwhelmed servicers outsourced large portions of the work to admin "consultants" and there is the source of the robo-signing disaster, consultant fraud but they have no deep pockets and are mostly being sued for what little money they didn't squander or they are out of business.

---Laying virtually all of the blame for the mortgage fiasco on the major banks is no way to get an economy back on its feet. Like them a little or hate them a lot, banks move money from savers to investors to entrepreneurs and manufacturers. If they are generally discredited and their capital is depleted in an unpredictable way over several years the economy will suffer. Many politicians and particularly our executive branch think that the government can recycle investable funds in a more moral and efficient way than the banks. There is no track record to prove this, and recent uses of government funds to primarily prop up unsustainable public service practices rather than invest in infrastructure or near term projects(not green energy solutions 10 years away) is current evidence that the economy needs a vibrant private banking system. As laudable and reliable as some regional and community banks can be, they do not participate in a world in which funds are sourced and priced globally, and they will only be able to facilitate a micro recovery in a macro world.

---Giving Blackrock and Pimco and others of the most sophisticated and well educated groups of investors massive compensation from the banks that were selling mostly legal paper with highly detailed, at times obtuse, but researchable information under securities laws is almost ass backwards in the servicing cases. Servicers are facilitators of administrative functions, they are not MBA's or PHD's. Where is the shared responsibility?

Banks made mistakes(some inexcusable ones at firms like Lehman, Bear, Merrill, Citi, and the bad mortgage originators previously mentioned). All involved banks should have some financial penalties and they should be held accountable, but held accountable on some kind of level playing field. It's as if major investors, hedge funds, regulators, the GSE's, the fraudulant buyers, the non-Wall Street retail brokers that loaded up retirees portfolios with small illiquid pieces of these securities, the system gamers, all of them, were just the victims of the banks. It's the easy answer for the politicians, it's the easy answer for people who made their own bad decisions, but it's not the quick way out of this mess.

It does, however, give everyone someone to hate, and that is for some reason a comforting alleviation to the human condition.


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