Here Come da Judge
In the midst of the massive dome of rubble that is the mortgage meltdown, there are indeed both winners and losers. The homeowners themselves are the most commonly recognized ‘losers’ in all of this…but as Bill Bonner points out, the homeowners are only one end of the stick. A stick, which happens to be short on both ends – and long in the middle.
Mother Nature is a hanging judge. How about the U.S. Federal courts?
Mr. C.A. Boyko recently fired a shot that was heard ’round the world. At least ’round the world of structured finance. Or, at least, ’round the world of Deutsche Bank, who got a bullet in the head.
Poor Deutsche Bank is the victim of its own avarice…its own stupidity…and the cycles of nature. Nothing to be ashamed of. In war, even the best soldiers get their brains blown out. In finance, they blow them out themselves.
Before pulling the trigger, the judge was curious…a curiosity shared by millions, no doubt. He wanted to crack open a sophisticated derivative product – a mortgage backed security – and find out what was in it. In the event, he discovered that something was missing; structured finance was not structured quite as well as it pretended to be.
Here unfolding is the story of a credit contraction. Its protagonist is neither a financier nor an economist. He is a U.S. federal judge. And at issue in his courtroom was whether Deutsche Bank National Trust Company could repossess 14 houses in the Cleveland area.
The first part of courtroom proceedings always begins with a ‘whereas’: Whereas the homeowners were living in houses with mortgages, said the lawyers. And whereas said homeowners hadn’t made their payments. And whereas Deutsche Bank was the de facto mortgage holder, the pleadings went on…said bank wished to foreclose on the 14 properties.
Here, we add some whereases of our own. Whereas there is about $6.5 trillion worth of securitized mortgage debt in the United States alone. And whereas the value of the collateral – the houses themselves – is going down. And whereas the hotshots who securitized this debt operated so fast and loose they might have been undertakers in a plague year. And whereas standards of creditworthiness…and details of the mortgages themselves…were permitted to slip. And whereas the whole idea was to earn high fees for loading people down with debt, while pushing the risk of loss onto the naïve, the slow-witted and the unborn. And whereas the losses are now expected to tote to somewhere between $150 billion and $400 billion…and as much as $2 trillion, according to Goldman Sachs, in lost credit… And whereas every half-wit knew there would be hell to pay when the credit cycle turned down…
…this case might be a bigger deal than people realized.
For his part, Judge Boyko showed little interest in the macro-economic whereases. What he wanted to know was: Where are the mortgage documents? It may be true that these people owe you money, he suggested, but we don’t take a man’s house away from him without a valid mortgage contract. Not in the sovereign state of Ohio anyway.
Deutsche Bank’s legal team looked at each other. Then, they looked in their briefcases. The lawyers had plenty of documents, including some clearly showing an "intent to convey the rights in the mortgages." But as for the mortgages themselves, they had none. Again, Deutsche Bank is hardly exceptional. When a law professor studied foreclosure proceedings recently, she found that in 40% of cases, the creditors either did not or could not produce the vital documents, giving them the right to retake the houses.
Apparently, the financial intermediaries who had bundled these 14 mortgages together with thousands of others to create the Structured Investment Vehicle (SIV) bought by Deutsche Bank had neglected to bundle in the actual mortgage documents. Searching high and searching low, they could not be located.
A year ago, it scarcely would have mattered. For the first six years of this century, credit was expanding. The mortgage companies earned fees by lending money to people who couldn’t pay it back. Then, the lenders shrewdly sold the mortgages on to Wall Street firms who bundled them up and turned them into tradable securities, backed by complex mathematical models that showed what they were supposed to be worth. These were then rated by companies such as Fitch and Moodys – again for fees – and sold on to people who didn’t know what was in them, generating more rich bonuses for the financiers. That was the beauty of securitized debt; the money was made in the middle, while the trouble was pushed out to both ends. Despite what the mathematicians said, the borrower would surely come up short sooner or later. So would the lender. The intermediaries would come out ahead. In effect, the stick was short on both ends, but long in the middle. In this case, one of the short ends was held by Deutsche Bank, who had bought the SIV and expected to enjoy the usufructs of said mortgages, such as they were. That is when Judge Boyko broke the spell:
"The institutions seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance. Finally put to the test, their weak legal arguments compel the court to stop them at the gate."
Of course, that’s what corrections are for – to put the pretentious innovations of the bull market to the test. Trillions of dollars worth of SIVs were laid off onto investors, based on dubious math, dizzy promises and dopey logic. Now, they’re being put on trial – in courtrooms and in markets. Some will get the gallows. Many more probably deserve it.
The Daily Reckoning
November 30, 2007
This morning, we’re making a speech to the World Money Show here in London.
So, today’s reckoning will be mercifully short.
What do we have to reckon with today?
Well, we begin with two stories.
"U.S. credit drying up, raising fear of recession," reports the front page of the International Herald Tribune. "Financial arteries constrict at fastest pace ever recorded."
This is a story of a credit contraction – a piece of the big story we’ve been following for the last few weeks.
Do you remember the rule, dear reader? The force of a correction is equal and opposite to the delusion that preceded it. What would you expect to follow the biggest credit expansion of all time? Something pretty dramatic.
"Credit flowing to American companies is drying up at a pace not seen in decades," continues the report, "threatening the creation of new jobs and the expansion of businesses, while intensifying worries that the economy may be headed for a recession.
"The combined value of two major sources of credit – outstanding commercial and industrial bank loans, and short-term loans known as commercial paper – peaked at about $3.3 trillion in August… By mid-November, such credit was down to $3 trillion, a drop of nearly 9%. Not since the Fed began tracking such numbers in 1973 have these arteries of finance constricted so rapidly. …"
"This is a very big deal," said Andrew Tilton, a senior economist at Goldman Sachs (NYSE:GS).
Yes, dear reader…this is the immoveable object the Fed is up against. It is deflation. And it is a very big deal.
Bankruptcies are running 35% ahead of last year. Foreclosures were up 94% in October, from a year ago. Sears (NASDAQ:SHLD) reported its profits had plunged 99%.
Meanwhile, on the other bank of the great Atlantic, the Financial Times offers this:
"New fears for housing in credit collapse."
Ah yes, that word – collapse – is back. We hadn’t seen it for years. Just this past summer we gave a speech in Canada, regretting the ‘collapse of collapse’ – meaning, that whenever anything in the financial world threatened to collapse, the financial authorities rushed in to prop it up. Humpty Dumpty could fall off the wall all he wanted; there was always someone there to catch him.
And then, the financial authorities let him slip through their hands.
In England, as in America, the story is virtually identical.
"Banks struggle to find money for mortgages," continues the FT report. The banks are willing to lend. But they have to borrow too in order to get the money. And three-month inter-bank rates – what banks pay when they borrow from each other – have risen to 6.59%. Banks typically borrow short and lend long. But when short rates are so high, how can they make any money lending for long-term mortgages? They can’t. So they stop lending. And without ready mortgage credit, buyers stop buying houses. And when buyers stop buying houses, house prices fall…and all of a sudden a lot of people are in trouble.
"The first concrete sign of a crunch in credit availability is likely to emerge today when Bank figures are expected to show a large fall in mortgage approvals for October. "
Oh well…something that had to happen sooner or later is bound to happen one day. The credit expansion couldn’t go on forever, after all. Why not today?
*** No milestones this week. In fact, instead of hitting the $850 mark, gold fell below $800. The yellow metal is in a bull market. But bull markets have corrections. Maybe this is just wishful thinking, but gold could easily fall below $700 before resuming its march to $1,000.
*** A friend of ours has been sent to jail. Poor fellow. He was just trying to help out a friend, he explained, by bringing her some drugs. Illegal ones, of course. Now, he’s doing a six-month stint in Her Majesty’s gaols.
"Prisoners cost the government 385 pounds per night (nearly $800)…Maybe I can convince them to let me stay at the Georges V in Paris…or the Ritz in London… It would be cheaper. And this place is no Four Seasons."
In some ways, it must be nice to be in prison. There are so many things you can’t do…it leaves you free to concentrate on a few things you can do.
You probably can’t call your broker, for example. So you have to figure out a Prison Portfolio – an investment position that will stay valid for as long as your term.
What would a prison portfolio look like today? Hmmm….we’ll have some thoughts next week.
*** Et ux.
A report in MoneyWeek magazine tells us that women consistently judge inflation to be running 1.9% higher than men. We don’t know whose opinions are more accurate, but there is always a gap between the sexes…a distance that can seem as inconsequential as a mountain brook some days…and as broad as the Amazon others. Some days we hop gaily over it. Other days it is unbridgeable.
As far as we know, no major plan is afoot to bring the distaff half of the American race closer to its male counterparts. Candidates for public office offer solutions and ameliorations for just about everything else, from the price of gasoline to the weather. But no candidate offers to put even a dollar into a program to make women more like men…which, in the male mind, is to make them better.
The subject is often discussed – why American women are the way they are. Men grumble about it: Women can’t stay on schedule. They can’t stay on the subject. They can’t stay on budget. They can’t stay at home. They won’t stay in their lanes or their places. They are pushy, demanding, aggressive, argumentative and domineering. You don’t have to be a misogynist to see that there is room for improvement.
With such a large and visible annoyance in front of the voters, you’d think some ambitious rogue in quest of a Senate seat would propose something. "If we can put a man on the moon," he might point out, "why can’t we turn our wives into more agreeable companions?" "Why can’t science do something for them?" "Why can’t our women be slim and sexy, like the Italians and the French? Why can’t they be more submissive and suggestible, like the Thais or Malays? Why must we put up with shrews and nags?"
Of course, something could be done – at least theoretically. Hundreds of billions are spent on education already; much of it could be diverted to retraining and re-educating women. In terms of human happiness, for all we know the money would probably yield greater returns. Women could be taught to hold their tongues, for example. Or to smile admiringly when their husbands were talking, like Pat Nixon or Nancy Reagan. Typically, when a communist regime took over, it condemned bourgeois elements either to death camps or re-education. Those camps must have been successful; once they were in place and fully functioning, here was scarcely any internal resistance. Could not the same programs work for women?
Of course, a scalable, public attempt to make people better is always a humbug; rarely are the results positive. In fact, the only public program we can think of that produced favorable results was Lady Bird Johnson’s effort to beautify America. Under hectoring pressure from the beautifiers – and faced with large fines – people stopped throwing trash out of their windows.
But what really stands in the way of a Manhattan Project to improve women? When people want to do something absurd, neither logic nor humility get in the way; just look at the Republicans’ war in Iraq or the Democratic Party platform. But proposing to improve the weather or the people of Mesopotamia is very different from proposing to improve our own fair sex. In offering to reform the Middle East, the Bush Administration was speaking nonsense in a vacuum. It could blab all it wanted about weapons of mass destruction, bringing democracy to the Middle East, or securing the flank of the great empire. The words passed over voters’ heads, and even right through their skulls, without striking a single brain cell. Scarcely anyone in America had ever seen a terrorist…and no one had any idea of the threat posed by the Iraqi government. People could imagine whatever they wanted.
Not so, women. We are too close to them. While the world of geo-politics is all make-believe, the world of women is very real. It is with us everyday. We live among them. They are our wives, our mothers and our daughters. We know far too much about them to imagine that we could improve them; we wouldn’t know where to start. And while every word written or uttered in support of the War on Poverty or the War on Iraq is palpable claptrap, every word ever written about women is true. They are adorable, they are sneaky, they are charming, they are perfidious, they are winsome, they are abominable. In fact, almost nothing you could say about women would be untrue. They are infinitely varied. Infinitely fascinating. Infinitely unfathomable.
Besides each man has his own women. And each one is indecipherable to him. Make her better? He has no idea what is wrong with her. Whatever the problem, she has already explained to him that it is his fault; and he suspects she might be right.
We can complain about them all we want…but we know we couldn’t make them better. Our clumsy hands could scarcely hope to shape the clay into a more fetching form.
*** Finally in today’s essay, we wished to describe the word "whereas," when used at the beginning of a sentence. What, exactly is it? We didn’t know. So we put the question to a German linguist. (It’s Friday…we permit ourselves a little lightheartedness at the end of the week.) His reply:
"You may also want to consult a native speaker or a member of the legal profession about this. This is what I think:
"1) Normally, ‘whereas’ is a subordinating conjunction.
"2) Prepositions mark syntactic relations between parts of sentences (e.g. phrases).
"3) Legal terms can transform prepositions into phrases (e.g. ‘ex post facto’) which take on adjectival functions, but I am not aware that conjunctions are turned into prepositions.
"4) In the cited usage, the syntactic position of ‘whereas’ is that of a conjunction, but the subordinate construction is broken down into separate, seemingly independent units. It is not in the position of a preposition.
"5) ‘Whereas’ is also a special legal term: See The Lectric Law Library:
"’WHEREAS – This word implies a recital, and in general cannot be used in the direct and positive averment of a fact in a declaration or plea. Those facts which are directly denied by the terms of the general issue, or which may, by the established usage of pleading, be specially traversed, must be averred in positive and direct terms; but facts, however material, which are not directly denied by the terms of the general issue, though liable to be contested under it, and which, according to the usage of pleading, cannot be specially traversed, may be alleged in the declaration by way of recital, under a whereas.’
"For an example of this usage in a document, See Consent Decree
"6) The usage of this term violates the syntactic rules of standard English. If you separate the ‘whereas’ with a comma, you can regard it as the functional equivalent of a full sentence which gestures at the conditions under which following sentence is deemed valid.
"7) ‘Pre-position’: does the text mean ‘legal proposition’? This might make more sense…
"Hope this helps – I’m not an expert.
Dr. F. Krause – 18th-century German literature, especially the Enlightenment; expressionism and literature in Germany, 1910-1925; Özdamar Goldsmiths, Department of English and Comparative Literature
The Daily Reckoning