Little House on PIMCO’s Prairie

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Includes: FMCC, FNMA, HSBC, MCO, SPGI, WFC
by: Michael Steinberg

The Wall Street Journal, in “Would You Pay $103,000 for This Arizona Fixer-Upper?”, reports on how a 576 square foot house not fit for human occupancy wound up as a foreclosure on a triple-A rated PIMCO MBS. PIMCO’s never short for words Bill Gross and Mohamed El-Erian refused to comment for the Journal article. These are the people that advertise themselves as the “experts” endlessly on CNBC, and are always available for television comment and consultation on every potential move by the Federal Reserve and Treasury. PIMCO is held in such high esteem that they were chosen as one of the four managers for the Fed’s $500B Fannie Mae (FNM), Freddie Mac (FRE), Ginnie Mae MBS purchase program.

The story starts with the $3,500 purchase of a suburban Phoenix home four decades ago by a woman who has been on various forms of public assistance for the last 13 years. The former homeowner admits that her weakness for hard liquor and gullibility for multiple cash-out refinancings lead to her downfall. In the end the house was in such disrepair that she gave up and moved to an apartment.

The last refinance in early 2007 netted the homeowner only an $11K cash-out on a $103K mortgage. The 30-year adjustable rate mortgage started at 9.25% and capped at 15.25% for a woman with children who was “earning” $3,000 per month in public assistance. The appraiser earned $350 for valuing the property at $132K. He plugged all the right numbers into to the formulas, even though he personally did not believe the house was worth that much. He claimed that he technically played by the rules, if not the spirit of the appraisal process.

This playing by the numbers amounted to putting “square foot logic in a round hole.” The Journal’s hut is certainly the type of outlier that trips up the mathematical formulas of the ratings agencies.

The final mortgage was originated by Integrity Funding LLC (a mortgage broker no longer in business) which collected $6,153 in origination, documentation and other fees. Integrity earned an additional $3,090 when the firm sold the mortgage to Wells Fargo (NYSE:WFC). Wells Fargo subsequently sold the mortgage to HSBC (HBC) which packaged it along with 4,050 other subprimes into a security. Standard & Poor’s (MHP) and Moody’s (NYSE:MCO) rated this collection triple-A. Our notable expert PIMCO was one of the greedy that bellied on up to this trough. And that’s the short story of how this love shack became PIMCO’s little house on the prairie.

Don’t forget how Sherri Winston, an educated Ft. Lauderdale Sun-Sentinel columnist, got seduced by cash-out refinancing. The Journal leads us to feel bad for its disadvantaged homeowner, but as I detailed in "The Anatomy of a Subprime Mortgage" almost anyone can be seduced by cash-out refinancing.

Disclosure: Author is long FNM, FRE, MCO and WFC.