The Wall Street Journal: All three of your clients — Pimco, Deutsche Bank, and now Paulson — were bearish early on housing and mortgages. Is there a connection?

Greenspan: I hadn’t [noticed] until you just raised the issue.

— The Wall Street Journal, Jan. 15

JOHN PAULSON, UNLIKE HIS NAMESAKE HANK, never entertained a fantasy that home mortgage problems were contained. But then, neither did he live in a neverland in which whatever he said was true. Paid by his clients to make money, not simply to imagine it, his two hedge funds that bet against the housing market rose 590% and 350% in 2007. Paulson earned a personal paycheck of a reported $4 billion.

Should Paulson & Co. repeat this performance in 2008, former Federal Reserve Chairman Alan Greenspan may join his new boss in the Forbes 400. The research department at Forbes might check to see if this would be the first public servant to leverage his persona among the modern Fords and Rockefellers.

Paulson hired Greenspan on Jan. 15. The Wall Street Journal observed: “Housing and mortgage markets have been of intense personal interest to Mr. Greenspan since the 1960s, and he devoted hours of personal and Fed staff time to the subject. That could come in handy for Paulson.”

Paulson has not announced the rookie’s duties, but Greenspan plans to introduce his data system, in which he “[analyzes] both new and existing home sales by means of financing.” One hopes — or the clients of Paulson & Co. should hope — the seasoned economist has discovered a magic potion that was absent four months ago.

On that occasion, when interviewed on Comedy Central by Jon Stewart, Greenspan admitted that models don’t work: “I’ve been dealing with these big mathematical models of forecasting the economy…I’ve been in the forecasting business for 50 years…I’m no better than I ever was, and nobody else is. Forecasting 50 years ago was as good or as bad as it is today. And the reason is that human nature hasn’t changed. We can’t improve ourselves.”

Should Greenspan’s models regress his 50-year average, clients may look at their 2008 returns with the same dejection expressed by Stewart: “You just bummed the [bleep] out of me.”

Paulson may suggest the man who modeled variable-rate mortgages for the masses leave his briefcase at home. Greenspan’s Jan.15 interview with The Wall Street Journal carried the title “Subprime Sales May Be Near Bottom.”

Paulson gave a recent presentation with the title “The Worst Is Yet to Come.” He predicts, “It will take years for home prices to recover.” Paulson seems more interested in the ex-Maestro’s broader view: “Few people, if any, in the world have the breadth of experience with, and depth of understanding of, global financial markets as Dr. Greenspan. Anticipating the direction of the economy and assessing the potential for severity of a U.S. recession are fundamental in formulating current investment strategy.”

Yet the nation’s most successful mortgage salesman has disowned his ability to offer such direction. According to MoneyNews.com, in March 2007, Greenspan told an audience he “doesn’t believe that [forecasts]…can be accurately made in the near term. ‘We really can’t forecast’ the economy over the next two years, he said.”

The “Three Billion Dollar Man” should trust his own instincts. In mid-2005, when the housing market was near its peak, Paulson knew the bubble was about to pop. He told one of his colleagues: “We’ve got to take as much advantage of this as we can.” Alan Greenspan, then chairman of the Federal Reserve, acclaimed by a lengthy list of economists as the greatest central banker who ever lived, told 60 Minutes in 2007 that he did not understand the consequences that low adjustable-rate mortgages posed: “I really didn’t get it until very late in 2005 and 2006.”

Nor has he shown much foresight since. On Oct. 26, 2006, Greenspan announced: “Most of the negatives in housing are probably behind us.” He predicted the housing slump is “likely past.”

Greenspan may not be quite the rube he appears: Exactly one week later, this opinion was expertly choreographed into a new National Association of Realtors $40 million advertising campaign. The full-page newspaper ads announced: “It’s a great time to buy or sell a house.” Greenspan contributed to the sales pitch by assuring the fourth quarter of 2006 would “certainly be better than the third quarter.” This was choreographed to the rumble of home-building stocks rolling off a cliff.

While some have suggested Greenspan was hired for his connections, he doesn’t seem to get around all that much. At the Brookings Institution in September 2007, he queried, in reference to the subprime explosion: “I ask you if anybody in early June could contemplate what we are now confronted with?” Anyone reading the morning newspapers already knew Paulson’s anti-mortgage funds were producing spectacular returns.

Paulson has defended his new hire: “It’s easy to look back and do Monday morning quarterbacking. The decisions he made at the time were right.” They were right for John Paulson, who explained his own insight: “Most people told us house prices never go down on a national level…Mortgage experts were too caught up [in the housing boom].”

As chairman, Greenspan told Congress (thus, the nation, which hung on his every market prediction) just what Paulson disparaged: “The ongoing strength in the housing market has raised concerns about the possible emergence of a bubble in home prices…the ‘national’ housing market is better understood as a collection of small, local housing markets. Even if a bubble were to develop in a local market, it would not necessarily have implications for the nation as a whole.”

This was exactly the line pushed by every real estate broker confronted with a hesitant prospective homebuyer. If Paulson had paid any attention to Greenspan’s opinion, he would not have pursued the course that has made him so rich.

Since Paulson is rooted in the real, rather than the fantastic, Greenspan’s opinions probably won’t influence portfolio construction. Maybe he hired the global financial wizard for causing such a moneymaking opportunity; he undoubtedly hired him for “access.” This was the opinion of every newspaper report when Pimco and Deutsche Bank signed him up.

Newspapers aren’t infallible, but the proof is in the discreditable statements made by the firms. Pimco claimed, “This engagement provides Pimco with unique access and insight from the former Fed chairman, whose perspective on financial markets, global economic trends and investor behavior is truly special.” (Granted, they are special.) Deutsche Bank CEO Josef Ackermann admires Greenspan’s ability to “explain very complicated subjects and situations in simple terms.” To cover all possibilities, maybe Greenspan was speaking German all these years.

A final possibility is the modern temptation of fame. Here, the hedge fund manager must be careful. According The Wall Street Journal, “Mr. Paulson has tried to keep a low profile, saying he’s reluctant to celebrate while housing causes others pain.” He may plan to live vicariously through his protégé, but his new aide-de-camp has lost the instincts that served him so well.

Greenspan controlled the media that elevated him to godlike status. He has forgotten that if the famous don’t manage their own publicity properly, the press will magnify every blemish on the way down that they concealed on the way up. A&E’s “most fascinating person in 1999” now competes with Britney Spears as a media punching bag. His off-the-cuff criticism of Ben Bernanke — for which Greenspan was rightly rebuked — elicited the most disingenuous of self-justifications: “I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.”

There have been few government bureaucrats who have craved the footlights as Greenspan did — and does. He needn’t fear lack of attention as long as he keeps talking. The economist’s poor judgment matches Britney’s. Claims from the podium include “I have no regrets” and “A lot of people are going to lose their homes. It’s a family tragedy. It’s not an economic — or macroeconomic — tragedy.” As with Britney, his primary function as Federal Reserve chairman was public entertainer. He shows no signs of disappointing us in this function.

Regards,
Fred Sheehan
January 28, 2008

Greenspan and Paulson was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“A wave of home mortgage foreclosures is sweeping across Brevard County — signaling a disastrous end to the local housing boom for those who could lose their homes…

“Many of the cases stem from homebuyers — both residents and investors — getting sucked into risky loans, with limited options to refinance or sell because of the recent decline in local property values…

“The trend is part of a rise in foreclosures nationwide, and especially in Florida, which ranked second in the nation in 2006 in foreclosures, behind California.

“In Brevard County, there were 982 foreclosures from November through February, more than double the 377 foreclosures during the same four-month period a year earlier, according to data provided by Brevard County Clerk of Courts Scott Ellis. The figures include some commercial foreclosures, but the vast majority are residential.

“In addition, there are more than 5,600 local properties where the owners are at least two months behind in mortgage payments, according to RealtyTrac.com, a Web site that tracks such data…

“If there is a marked downturn in the economy, ‘this could be seen as the tip of the iceberg,’ said David Brown, Bank of America professor at the University of Florida’s Department of Finance, Insurance, and Real Estate…

“‘There are a variety of factors here,’ said Steve Srein, founder of People’s First Financial Services of Melbourne. ‘The first thing is people are not changing their lifestyles to pay for the loans they took on their homes. We’ve adapted to what I call “The Easy Society,” in that we made it easy for people to get into houses with submarginal credit. Since they had submarginal credit, that puts them in the subprime category, ripe for a product like the exotic mortgage or the junk loan, or optional adjustable-rate mortgage.’

“‘The problem today is that the people were pushed into loans they really couldn’t afford,’ Srein said. ‘The real estate people and the mortgage brokers are saying the borrowers knew what they were doing. But, really, it’s the optional (adjustable-rate mortgages) that are the big culprit behind the whole problem’…

“‘These people weren’t prepared for what they were getting into,’ Srein said. ‘They weren’t ready for phenomenal real estate tax increases and phenomenal homeowners’ (insurance) increases. So if you take that element, and combine it with a person that isn’t willing to make changes in their finances, you have defaults. If your habit is spending on lavish trips or spending on clothes, you need to cap the spending to keep your house. It’s the wants versus the needs.’

“The other factor is that, in recent years, housing prices have soared in Florida overall, Srein said, ‘and the salaries have not.’”

Tsunami of Defaults

A tsunami of subprime defaults is about ready to sweep The Easy Society right out of their houses. Fed Governor Susan Bies says, “Subprime Defaults Are ‘Beginning of Wave’”:

“The nation’s banks are just beginning to feel the pain of defaults on risky mortgages they made at low introductory rates when housing prices were soaring, U.S. Federal Reserve Governor Susan Bies said.

“Bies, who has been the Fed’s top banking policy official in her tenure at the U.S. central bank, said today banks are likely to see more missed payments and foreclosures as consumers with weak credit histories begin to face higher monthly mortgage payments.

“‘What’s happening is the front end of this wave of teaser-rate loans that are coming into full pricing,’ Bies said at a risk-management forum in Charlotte, N.C. ‘So what we’re seeing in this narrow segment is the beginning of the wave. This is not the end, this is the beginning’…
 
“The Fed and four other bank regulators released proposed guidelines last week instructing banks to strengthen their underwriting standards and offer clear disclosures on loan terms to subprime borrowers.

“The central bank also said last week that the delinquency rate on banks’ residential real estate loans reached a four-year high last quarter.

“Bies said the problems in the mortgage market are well contained.

“‘We’re seeing this in a very narrow segment,’ Bies said. ‘We’re watching for contagion, we haven’t seen it.’

“Outside of the housing and auto industries, ‘the economy is strong,’ Bies said.”

Given that housing alone accounted for over 40% of the jobs this recovery, that last statement by Bies seems pretty feeble. The Fed is also four years and trillions of dollars too late on those lending guidelines. I talked about that in “Malinvestments, Predatory Lending, and Demagogues,” and it is likely that I will be writing on that theme again soon.

Contagion Watch

So the Fed is “watching for contagion.” Exactly what can the Fed do about it when it hits? That will not be Bies’ problem, as she is cleverly leaving her post at the end of March, as Forbes reported back in February in “Fed Gov. Bies Quits”:

“Two days after a group of major U.S. banks asked regulators to reconsider proposals for regulating bank risk, the Federal Reserve governor heading their implementation resigned.

“Fed Governor Susan Bies submitted her resignation on Friday that will become effective March 30. Bies leaves five years into an appointment that was not slated to end until 2012. In a resignation letter address to President Bush, Bies called her experience on the board ‘very rewarding’ but offered no reason as to her departure.”

That seems like a good move. I would not want to stick around for this tsunami, either. Most of those in The Easy Society won’t even know what hit them. They will be blaming predatory lenders, hurricanes, insurance companies, and anyone and everyone but the primary culprit (the Greenspan/Bernanke Fed). I suspect that is the real reason (at least one of them) for Bies’ resignation.

To be fair, Forbes also reported:

“In her last position, she was spearheading efforts to revise and implement the international capital standards for banks developed in 1988. Although banks and regulators agreed the old standards were outdated and overly simplistic, updating them has been a contentious issue for years.

“Bies had recently voiced frustration at the slow progress. After a speech at the National Credit Union Administration’s Risk Mitigation Summit in January, Bies told reporters that ‘I’m an impatient person. I clearly wish that things were going faster, but I’m very happy that we’ve got everything out for comment now.’

“On Wednesday, four major U.S. banks submitted a letter to the Federal Reserve and urged it to move away from certain Basel II proposals. JPMorgan Chase, Washington Mutual, Wachovia, and Citigroup complained that the new rules would require U.S. banks to hold more minimum capital and would give foreign banks an advantage.”

If Bies is resigning because she refuses to go along with tightening minimum capital requirements, then perhaps she should be applauded. For now, she isn’t saying. Once she is gone, I hope she will disclose her reasons. It will also be interesting to see if she stops chirping the economy is strong with Paulson, and starts singing the recession blues with Greenspan.

Regardless of what tune she will be singing, The Easy Society is in for very harsh times.

Regards,
Mike Shedlock ~ “Mish”

March 13, 2007

The Easy Society was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Realtors Say Home Prices Are “Close to a Peak,’ With Condos to Fall”:

“‘The housing market is probably close to a peak right now in terms of sales activity, but there is tremendous momentum,’ said David Lereah, chief economist for the [National Association of REALTORS], in a statement. ‘Sales are expected to coast at historically high levels into next year, but they will trend slightly downward.’

“Lereah’s statement on Tuesday comes six months after the release of his book, Are You Missing the Real Estate Boom? Why Home Values and Other Real Estate Investments Will Climb Through the End of the Decade — and How to Profit From Them.”

Can’t afford to buy? No problem. The Orange County Register reports, “Buyers Doubling Down”:

“More buyers are piggybacking, using tow loans to buy an O.C. home.

Buyers are commonly using yet another new loan trick. They take out two mortgages at the time of purchase in so-called “piggyback” transactions, according to DataQuick.

“Piggybacks are frequently used by cash-strapped buyers who can’t meet a key financial hurdle.

“Lenders prefer a down payment so large that a key mortgage ratio — the loan’s size versus the value of the home — is 80% or less. That’s an industry quality standard to get the best mortgage deals.

“But as purchase prices soar, lenders now allow buyers to essentially borrow the down payment shortfall: a first mortgage at the desired 80% loan-to-value ratio plus a second mortgage to make up the difference.

“Such double-dippers averaged 38% of all local buyers in the 12 months ending in June — basically double the rate in 2002, DataQuick says. A decade ago, just 2% of O.C. home purchases went piggyback.

“With every boom comes two things:
1) Panic fear of “missing out”
2) Rampant fraud”

Real Estate Fraud: False Rescue

Let’s take a look at No. 2 since No. 1 should be blatantly obvious by now.

The Detroit News reports, “Refinancers Must Beware Foreclosure “Rescuers: Fast-talking predators can quickly get your home for a fraction of what it is really worth”:

“You may think kindly toward companies that would offer a hand to debt-ridden homeowners on the brink of foreclosure. Don’t. The majority of these so-called foreclosure ‘rescuers’ are actually predators who offer sinking homeowners what Harvard Law School professor and bankruptcy expert Elizabeth Warren calls ‘the cement life jacket.’

“Before you’re even aware of it, these scam artists will have acquired your home for a fraction of what it would have brought at sale. Or in an even worse scenario, they will have transferred your title into a trust that then enables them to rent or ‘resell’ your property to equally hoodwinked buyers while, to your surprise, you remain legally obligated to make the mortgage payments…

Foreclosure ‘rescue’ scams fall into three main categories:

** Phantom help: The “rescuer” charges outrageous fees for light-duty phone calls or paperwork that the homeowner could easily do, none of which results in saving the home. This predatory scam gives homeowners a false sense of hope and prevents them from seeking qualified help.

** The bailout: In this scam, the homeowner is deceived into signing over title with the belief that they will be able to remain in the house as a renter and eventually buy it back over time. The terms of these scams are so onerous that the buyback becomes impossible, the homeowner loses possession, and the ‘rescuer’ walks off with most or all of the equity.

** The bait-and-switch: In this scam, the homeowners think they are signing documents to bring the mortgage current, but instead actually surrender their ownership. They usually don’t even know they’ve been scammed until they’re evicted.”

** Following is an e-mail about fraud from a broker friend of mine. In this case, it is about appraisal fraud. Dave Donhoff of No Bull Mortgage writes:

“A friend of mine is a retired mortgage banker with over 40 years in the industry…one of the pioneers of the original equity stand-alone second, and over 25 years in management at Beneficial Finance. He not only KNOWS all the myriad regulatory issues (Reg Z [TILA], Reg X [RESPA], FACTA, Sarbanes-Oxley, and many others), he’s been involved in crafting them at various stages in his career.

“He and I watch and chat about the ‘fraud blogs’ (by industry attorneys) daily, and marvel at the blatant, unrepentant fraud that goes unconstrained on several of the mortgage industry professionals’ discussion boards.

“So…my pal calls up the FBI (and goes through a massive runaround of handoffs and brushoffs to get to someone who theoretically is in the authorized position), explains who he is and what his background is (to establish he’s not just another crackpot old fogy complaining about noisy-neighbor communist insurgents), and seeks to find who he can channel airtight fraud leads to for prosecution. FINALLY, he’s handed off to someone who appears to understand the issues and has an interest in proceeding. This agent sets an appointment to personally visit my pal onsite at my buddy’s home.

“The day comes (last week), and the agent doesn’t show. Instead, two junior agents come out in his place, have absolutely no clue about anything about the finance business, let alone the pertinent laws and regulations, and merely do a ‘fill in the forms’ data collection interview with my pal, as though it were a police report for a stolen car. The attitude was very clearly, ‘Let’s get this over with…don’t call us, we’ll call you.’

“Mind you…we see brazen and pure banking fraud being committed, out in the open, by not only loan originators, but by wholesale lenders’ agents and underwriters (not to mention ‘make it work whatever it takes’ real estate agents) CONSTANTLY! It’s being done, unencrypted, on industry message boards nationally…it’s BEGGING to be ‘trimmed’ (if not whacked at the knees unmercifully!).

“The FBI delivered a very clear and obvious message: ‘This isn’t news, this isn’t terrorism…this is only going to be little fish commercial issues, so we frankly don’t give a damn…but thank you, and have a nice day ;~).’

“So…I have no idea what the solution is, short of the disease going full course. Our regulatory enforcement is less than sufficient; it’s leaving the warehouse back door open, going to the roughneck bar, and bragging about it.”

Real Estate Fraud: Horror Story

Check out this snip of a horror story posted by MEW on The Motley Fool:

“A few years ago, I refinanced my house and got a lower mortgage, took a little money out for some landscaping and bills. Loan was $187K, house was appraised at $225K.

“This spring, I went to refinance again. Unfortunately, because times have been hard, employment has been on and off, and we were hoping to sell the house in a few years, so I refinanced to an interest-only loan, took some money to pay more bills, and kept a pretty low rate, 5.25% fixed, I think. At this time, just a few short months ago, the appraisal of my house was $260K, my new loan amount $204K.

“I was only willing to refinance and take out money because my home was now valued at $260K. $260K seemed high to me, I’ve also seen nonremodeled homes on my street selling for under $200K, but I thought I could probably sell for $240K.

“I live in an area that realtors say is ‘hot.’ It’s a neighborhood that used to be undesirable because it was near the airport, but now the airport has moved far away and the old airport is a very hip and trendy new home community. New shopping areas are springing up around this area; recently they built a brand-new arts magnet school one block away….

“So we decided we would try to sell the house this month. I called a realtor…. They did a very thorough comp evaluation and came back to me saying I would be lucky to get $200K for the house.

“In my mind, I thought I would like to list it for $250K and accept $240K. I was floored. I explained the $260K appraisal and the response, ‘Oh yeah. Appraisers do that for mortgage brokers to get the loans/refinances.’ IS THIS LEGAL? ETHICAL?”

Real Estate Fraud: Is this Legal?

Let’s address Mew’s question: Is this legal? Is this ethical?:

** No, it is not legal, but proving appraisal fraud is going to be very tough to do

** Is it unethical? Of course, but no one cares

**  Credit card companies like it because they get paid and consumers just go right out and run up their credit card debts again

**  Originators like it because they get paid to originate the loan no matter how bad it is

**  Originators in turn take all of the poor loans and sell them to Fannie Mae or to other “investors” stupidly striving for yields just slightly better than Treasuries, with nearly infinite more risk on a percentage-wise basis.

As long as originators can count on selling mortgages to Fannie Mae (no matter how bad they are) or securitize them in a package of loans sold to “investors,” blatant fraud is likely to continue. Such practices will continue until credit lending eventually blows up. At that time, there will be 24 congressional hearings trying to figure out “how it happened.” Mish is quite confident that in the upcoming “biggest hand-washing affair in history,” the loudest proclamation will be, “No one could possibly have seen this coming.”

Regards,

Mike Shedlock / Mish
August 18, 2005

Real Estate Fraud: Are You Missing the Real Estate Boom? (Part 1 of 2) was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.