Angry Banker's  Instablog

Is it no secret that the Foreclosure Prevention Act of 2008 has not lived up to expectations in terms of keeping families in their homes, slowing down the rate of default on mortgage loans and stabilising the housing market.  Why?  Because after all is said and done, many people are still living in homes that they cannot afford, and never should have bought in the first place.

The solution is not to throw money at the problem in a desperate attempt to “keep families in their homes”, particularly when it comes to rewarding people who made bad borrowing decisions by rescuing them from their mortgages and forcing lenders to write down the balance of outstanding loans.  No, the solution is to get people back to living within their means.

I have said from day one of this crisis that the responsibility for the problem is shared among all of us. No, I don’t mean all of us bankers.  I mean all of us. “Us” includes bankers, brokers, investors, Congress, the regulators, and like it or not the borrowers who speculated in the housing market and happily accepted easy loans that were being offered them.

So to solve the problem created by all of us, I propose that we assign specific accountability to each guilty party and then implement corrective actions that will rectify any damage done to a party beyond what they were directly accountable for.  Without further ado, here is my is plan for helping those families who can no longer afford to live in their homes:

Borrowers who can no longer afford their mortgage payment, but were in fact responsible borrowers:

If a borrower can demonstrate that he/she borrowed responsibly (within his ability to pay and was not speculating in the housing market), then I assign very little blame to him/her and believe he is deserving of maximum support.  However, foreclosure should still take place (but with protections outlined later).

How does a borrower demonstrate he borrowed responsibly? Easy:

• Can the borrower prove he had the ability to pay (proof of stable income at the time of borrowing)?
• Was the LTV (loan-to-value) 80% or less?
• Was the borrower’s debt-to-income ratio after obtaining the loan less than 30%?

If the answer to all these questions is “Yes,” I believe the borrower most likely behaved in a responsible manner and that his current situation is most likely not his fault. Therefore the borrower would be eligible for the following benefits:

• Upon foreclosure, government assistance of a few thousand dollars (or a tax credit) to help with expenses to move to a less expensive house or apartment should be provided.
• The borrower’s default should not be recorded in the credit bureau, thus enabling the borrower to obtain a new loan when his financial situation improves.

What about borrowers who were gambling?

If the customer fails the “responsible borrower” tests above, I am still not yet prepared to assign full responsibility to him though.  The reason is that I believe banks have a fiduciary responsibility to their depositors to ensure they do not extend credit on excessively risky terms (in other words, it’s the depositor’s money at risk, not the lender’s). Therefore, for failure to answer “yes” to any of the three questions above, here is how I propose we rectify the wrongdoing:

• The lender should be fined for failure to lend in a responsible manner and the full amount of the fine should be applied to the outstanding balance of the borrower’s loan. The amount of the fine should be calculated as the difference between the value of the loan the borrower could have legitimately afforded and the amount of loan that was actually made.
• If the loan can be refinanced now with lower payments that the borrower can afford, problem solved.
• Otherwise, proceed with foreclosure, but with the new lower balance as the recoverable amount for the bank.

Note that the program above should only be applied to loans on primary residences. If people have two houses, but lose one of them, they still have a place to live and will probably have better cash flow once their second house is foreclosed.

Why the “Angry Banker’s Foreclosure Solution” will work

Allowing the foreclosure process to proceed naturally – but with relocation support and no negative credit bureau impact for responsible borrowers – will be almost like pressing the “reset” button for millions of borrowers who legitimately became victims of an unprecedented economic downturn. They will have improved personal cash flow after foreclosure and still be able to obtain loans in the future. With their improved cash flow, they may also be able to go ahead and more easily service their credit card debts, helping to avert the next major credit crisis for the banking industry.

For banks, fining them for irresponsible lending practices and applying the fines to the loans themselves, forces the banks to accept financial responsibility for their bad business decision to allow no-doc liar’s loans at imprudent LTV’s.  But for those banks that made responsible loans (those made to customers passing the “responsible borrowers” test above), the bank should rightly be able to recover their losses through sale of the collateral just like in a normal economy.

For the economy, we will see excess supply in the housing market as foreclosures increase in the short term. This will drive down the prices of homes, which will spur people to start buying.  When people buy used homes, they will naturally renovate and improve them, meaning they will be spending money again. This will drive domestic consumption and motivate companies to hire again, resulting in reduced unemployment, and so the positive feedback loop begins.

Now I recognize that there are many ways to further improve this plan. But the fundamentals are sound. Don’t reward bad business decisions (either by banks or borrowers), but do give a helping hand to those people who were legitimate victims of the global economic meltdown.

I welcome your comments.

Disclosure: Long C, Long XLF

Dear Mr. Feinberg,

I am an investor in Citigroup, both through direct ownership of thousands of shares of common stock, as well as indirectly through a partnership that has recently acquired 34% of the company.  As such, I am highly motivated to ensure that my investment grows in value and that our investment partnership is able to sell its shares in the future for a substantial profit.

Considering we have already invested in Citigroup (whether we wanted to or not), it is an incontrovertible fact that this decision has already been made and the money has already been spent. Therefore, it is very important that we as shareholders do all we can to ensure the success of the company we have purchased. It is for this reason that I am writing to you today.

You will soon be evaluating Citigroup's compensation structure, including that of Andrew J. Hall, the leader of Citigroup's energy trading unit Phibro.  Mr. Hall's unit has earned Citigroup hundreds of millions of dollars in profit annually for several years. The company has a contract with Mr. Hall and his small team which rewards them handsomely when the team earns a profit. This year, it has been reported that Mr. Hall and his team may be due approximately $100 million under the terms of his contract.

I would like you to carefully consider Mr. Hall's compensation package and ensure that it has the right structure to compensate Mr. Hall appropriately for earning huge profits for Citigroup, but that it also ensures he gets no reward should he or his team's trades cause losses for the company in the future.

Beyond this simple analysis above, I beg you not to request Citigroup to break the contract the company has with Mr. Hall and refuse to pay him what is contractually due to him.  While you will undoubtedly hear from "outraged" fellow taxpayers that "no one is worth that much," please look at the matter from the viewpoint of an investor, not from the view of someone who does not understand that if we want our investment to grow, we must keep the people who make the money!

Mr. Feinberg, you will surely also read articles and hear from numerous people that it is okay to break the contract because without government support, Citigroup would have gone bankrupt and Mr. Hall would not have gotten paid anyway (see one such article written by my fellow taxpayer Felix Salmon -- "Revamping Traders' Pay").

However, please also ignore this inane drivel.  Again as I noted at the beginning of this letter, for better or for worse our decision to invest in Citigroup has already been made and we have already purchased the shares. If we wanted to punish the employees of the company, we should have done that last year by refusing to invest in the company.  However, we apparently realized that not all the employees of the company were bad and in fact many parts of the company can make a lot of money.

So as prudent investors, we instead decided to invest in the company and hope for a healthy return on our investment.  Therefore, also as prudent investors, we definitely want to retain the best talent, those managers who are helping the company to return to sustained profitability.  If we alienate those managers by breaking our contracts with them, they will almost certainly leave the company and Citigroup will have lost some very talented individuals that have been consistently earning significant profits for many years.

Having said all of the above, I still expect that you will be under severe political and public pressure to void the $100 million payment due to Mr. Hall and his team.

However, I trust that you actually understand your fiduciary duty to the taxpayer. Thus recognizing that Mr. Hall and his team earn profits for Citigroup that are five to ten times their annual compensation, I am certain you will agree that it would be the most intelligent decision to pay them as agreed, so that they will continue to perform well and help our investment grow in value.

Yours truly,
Angry Banker

P.S. Disclosure: Long XLF and Long C (as we all are)

 

First let's stage the stage. In a previous article I railed on Ben Bernanke's inappropriate (and possibly illegal) pressure on Bank of America's Ken Lewis to complete BAC's acquisition of Merrill Lynch.

Now Hank Paulson has testified before Congress and confirmed what I had said previously, that the government seriously overstepped its bounds in pushing through this deal. Here is an excerpt from Paulson's testimony (emphasis added by me):

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As if the world’s bankers haven’t already been demonized enough over the past 21 months, the FT has reported that none other than the Pope himself has now piled on and pontificated on the “grave deviations and failures” of capitalism.

Pope Benedict XVI, on the eve of the G8 summit in Italy, used his bully pulpit to call for a “true world political authority” to oversee a return to ethics in the global economy.  I can only pray that the Pope is not purporting that we should look to the Vatican and its policies as a model of how the rest of the world should behave.  While I have to acknowledge that many of my fellow bankers have not been the most upstanding members of the global community, to my knowledge we have not yet descended into widespread pedophilia, genocide, drug running, extortion, and racketeering (oh wait, maybe just a little of those last two…).

Seriously though, as easy of a target as the Catholic Church is (try Googling “Crimes of the Catholic Church” – over 2 million hits, compared to just 346,000 for “Crimes of Goldman Sachs”), I am a strong believer of separation of church and state, especially when it comes to establishing the right structure for global finance.

The Pope’s decree for “forms of redistribution of wealth” is exactly the kind of language used by every communist and socialist leader in history who has used an economic crisis as a means to gain populist support for their regimes and to implement policies that are specifically designed to take from the rich and give to the poor.

But inevitably, also as seen in every true communist regime in history, the destruction of capitalist principles – in reaction to what would have otherwise been a temporary economic crisis – has resulted in the obliteration of much more than just economic vitality.  After the State wrests economic freedom from the populace, freedom of the press, freedom of association, freedom of thought, freedom of religion and many other fundamental human rights that we in capitalist societies usually take for granted also quickly fall in short order, slaughtered victims of the new “People’s State”.

Indeed, mixing religion with politics and economic policy is a slippery slope that everyone should be diligent to avoid like the plague.  I only hope (and pray) that the leaders of the G8 listen to the Pope politely, then proceed to implement policies that continue to promote capitalism as the best means to ensure prosperity for the most and poverty for the least.

Indeed, while this article will surely be crucified for concluding that capitalism is the best economic model in the world – with the usual references to the U.S. being the home of some of the largest income disparities between the wealthy and the poor of any country in the world – what we should also be mindful of is the fact that even the bottom 10% in the U.S. are significantly more wealthy and have a far better standard of living than the typical middle class citizens of Russia, China, North Korea, Venezuela, Cuba, Vietnam and numerous other current or historical socialist states.

 

Media thrives on exciting stories. And when the straight news is controversial, media has every right (nay, an obligation) to spread the word.  However, a disease that has infected tabloid media for decades is starting to spread to much more respectable media and threatening to cause real harm if it is not quarantined and inoculated.

This disease is the sickness of taking a straight news story (or even something that otherwise should not be news) and reporting it as if a major scandal has been uncovered, and then adding comments and superlatives that are essentially editorials, without any tangible evidence of the basis of their statements. Some call this “yellow journalism,” the goal of which is to stir the emotions of readers, who will then demand that their politicians “do something” about the article’s subject.
 
Today’s FT.com provides a good example of this sort of sensationalist reporting with their story “Citi raises card rates on millions”.  When I started reading this story I could tell from the very first sentence that this was to be a hatchet job:

“Citigroup has sharply increased interest rates on up to 15m US credit card accounts just months before curbs on such rises come into effect, in a move that could fuel political anger at the treatment of consumers by bailed-out banks.”

Let’s break this single sentence down into three parts to illustrate how in the opening statement, the authors immediately departed from giving us straight news and instead launched into yellow journalism:
 

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Analysts are predicting continued positive earnings for Bank of America (BAC), but are wagering on another bloody quarter for Citigroup (C). The average of estimates for BAC’s earnings for Q2 is $0.27 per share, while the analysts predict C will lose $0.31.

Undoubtedly over the next three weeks, numerous financial news pundits and other so-called experts will reference these analyst estimates countless times when telling investors whether they should buy, hold, or sell shares of these two firms.

But when I dive into the gory details, I find it hard to give any credence whatsoever to analyst estimates when deciding my investment strategy for companies in the financial sector. If you take a look at how skilled the analysts have been in predicting BAC’s and C’s price over the last four quarters, you too will likely decide their reports are not worth the paper they are written on.

Case in point, in the last four quarters the analyst estimates for Citigroup have been off by 18%, 14%, -86.3%, and 47.1%.  Even worse, for Bank of America the analysts missed the mark by 36%, -76%, -700%, and 780%!  (By the way, if you think this phenomenon is unique to these so-called “zombie” banks, on average the analyst estimates for Goldman Sachs (GS) and J.P. Morgan (JPM) over the last four quarters have missed their actual results by 45% and 67% respectively).

Granted, the entire market has been extremely difficult to predict since the second half of 2007.  But in the age of Sarbanes-Oxley, with its emphasis on transparent disclosure of financial matters, it still amazes me that analysts can be so in-the-dark about the likely financial results of the companies that they purportedly cover in great detail.  If the analysts – who are paid quite handsomely for their services – cannot accurately predict the financial results of the firms they evaluate (or at least come within 5 to 10% of the actual results), then what are they good for?

Even more astonishing is despite the obvious fact that the average analyst estimates are rarely even close to actual results, the market still reacts with shock when a company fails to match the consensus view, often times driving down the share price ten, twenty, or even thirty percent and more. Of course the inverse is true as well; when a company beats estimates the stock price may soar 20% or more in a single day.

Personally, I try to think longer term and decide whether fundamentally a company has the right stuff to succeed beyond the current quarter.  In the case of C and BAC, much maligned as they are, it is still a fact that their Tier 1 Capital Ratios are now in the top 3 in the world, they have increased reserves for loan losses to levels beyond anything they have ever had before, and they have been on strict diets to cut expenses, shed non-core businesses and to rid their balance sheets of risk associated with a host of “exotic” products they have sold over the years.

The executives of these companies know without a doubt that their jobs (and all the cushy perks that go with them) are on the line if their companies continue to fail to perform, not to mention that much of their prior compensation was in stock options that have a long way to go before rising above water again. Their incentives now I believe are truly aligned with the shareholders and therefore they will do everything in their power to make their companies successful again.

By the way, for what its worth I think BAC is going to meet the analysts’ expectations this quarter, and I think C is going to beat consensus considerably….

Disclosure: Long C, XLF