Morals, Money and the Bailout

We’ve heard lots of moralism about the economy recently from both ends of the political spectrum.  Wall Street is guilty of greed and homeowners in trouble are guilty of irresponsibility. Instead of offering a cogent systemic analysis of how we got into this financial mess, and the best way to change our economic and financial system in order to fix it, both parties seem to prefer preaching about the wages of sin. 

But while wagging a self-righteous finger while invoking the Seven Deadly Sins (in particular Greed, Envy, Sloth, and Pride, but we could also make a case for Gluttony and Lust) makes for good politics, it is a terrible way to approach the current crisis. 

We should not expect capitalists not to be greedy.  And we should not expect consumers to want fewer or less expensive goods, including fewer and less expensive homes and cars.

The desire for more, for bigger, and for better is not the enemy of capitalism. 

Unregulated capitalism is the enemy of capitalism.

What we should expect, and what we need, is for the economic and financial system to be structured by law and regulation to channel the desires of both capitalists and consumers for more, for bigger, and for better into productive, sustainable economic growth.

Moralism won’t get us there, and will distract us from seeing the problem for what it is: a matter of systemic, not moral or individual, failure.

Major Law Firm Creates “Distressed Real Estate” Section as Crisis Deepens

In what could be a new and significant trend in American legal practice — and a sign that the real estate crisis is expanding — the prestigious Philadelphia-based law firm Ballard Spahr Andrews & Ingersoll LLP has announced that it is establishing a “distressed real estate” section. 

The firm’s “Distressed Real Estate Initiative” will involve at least 16 core lawyers in ten offices throughout the country, including those in Mid-Atlantic and Western locations hardest hit by the housing bust and the mortgage crisis, including Los Angeles and Las Vegas.

The purpose of the section, according to the firm, will be “to provide representation in acquisition, restructuring and bankruptcy matters.”

 “In this period of turmoil in the financial markets and economic uncertainty, new real estate opportunities and challenges present themselves,” said Michael Sklaroff, chair of Ballard’s Real Estate Department. “We stand ready to serve clients with respect to existing positions and also in assisting them in acquisitions and debt and equity investments in troubled projects.”

Ballard Spahr Andrews & Ingersoll was founded in 1886 and now employs more than 550 lawyers in twelve offices located throughout the mid-Atlantic corridor and the western United States.

When there is blood in the water, the sharks will appear.

FBI Hits Mortgage Fraud with “Operation Malicious Mortgage” — 400+ Indictments and the Arrests of Two Bear Stearns Execs

The FBI announced today that the Justice Department’s crackdown on mortgage fraud has resulted in more than 400 indictments since March — including dozens over the last two days.

Those arrested run the gamut of players in the mortgage industry, including lenders, real estate developers, brokers, agents, lawyers, appraisers, and so-called straw buyers.

The Department of Justice’s name for the crackdown is “Operation Malicious Mortgage,” which it describes as “a massive multiagency takedown of mortgage fraud schemes.”

According to the FBI, the on-going “Operation Malicious Mortgage” focuses primarily on three types of mortgage fraud — lending fraud, foreclosure rescue schemes, and mortgage-related bankruptcy schemes.

“To persons who are involved in such schemes, we will find you, you will be investigated, and you will be prosecuted,” said Federal Bureau of Investigation Director Robert Mueller. “To those who would contemplate misleading, engaging in such schemes, you will spend time in jail.”

In its statement, the FBI said that “Among the 400-plus subjects of Operation Malicious Mortgage, there have been 173 convictions and 81 sentencings so far for crimes that have accounted for more than $1 billion in estimated losses. Forty-six of our 56 field offices around the country took part in the operation, which has secured more than $60 million in assets.”

While most of those indicted so far are relatively small players in the industry-wide fraud crisis, Mueller today repeated his earlier promise that federal authorities are not ignoring the major players in the mortgage industry, but are investigating some “relatively large corporations” as part of its sweeping mortgage-fraud probe, including some 19 large companies, including mortgage lenders, investment banks, hedge funds, credit-rating agencies and accounting firms.

Most of these corporate fraud investigations, said Mueller, deal with accounting fraud, insider trading, and the intentional failure to disclose the proper valuations of securitized loans and derivatives.

The FBI’s announcement of Operation Malicious Mortgage coincided with the indictment and arrest in New York on Thursday of two former Bear Stearns managers, Ralph R. Cioffi and Matthew Tannin, who are charged with nine counts of securities, mail and wire fraud resulting in $1.4 billion in losses on mortgage-related assets.

According to the New York Times,  Cioffi and Tannin “are the first senior executives from Wall Street investment banks to face criminal charges, and the investigation by federal prosecutors based in Brooklyn is likely to become a test case of the government’s ability to make successful prosecutions of arcane financial transactions.”

“This is not about mismanagement of a hedge fund investment strategy,” said Mark J. Mershon, the head of the New York office of the Federal Bureau of Investigation at a news conference Thursday afternoon. “It’s about premeditated lies to investors and lenders. Its about the defendants prostituting their client’s trust in order to salvage their personal wealth.”

 

Has the Credit Market Thawed? Is it Freezing Up Again? And Are You Still Out in the Cold?

We’ve written before about the failure of the Fed’s policy of cutting short-term interest rates — seven times since September 2007 — to spur liquidity in the credit market. 

The good news today is that there is “significant improvement in the credit markets since late March,” according to the Wall St. Journal.

The bad news, also reported by the Wall St. Journal, is that this recent thaw in the credit market is not expected to last:

“‘Most of us are anticipating two steps forward, one step back and carefully watching where the markets can handle deals,’ said Tyler Dickson, who oversees capital raising at Citigroup.”

“‘There’s no question the tone in the market is getting better,’ says Jim Casey, co-head of leveraged finance at J.P. Morgan Chase.  He adds, however, that ‘there is some concern that this might be a short-term window of opportunity for issuers, since investors are still very focused on default rates and the potential severity of a recession.'”

“‘Risk tolerance is still pretty low,’ says Daniel Toscano, a managing director of leveraged and acquisition finance at HSBC Securities in New York.”

“Banks and debt investors are treading carefully,” the article said. “Investment banks, which incurred big losses after selling a lot of buyout debt at heavily discounted prices, are committing only to deals they can underwrite at a profit. And investors don’t want to be caught wrong-footed if corporate defaults spike.”

We think that the report of a credit thaw is premature.  For most businesses and individuals, the credit market is still frozen solid. 

Blackstone Group LP President Tony James appears to agree with us.  James told Bloomberg News that banks are mistaken if they think credit markets have begun a sustained recovery. 

Rather than a real break in the dismal credit forecast, James said that this little patch of sunshine may be “the eye of the hurricane.”

There is clearly no de-icing of the credit market that would significantly impact the housing crisis or allow Fed Chair Ben Bernanke to sleep without getting the chills at night.

 

 

FBI Expands and Intensifies Criminal Investigation of Mortgage Industry

The New York Times reported today that the federal taskforce established in January to investigate the mortgage industry is intensifying its efforts. 

The initial purpose of the taskforce, comprised of the Federal Bureau of Investigation and the criminal division of the Internal Revenue Service, as well as federal prosecutors in New York, Los Angeles, Philadelphia, Dallas and Atlanta, was to examine mortgages that were made with little or no documentation of the earnings or assets of the borrowers. 

The investigation is now also focusing on how these loans were bundled into securities.

The taskforce began with an investigation of 14 unnamed mortgage companies; in March, FBI Director Robert Mueller said that the FBI’s probe into potential mortgage fraud had grown to include investigations into 19 separate mortgage companies and involved an estimated 1,300 home mortgage fraud cases.

It is now believed that the investigation has expanded even further.

According to an unnamed official, the expansion of the probe was triggered by the financial industry’s disclosure last week of additional billions of dollars in write-downs from bad mortgage investments.

“This is a look at the mortgage industry across the board,” the official said, “and it has gotten a lot more momentum in recent weeks because of the banks’ earnings shortfalls.”

 

 

 

The Fed Nears the End of the Rate-Cutting Line — Now its the Banks’ Move

After the Federal Reserve cut short-term interest rates on Wednesday for the seventh time since September 2007 — lowering the federal funds rate to 2 percent, from 2.25 percent, the lowest level since November 2004 — most analysts observed that the Fed’s move showed that it was more concerned with preventing recession than halting inflation.

We’re not so sure that it is a question of recession verses inflation that’s driving the Fed.

We think that the Fed’s real concern right now is neither inflation nor recession, at least not directly, but the lack of liquidity in the financial markets and the lack of funds that financial institutions are making available to borrowers.

So far, the Fed has pumped more than $400 billion into major U.S. financial institutions in the hope that these institutions would make this money available to borrowers. 

And, so far, they haven’t done so, and liquidity conditions in the credit markets have continued to deteriorate. 

Despite the Fed’s inceasing generosity for the past six months, it has been harder, not easier, for businesses (and individuals) to borrow money.

The Fed is nearing the end of its rate-cutting line.  If the financial spigot does not loosen for borrowers based on the latest cuts, there may be no more that the Fed can do, especially since, with rising fuel and food prices, fears of inflation are already starting to overtake fears of recession, in America’s living rooms as well as its Board rooms.

Two members of the Fed’s Open Market Commitee  — Richard W. Fisher, president of the Dallas Fed, and Charles I. Plosser, president of the Philadelphia Fed — which is charged under federal law with overseeing national monetary policy — voted against lowering the rates this time.  And the criticism of the Fed’s policy of lowering interest rates and providing cheap money for the banks is getting broader, louder and more influential.

The banks and major lending institutions have been waiting for the Fed to cut interest rates as far as it possibly would before they start lending.

That moment has probably arrived.

Now it’s the financial market’s turn to make a move.

 

 

FBI Expands Probe of Mortgage Fraud — Now Involving 19 Mortgage Companies and 1,300 Cases. Reverse Mortgages Also Under Scrutiny.

The FBI is expanding its wide-ranging probe of the mortgage industry.

At a Senate hearing on Wednesday, FBI Director Robert Mueller said his agency is currently investigating an estimated 1,300 home mortgage fraud cases, and that the FBI’s probe into potential mortgage fraud now includes investigations into 19 separate mortgage companies.

The FBI, he said, has already “identified 19 corporate fraud matters related to the sub-prime lending crisis … targeting accounting fraud, insider trading, and deceptive sales practices.” 

Mueller also said that the FBI expected to expand its investigation even further. 

There was, he said, “no end in sight” to the growing number of fraud cases. 

“We’ve had a tremendous surge in cases related to the sub-prime mortgage debacle,” Mueller told a Senate Appropriations panel. “We expect them to grow even further.”

“I’m not sure at this point we can see the extent of the surge,” he added.

Mueller declined to go into the specifics of the investigation, but in previous announcements the FBI said it was looking into possible accounting fraud, insider trading or other violations in connection with loans made to borrowers with weak, or subprime, credit.

Mueller said he believes part of the problem is “rampant conflicts of interest in the corporate suites.” He said that FBI investigations “further emphasize the need for independent board members, auditors, and outside counsel. Shareholders rely on the board of directors to serve as the corporate watchdog. … [But] board members are often beholden to the executives they are expected to oversee.”

With one exception, the agency declined to identify the companies under investigation but has said that the inquiry, which began last spring, involves companies across the financial industry, including mortgage lenders, loan brokers and Wall Street banks that packaged home loans into securities.

The FBI has also said that the “hotspots” for its mortgage fraud investigations include California, Texas, Arizona, Florida, Ohio, Michigan, and Utah.

The one company that Mueller did acknowlege as being involved in the probe, Doral Financial Corp., had its former treasurer indicted last month for investment fraud. 

The FBI has also acknowledged in the past that the largest U.S. mortgage lender, Countrywide, is under investigation for misrepresenting its financial position and the quality of its mortgage loans.

It is also known that several major investment banks, including Goldman Sachs, Morgan Stanley, and Bear Stearns, have been asked to provide information to the government, and Beazer Homes has said that it had received a federal grand jury subpoena related to its mortgage business.

In addition to announcing an expansion of the number of cases and companies being investigated, Mueller also indicated a new direction for the FBI’s inquiry: reverse mortgages. 

Reverse mortgages release the equity in a property to the homeowner in one lump sum or multiple payments. The homeowner’s obligation to repay the loan is deferred until the owner dies, the home is sold, or the owner leaves the home.  In the U.S., reverse mortgages are available for people 62 years old or older.

Reverse mortgages are typically used to finance retirement or pay unexpected medical bills.  While reverse mortgages can make sense for seniors, the FBI is concerned about possible abusive sales practices that prey on seniors, such as aggressive and untruthful marketing and excessive fees.

Mueller said that the increasing number of mortgage cases has forced the FBI to shift agents from other areas, such as health care fraud and other financial crimes, to focus on mortgage lending practices.

The FBI has also previously indicated that it is cooperating with the Securities and Exchange Commission, which is conducting more than three dozen civil investigations into how subprime loans were made and packaged, and how securities backed by them were valued. 

UPDATE:

For the latest news of the FBI’s expanding probe of the mortgage industry, click here.

 

Bascom Group Expands Reach for Distressed Real Estate

Another major player has expanded its participation in the distressed real estate market.

Bascom Group, an Irvine, California, real estate (apartment) investment and asset management firm, has announced a new joint venture called Bascom Portfolio Advisors (BPA) that will target distressed multi-family, office, industrial and retail properties in markets throughout the nation,  including broken condo deals.

According to the Bascom Portfolio Advisors’ press release, “In anticipation of looming credit problems stemming from impending loan maturities, potential capital imbalances and decreasing property values, BPA offers workout expertise. Through a range of consulting services, BPA will evaluate distressed assets, identifying financial, operational and market driven issues and present effective solutions to optimize asset values and minimize losses. BPA has resources in place to implement work out solutions, including, asset management/oversight, new capital infusion, and assistance with liquidation.”

Bascom Group has previously engaged in several other join ventures in the distressed property market, including a 2006 joint venture with the private equity firm Warburg Pincus Real Estate I, L.P. to invest up to $200 million in non-performing loans and distressed multi-family properties and both non-performing and sub-performing loans by investing in the underlying senior and mezzanine debt instruments.

We noted in a recent post that major investors, fueled by domestic and foreign investment groups, wealthy individuals, endowments and pension funds, are about to spend billions of dollars buying distressed debt and real estate.

We think that Bascom Group’s announcement is further evidence that there is currently no hotter market than distressed real estate, and that major investors are ready to scoop up distressed properties with significant equity or which they believe to have been mismanaged.

Billions Poised to be Invested in Distressed Real Estate — But Small Buyers, Beware!

The New York Times reports today that major investors, fueled by domestic and foreign investment groups, wealthy individuals, endowments and pension funds, are prepared to spend billions of dollars buying distressed debt and real estate. 

These investors – often called “vultures” although the Times calls them “market opportunists” – believe that “some people have thrown the good out with the bad, and that the prices of some investments have simply fallen too far.”

For example, the Times reports that one Wall Street specialist in so-called distressed debt “recently spent at least $450 million for assets of Thornburg Mortgage, the battered mortgage servicing company. Others are buying beaten-down corporate bonds and looking at car and credit card loans.” 

“They are buying up mortgages of hard-pressed homeowners, the bank loans of cash-short businesses, and companies that seem to be hurtling toward bankruptcy,” said the Times, “And they are trying to buy them all on the cheap.”

A former executive of the Countrywide Financial Corporation, one of the mortgage giants that fostered subprime lending, recently helped start a company to buy mortgages.

In addition, the Blackstone Group “just raised $10.9 billion from investors to scoop up real estate.”

GlobeSt reports that “According to a company statement, this fund was the largest real estate opportunity fund ever raised.”

Blackstone senior managing director and New York City-based co-head of Blackstone’s real estate group, Jonathan Gray, stated that  “we believe there should be attractive investment opportunities for this capital given the market dislocation that exists today.”

We agree that the current distressed real estate market offers tremendous opportunities. 

The time is right for active, intelligent investors to take advantage of the multi-billion dollar distressed real estate market.  The real estate market is brimming with profit opportunities for those with leverage and expertise

But this is not an easy market for individual, smaller investors to penetrate.

The truth is that most smaller investors do not have the leverage and expertise to succeed in this volatile and extremely competetive market.

In fact, the effort that the smaller, part-time investor in foreclosures and distressed real estate would need to spend identifying properties, haggling with lenders and distressed owners, attending auctions and establishing financing is equivalent to a full-time job — and even then, success is far from likely.

Most smaller investors in this market will get caught up in the buying frenzy, spending too much time and money on so-called coaching and how-to courses from self-proclaimed foreclosure gurus, and then spending too much on property that will continue to fall in value and fail to provide an adequate income stream.

Great real estate deals do exist across the country. But to be successful, investors will need a high level of sophistication in identifying properties, acquiring them and developing the right exit strategy for each asset.

Smaller buyers, beware!

UPDATE:

For the lastest on the real estate vulture fund being formed by disgraced ex-Governor of New York Eliot Spitzer, click here.

New Regulation of Credit Industry is Now Inevitable. The Only Question is How Much Regulation, and with How Much Bite?

There can no longer be any question whether there will be new regulation of the credit industry in the wake of the housing meltdown and the mortgage crisis.

The only question now is the extent of the regulation and how much teeth it will have.

Treasury Secretary Henry Paulson eliminated any doubt regarding new regulation when he conceded that the Federal Reserve should bolster its supervision of investment banks while they are taking cheap money from the Fed’s new emergency program.

Paulson said that the Bush administration will soon put forth a blueprint for federal oversight in an effort to promote smoother functioning of financial markets.

”This latest episode has highlighted that the world has changed as has the role of other nonbank financial institutions and the interconnectedness among all financial institutions,” Paulson said.  ”These changes require us all to think more broadly about the regulatory and supervisory framework that is consistent with the promotion and maintenance of financial stability.” 

Greater oversight is necessary, according to Paulson, to “enable the Federal Reserve to protect its balance sheet, and ultimately protect U.S. taxpayers.”

Wall Street’s major investment banking firms, including Goldman Sachs, Lehman Brothers and Morgan Stanley, averaged $32.9 billion in daily borrowing over the past week from the new Fed program, compared with $13.4 billion the previous week. On Wednesday alone, their borrowing from the Fed reached $37 billion.

To add to the growing conservative consensus that greater federal regulation of the credit market is necessary, Wall Street Journal columnist Jon Hilsenrath wrote on the front page of the newspaper’s Money and Investing section that “if the government is going to intervene aggressively when bubbles burst, as it’s doing now, then maybe policy makers should do some new thinking about how to prevent bubbles in the first place.”

Democrats, both in Congress and on the presidential campaign trail, have called for more extensive and permanent regulation of both the credit market and the mortgage industry than that proposed by the Bush administration.

The final outcome will depend on who wins in November and what happens in the economy between now and the next Inauguration Day. 

But it is now clear that one consequence of the Bear Stearns bailout and the Fed’s cheap money policy for the major investment banks is to have made some form of new regulation of the credit market and the mortgage industry inevitable.

In the meantime, we’re still waiting for the enormous sums of cheap money that the Fed has pumped into the credit industry to make its way down the pipeline to the rest of us in the economy.