The Wall Street Journal published one of those stupid 'shoot the messenger' articles about the consumer lawyers who by doing their jobs brought to light the robosigning and document fabrication that has become endemic in the foreclosure process. The article reeked of implicit class bigotry, which will play well with the WSJ's intended demographic. And properly reflects the complete capture by paradigm of the formerly ink-stained wretches who currently inhabit the gilded cage of the higher reaches of salaried journalism.
The denizens of Wall Street whom the WSJ serves elected to jettison the safeguards, procedures and formalities of the credit culture they had inherited. That credit culture had developed over generations. Remember the three C's? Probably not. For the last decade, those pillars of financial innovation shoved money out the door with utter abandon and cut a lot of corners doing that. They lent a lot of money to customers they shouldn't have.
Now, surprise, they're taking the same cavalier approach to getting the money back.
The great public was willing to take the money pushed its way. But when it comes to cowboy recklessness in getting the money back, not so fast, hombre. The legal and judicial safeguards and procedures developed over generations in real property matters exist to protect legal rights. They evolved and reflect a prudent and painfully developed set of accomodations and balances. Just because the financial services sector lost its collective sanity and jettisoned the credit culture is no reason for the judicial system to follow its example.
And the news of the last couple of months suggest that those legal safeguards and procedures need to be strengthened, not diminished. Which, of course, is what the New York courts took a step towards yesterday by rule imposing additional duties on counsel for foreclosing financial institutions.
Thursday, October 21, 2010
Wednesday, October 20, 2010
Wells Fargo and the New York Fed: Three Fronts and A Big Issue
Yesterday was big for the New York Fed on the MBS problem. Bill Dudley implicitly questioned the adequacy of the current back office operations in a speech and in a demand letter the New York Fed joined a group of other potential plaintiffs in starting the clock ticking on BofA in a situation involving bad loan putbacks.
Meanwhile, out on the left coast Wells Fargo today vigorously defended its own mortgage servicing operation. Admittedly, the defense could be interpreted, depending on one's perspective, as either 'our operations meet and exceed industry standards' or 'we're not as lame as the rest of the business.' But it was vigorous.
All of this has been freighted with much meaning. But I'm not so sure that the people either dismissing or heralding these developments have enough to go on to be very persuasive. The old joke about litigators--frequently wrong but never in doubt--comes to mind.
So I'm not going to say anything about the viability of the litigation implicitly threatened by a demand letter. I'm not going to speculate on the course of regulatory response to the possibility that material operations of some too big to fail financial institutions suffer from inadequate systems, procedures and controls, or management failures that have resulted in a pattern of routine violations of law. And I don't know how to sort out what Wells Fargo senior management says on the quarterly earnings call versus what Wells Fargo operating managers say under oath in deposition (beyond observing that maybe neither bank officers nor sworn testimony enjoy the confidence they'd once earned).
Instead, I'll offer something organizational--three fronts and a big issue. There are three fronts on which the mortgage backed securities business is being challenged.
Front No. 1. The originate to distribute part of the model. This where the put back issue comes from. There appear to be some problems with the disclosures made in offering documents. This will all be the grist of expensive and lengthy litigation. Both the plaintiffs and the defendants will be drawn from the financial services sector. There may be tax issues, though I'd be stunned if the IRS challenged the conduit status of the REMICs. The separation of record and beneficial ownership of the notes and security interests occurred at this point, but the problems it is now presenting lead directly to Front No. 2.
Front No. 2. The ongoing mortgage servicing operations of trustees and servicing organizations. In a kinder and gentler time (the boom of five years ago), these operations were seen as essentially custodial (the trustee holding the property for the benefit of the trust that issued the MBS) and ministerial--the accounting, recording keeping, reporting, disbursing of cash flows, etc.--of the mortgage servicer. These systems are now being stressed past the breaking point. In the first instance, that stress showed up in the foreclosure scandal, but it's rapidly spreading to other issues (viz., the demand letter). That first stress takes us to Front No. 3.
Front. No. 3. The legal issues coming out of the foreclosure disclosures. This is rough stuff. Without prejudging the question of whether the actual conduct was an endemic and indefensible as it appears to have been, the policy question of what to do about it is just beginning to surface. Do you settle for a patch and a local fix? Or do you conclude that the too big to fail financial institutions require rethinking? One relevant observation--those institutions seems to have many, many problems in a wide variety of different arenas. Foreclosure gate is part of a pattern, not a one-off. Consider the pay to play scandals in state and municipal finance. Consider the pay practices. And, don't forget the meltdown in the financial markets two years ago (a situation salvaged by bureaucrats and the taxpayer, though the leadership of those institutions and their publicists have conveniently forgotten that).
And, finally, the big issue. It's less global than pondering what to do about too big to fail financial institutions, but it's an aspect of their size. Conflicts of interest are a huge problem in the mortgage servicing business. The extent to which the different roles are intertwined in different operations of the same ultimate parent organization are going to be an enormous obstacle to resolving this mess. (It also may be a fatal weakness in legal attempts to contain it). One of the institutions joining in the demand on Bank of America is 34% owned by BofA. Wells Fargo is famous for making both first and second mortgages on the same property. One reason HAMP is believed to have had such dismal results is that the servicers were in a blatant conflict of interest situation.
All in all, interesting times. A lovely mess of policy issues, legal complications, operational challenges, all in a stew of tangled jurisdictional questions, potential criminal liabilities, and so on. A recipe for . . .
Meanwhile, out on the left coast Wells Fargo today vigorously defended its own mortgage servicing operation. Admittedly, the defense could be interpreted, depending on one's perspective, as either 'our operations meet and exceed industry standards' or 'we're not as lame as the rest of the business.' But it was vigorous.
All of this has been freighted with much meaning. But I'm not so sure that the people either dismissing or heralding these developments have enough to go on to be very persuasive. The old joke about litigators--frequently wrong but never in doubt--comes to mind.
So I'm not going to say anything about the viability of the litigation implicitly threatened by a demand letter. I'm not going to speculate on the course of regulatory response to the possibility that material operations of some too big to fail financial institutions suffer from inadequate systems, procedures and controls, or management failures that have resulted in a pattern of routine violations of law. And I don't know how to sort out what Wells Fargo senior management says on the quarterly earnings call versus what Wells Fargo operating managers say under oath in deposition (beyond observing that maybe neither bank officers nor sworn testimony enjoy the confidence they'd once earned).
Instead, I'll offer something organizational--three fronts and a big issue. There are three fronts on which the mortgage backed securities business is being challenged.
Front No. 1. The originate to distribute part of the model. This where the put back issue comes from. There appear to be some problems with the disclosures made in offering documents. This will all be the grist of expensive and lengthy litigation. Both the plaintiffs and the defendants will be drawn from the financial services sector. There may be tax issues, though I'd be stunned if the IRS challenged the conduit status of the REMICs. The separation of record and beneficial ownership of the notes and security interests occurred at this point, but the problems it is now presenting lead directly to Front No. 2.
Front No. 2. The ongoing mortgage servicing operations of trustees and servicing organizations. In a kinder and gentler time (the boom of five years ago), these operations were seen as essentially custodial (the trustee holding the property for the benefit of the trust that issued the MBS) and ministerial--the accounting, recording keeping, reporting, disbursing of cash flows, etc.--of the mortgage servicer. These systems are now being stressed past the breaking point. In the first instance, that stress showed up in the foreclosure scandal, but it's rapidly spreading to other issues (viz., the demand letter). That first stress takes us to Front No. 3.
Front. No. 3. The legal issues coming out of the foreclosure disclosures. This is rough stuff. Without prejudging the question of whether the actual conduct was an endemic and indefensible as it appears to have been, the policy question of what to do about it is just beginning to surface. Do you settle for a patch and a local fix? Or do you conclude that the too big to fail financial institutions require rethinking? One relevant observation--those institutions seems to have many, many problems in a wide variety of different arenas. Foreclosure gate is part of a pattern, not a one-off. Consider the pay to play scandals in state and municipal finance. Consider the pay practices. And, don't forget the meltdown in the financial markets two years ago (a situation salvaged by bureaucrats and the taxpayer, though the leadership of those institutions and their publicists have conveniently forgotten that).
And, finally, the big issue. It's less global than pondering what to do about too big to fail financial institutions, but it's an aspect of their size. Conflicts of interest are a huge problem in the mortgage servicing business. The extent to which the different roles are intertwined in different operations of the same ultimate parent organization are going to be an enormous obstacle to resolving this mess. (It also may be a fatal weakness in legal attempts to contain it). One of the institutions joining in the demand on Bank of America is 34% owned by BofA. Wells Fargo is famous for making both first and second mortgages on the same property. One reason HAMP is believed to have had such dismal results is that the servicers were in a blatant conflict of interest situation.
All in all, interesting times. A lovely mess of policy issues, legal complications, operational challenges, all in a stew of tangled jurisdictional questions, potential criminal liabilities, and so on. A recipe for . . .
Tuesday, October 19, 2010
Back Office Collapses in History
Of course it's still way too early to tell just how systemically important the back office failings of the mortgage servicers will turn out to be. But NY Fed President Dudley referenced the importance of robust back office operations underpinning a functioning mortgage securities markets in his speech this morning. And that is important.
Indeed, the financial markets were wrecked by a back office meltdown the living of memory man, indeed in the memory (just barely) of non-retirement age living man--and woman, for that matter, though back then the women weren't the, ah, players they've since become. Actually, the back office meltdown just finished the job. It came after a market boom followed by a meltdown had stressed the whole system, against the backdrop of prolonged and unsatisfying military entanglements on the Asian landmass and a rickety economy.
Maybe that all sounds familiar. And in the last three years we've had a debate about whether we were headed for a reprise of the 1930s or the 1970s. What I'm talking about here happened early in the 1970s, and was really the final inning of a game started in the 1960s.
The 1960s were the Go-Go years. You had mutual funds instead of program trading and conglomerates rather than hedge funds, but you had the same psychology of boom. Which was followed by bust. And throughout it all, elevated levels of transactional activities.
All of which settled on paper. And all that paper swamped the back offices. Now these were the back offices of the member firms of New York Stock Exchange firms. Those firms were partnerships and the partners were frequently more interested in playing golf at Winged Foot, racing sailboats on Long Island City or drinking at the Brook Club.
By the time anybody started paying any attention, the systems had broken down. As in, knee deep in trade slips, lost stock certificates, daily ledgers weeks behind in recording transactions, blown settlements, broken trades, etc. A number of firms failed.
Unlike the current situation, all of these failures were internal, pretty much confined to Manhattan, maybe bleeding over to Jersey City. An effort today is being made to portray the problem as one of antiquated state property laws and filing requirements. As far as I can tell, those antiquated state systems and procedures work just fine, and 'time-tested' might be a more polite adjective.
The problem is a systemic back office failure to comply with state legal requirements, leaving the beneficial owners of the notes in a position where they are unable to efficiently and quickly assert their rights under state law. At worst, they lose the benefit of their security interest and become general creditors in a bankruptcy. At best, at considerable expense to the trusts, servicers and perhaps even the deal sponsors, the remedial work necessary to comply with well-established state law requirements.
But it's difficult to challenge the notion that, if a litigant wants to assert rights in a state court under the laws of that state, it should be compelled to comply with the procedural requirements of that forum. And it that litigant is a federally regulated financial institution, it's about time that federal regulators look into the situation. If those institutions have by their own strategic decisions, operating procedures, and resource allocation, put themselves in a position where they can't obtain state legal remedies, then there need to be some changes--in the financial institutions, not in the state laws.
Indeed, the financial markets were wrecked by a back office meltdown the living of memory man, indeed in the memory (just barely) of non-retirement age living man--and woman, for that matter, though back then the women weren't the, ah, players they've since become. Actually, the back office meltdown just finished the job. It came after a market boom followed by a meltdown had stressed the whole system, against the backdrop of prolonged and unsatisfying military entanglements on the Asian landmass and a rickety economy.
Maybe that all sounds familiar. And in the last three years we've had a debate about whether we were headed for a reprise of the 1930s or the 1970s. What I'm talking about here happened early in the 1970s, and was really the final inning of a game started in the 1960s.
The 1960s were the Go-Go years. You had mutual funds instead of program trading and conglomerates rather than hedge funds, but you had the same psychology of boom. Which was followed by bust. And throughout it all, elevated levels of transactional activities.
All of which settled on paper. And all that paper swamped the back offices. Now these were the back offices of the member firms of New York Stock Exchange firms. Those firms were partnerships and the partners were frequently more interested in playing golf at Winged Foot, racing sailboats on Long Island City or drinking at the Brook Club.
By the time anybody started paying any attention, the systems had broken down. As in, knee deep in trade slips, lost stock certificates, daily ledgers weeks behind in recording transactions, blown settlements, broken trades, etc. A number of firms failed.
Unlike the current situation, all of these failures were internal, pretty much confined to Manhattan, maybe bleeding over to Jersey City. An effort today is being made to portray the problem as one of antiquated state property laws and filing requirements. As far as I can tell, those antiquated state systems and procedures work just fine, and 'time-tested' might be a more polite adjective.
The problem is a systemic back office failure to comply with state legal requirements, leaving the beneficial owners of the notes in a position where they are unable to efficiently and quickly assert their rights under state law. At worst, they lose the benefit of their security interest and become general creditors in a bankruptcy. At best, at considerable expense to the trusts, servicers and perhaps even the deal sponsors, the remedial work necessary to comply with well-established state law requirements.
But it's difficult to challenge the notion that, if a litigant wants to assert rights in a state court under the laws of that state, it should be compelled to comply with the procedural requirements of that forum. And it that litigant is a federally regulated financial institution, it's about time that federal regulators look into the situation. If those institutions have by their own strategic decisions, operating procedures, and resource allocation, put themselves in a position where they can't obtain state legal remedies, then there need to be some changes--in the financial institutions, not in the state laws.
Monday, October 18, 2010
Political Fallout from the Foreclosure Mess
As far as I can tell, so far there hasn't been any.
On a personal level, our political classes don't have a dog in the fight. They may be collectively regretting the purchase of that vacation condo back in 2005, but they are current on the mortgage of their principal residence (except for that California representative).
On an professional level, the foreclosure mess is as much a problem as it is an opportunity. It lies awkwardly on top of a construct created by various spin meisters at a great expenditure of time, effort and treasure, to paint in the darkest colors a collection of deadbeat borrowers who took out liar loans to speculate in homes they never should have been allowed to buy, then, to top it off, ruthlessly defaulted. Now, to use Ron Zeigler's words from his time as Nixon's press secretary, those facts are no longer operative.
Now, in Congressional district by Congressional district, media outlet after media outlet develop endless heart rending stories of incredible abuses. Well, in the context of millions of foreclosures, if you have thousands of horror stories, that's a rate of one in a thousand. As long as those stories sell newspapers, atttract eyeballs or goose the ratings, that vein will be mined. So it's reasonable to expect the stories to continue, at least through the midterms.
Inside the Beltway, the political leadership is doing what comes natural to it. Congress will grandstand with hearings. Those may not help homeowners or shed much light on the situation, but they'll put the heat on the mortgage servicers and provide some entertainment. If they have anyeffect, it will be to jell public opinion and (more importantly) the political calculus against any legislative accommodation of the financial services sector on this one.
And within the agencies and executive branch, those politicians are doing what comes naturally to them when tossed a hot potato. They're handing the hot potato off to the professionals. Of course, in this case the professionals will be teams from enforcement, compliance, regulatory oversight, and perhaps the criminal division of DOJ (in a liaison capacity, at first). That's already happening. Those mills grind slowly and implacably and are pretty hard to turn off, once fired up.
So there, the process is at work. But as far as political fallout in the run up to the midterm elections, nothing has developed so far. Maybe, given the timing of all this, the problem has to be a post-election issue.
Which brings us back to the bigger question of what kind of construct to put on foreclosure-gate. Is it a story of modern innovative and creative financial institutions who've developed new and better ways of making the American Dream possible being tripped up by a few ancient legal technicalities in a few backwards state jurisdictions? Is it a crisis threatening the integrity of our largest securities market and most important financial institutions that requires a federal fix to a patchwork of outmoded state real property laws? Or it is an arrogant, out-of-control Wall Street, not satisfied with destroying the retirement savings of millions, not satiated by shipping the jobs of more millions off to China, launching a criminal attack on the American Dream of home ownership?
My gut tells me that the first choice is so ludicrous at this juncture that even the toadies and lackies still mouthing it will be told by their masters to shush. So the alternatives likely come down to some blend of the second and the third. The problem with the second choice is that the card has already been played once in the last couple of years, and I sense that the political classes feel betrayed in the aftermath by the financial elite. The problem with the third choice is that it sounds like so much tea party dementia and drivel.
I suppose an ideal outcome would be to cloth the policies implicit in the third in the phraseology of the second. That'll happen when pigs fly.
On a personal level, our political classes don't have a dog in the fight. They may be collectively regretting the purchase of that vacation condo back in 2005, but they are current on the mortgage of their principal residence (except for that California representative).
On an professional level, the foreclosure mess is as much a problem as it is an opportunity. It lies awkwardly on top of a construct created by various spin meisters at a great expenditure of time, effort and treasure, to paint in the darkest colors a collection of deadbeat borrowers who took out liar loans to speculate in homes they never should have been allowed to buy, then, to top it off, ruthlessly defaulted. Now, to use Ron Zeigler's words from his time as Nixon's press secretary, those facts are no longer operative.
Now, in Congressional district by Congressional district, media outlet after media outlet develop endless heart rending stories of incredible abuses. Well, in the context of millions of foreclosures, if you have thousands of horror stories, that's a rate of one in a thousand. As long as those stories sell newspapers, atttract eyeballs or goose the ratings, that vein will be mined. So it's reasonable to expect the stories to continue, at least through the midterms.
Inside the Beltway, the political leadership is doing what comes natural to it. Congress will grandstand with hearings. Those may not help homeowners or shed much light on the situation, but they'll put the heat on the mortgage servicers and provide some entertainment. If they have anyeffect, it will be to jell public opinion and (more importantly) the political calculus against any legislative accommodation of the financial services sector on this one.
And within the agencies and executive branch, those politicians are doing what comes naturally to them when tossed a hot potato. They're handing the hot potato off to the professionals. Of course, in this case the professionals will be teams from enforcement, compliance, regulatory oversight, and perhaps the criminal division of DOJ (in a liaison capacity, at first). That's already happening. Those mills grind slowly and implacably and are pretty hard to turn off, once fired up.
So there, the process is at work. But as far as political fallout in the run up to the midterm elections, nothing has developed so far. Maybe, given the timing of all this, the problem has to be a post-election issue.
Which brings us back to the bigger question of what kind of construct to put on foreclosure-gate. Is it a story of modern innovative and creative financial institutions who've developed new and better ways of making the American Dream possible being tripped up by a few ancient legal technicalities in a few backwards state jurisdictions? Is it a crisis threatening the integrity of our largest securities market and most important financial institutions that requires a federal fix to a patchwork of outmoded state real property laws? Or it is an arrogant, out-of-control Wall Street, not satisfied with destroying the retirement savings of millions, not satiated by shipping the jobs of more millions off to China, launching a criminal attack on the American Dream of home ownership?
My gut tells me that the first choice is so ludicrous at this juncture that even the toadies and lackies still mouthing it will be told by their masters to shush. So the alternatives likely come down to some blend of the second and the third. The problem with the second choice is that the card has already been played once in the last couple of years, and I sense that the political classes feel betrayed in the aftermath by the financial elite. The problem with the third choice is that it sounds like so much tea party dementia and drivel.
I suppose an ideal outcome would be to cloth the policies implicit in the third in the phraseology of the second. That'll happen when pigs fly.
Sunday, October 17, 2010
The State of Play or . . .
moving slowly and implacably.
Two very important things to remember as the robo-signing scandal morphs into something more interesting and systemically threatening.
First, we are only in the earliest stages of the unfolding of this situation. It's too early to tell what we are dealing with. The problem may have been brewing for some time (and with benefit of hindsight it may come to be regarded as having been inevitable). But until the large servicers started voluntarily suspending foreclosures the situation didn't occupy that much bandwidth. It was possible to assume that lenders had simply adapted to the subprime market and underwater houses the aggressive repo techniques they'd always used to grab cars securing bad car loans and the furniture involved in various tawdry lease to buy schemes.
The shock of the public announcements that the country's largest mortgage servicers were suspending foreclosures grabbed public attention. It made the Daily Show. Unfortunately, as a culture we've become addicted to the idea that everything should be resolved in a 30 or 60 minute media window, or over the course of a week (the length of a made-for-TV mini-series), or (at the longest) a viewing season.
So far, not one aspect of the financial crisis has conformed to those dramatic dictates. Don't expect this one to, either.
The second is like unto it. This situation does not lend itself to quantification. We've developed a taste in this country for measuring, quantifying, modelling the impact of a development or a decision on (you chose) a divisional P&L statement, an investment portfolio, a tranche is a securitization, etc. The important decisions in that process were always veiled in the model's assumptions or the financial statements footnotes. But not worry. Those things didn't lend themselves to sound-bite treatment, anyway.
What's happening--foreclosure gate--presents a legal, regulatory, management and operational set of issues, and their interplay that defy prediction, much less forecasting, modelling or quantifying for purposes of throwing a number up on a trading screen, modelling impacts on tranches of differeing seniorities of changes in cash flow projections or determining the adequacy of a litigation reserve. Unfortunately, there's a reason they call them talking heads, not thinking heads.
That idea that a non-trivial part of the operations of too big to fail financial institutions have involved recurring violations of law, and that those operations cannot as currently configured by conducted without those legal violations is something to think about. It requires more than a knee jerk reaction.
If spending that time gives industry apologists, shills and lobbyists time to regroup, that is a cost of how things work. It also gives time to determine whether some of these institutions should be indicted, and at what organizational levels.
Two very important things to remember as the robo-signing scandal morphs into something more interesting and systemically threatening.
First, we are only in the earliest stages of the unfolding of this situation. It's too early to tell what we are dealing with. The problem may have been brewing for some time (and with benefit of hindsight it may come to be regarded as having been inevitable). But until the large servicers started voluntarily suspending foreclosures the situation didn't occupy that much bandwidth. It was possible to assume that lenders had simply adapted to the subprime market and underwater houses the aggressive repo techniques they'd always used to grab cars securing bad car loans and the furniture involved in various tawdry lease to buy schemes.
The shock of the public announcements that the country's largest mortgage servicers were suspending foreclosures grabbed public attention. It made the Daily Show. Unfortunately, as a culture we've become addicted to the idea that everything should be resolved in a 30 or 60 minute media window, or over the course of a week (the length of a made-for-TV mini-series), or (at the longest) a viewing season.
So far, not one aspect of the financial crisis has conformed to those dramatic dictates. Don't expect this one to, either.
The second is like unto it. This situation does not lend itself to quantification. We've developed a taste in this country for measuring, quantifying, modelling the impact of a development or a decision on (you chose) a divisional P&L statement, an investment portfolio, a tranche is a securitization, etc. The important decisions in that process were always veiled in the model's assumptions or the financial statements footnotes. But not worry. Those things didn't lend themselves to sound-bite treatment, anyway.
What's happening--foreclosure gate--presents a legal, regulatory, management and operational set of issues, and their interplay that defy prediction, much less forecasting, modelling or quantifying for purposes of throwing a number up on a trading screen, modelling impacts on tranches of differeing seniorities of changes in cash flow projections or determining the adequacy of a litigation reserve. Unfortunately, there's a reason they call them talking heads, not thinking heads.
That idea that a non-trivial part of the operations of too big to fail financial institutions have involved recurring violations of law, and that those operations cannot as currently configured by conducted without those legal violations is something to think about. It requires more than a knee jerk reaction.
If spending that time gives industry apologists, shills and lobbyists time to regroup, that is a cost of how things work. It also gives time to determine whether some of these institutions should be indicted, and at what organizational levels.
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