Part 4 (1/2)

My client later reminded me of those words when a.s.sociate Justice of the Supreme Court, Antonin Scalia, told 60 Minutes 60 Minutes that torture (such as waterboarding) is not ”punishment,” that torture (such as waterboarding) is not ”punishment,”20 implying that the const.i.tutional prohibition against cruel and unusual punishment wouldn't apply to torture. My client joked that investment banks would like to waterboard me to implying that the const.i.tutional prohibition against cruel and unusual punishment wouldn't apply to torture. My client joked that investment banks would like to waterboard me to prevent prevent me from talking. me from talking.

My loss projections were higher than anything coming out of the U.S. government or Wall Street. It turns out I was predicting the greatest losses, and I was too optimistic. Housing speculators and overreaching homeowners took risk, seemingly with ”eyes wide shut.” Many others were lured with the promise of homeowners.h.i.+p. Predatory lenders targeted minorities and lower-income people who were intellectually and financially mugged, then dumped on the side of the road. The motto of predatory lenders is ”every minority left behind.”

Before meeting Warren, I wrote about industry problems, but only in a general way. Warren's subtle encouragement helped me find my voice. Now I specifically challenged the Federal Reserve Bank and major investment banks on national television.

I told CNBC's Joe Kernen that I advocated a temporary moratorium on subprime foreclosures, followed by mortgage restructurings.That meant first first reappraising to lower values reflecting the devastation caused by predatory lending and reappraising to lower values reflecting the devastation caused by predatory lending and then then restructuring mortgages to an affordable fixed rate. In some areas, the reappraised values will be drastically lower and the mortgage terms radically different.This protects misled homeowners. Borrowers complicit in fraud, or who willfully overleveraged, should not be given the same protection but could unintentionally benefit. Helping fraudsters is not anyone's idea of a solution but having a few of them slip through the cracks was preferable to the ruination of entire neighborhoods.The devastation was already well underway and needed to be halted. restructuring mortgages to an affordable fixed rate. In some areas, the reappraised values will be drastically lower and the mortgage terms radically different.This protects misled homeowners. Borrowers complicit in fraud, or who willfully overleveraged, should not be given the same protection but could unintentionally benefit. Helping fraudsters is not anyone's idea of a solution but having a few of them slip through the cracks was preferable to the ruination of entire neighborhoods.The devastation was already well underway and needed to be halted.

In some parts of the Midwest every third home is vacant in minority neighborhoods. Housing prices have plummeted. Fixing the problem for innocent homeowners will mean losses must be born by lenders, including subprime mortgage bankers, investment banks that provided financing to the mortgage bankers, and the investors in subprime mortgages and securitizations backed with subprime mortgages. There is no reason for U.S. taxpayers to bail out the sophisticated financiers.

It is counterintuitive, but limiting losses by reappraising and rewriting mortgages would result in a higher recovery rate that would be good for everyone and limit overall losses.

Servicers collect and record loan payments and credit loan accounts. In the summer of 2007, a major Midwest-based servicer of mortgage loans told me the rating agencies' subprime recovery rates were much too optimistic.The servicer said modifying a mortgage was highly preferable to recovering zero or negative value negative value after foreclosure fees and depressed a.s.set prices took their toll on recovery of relatively low loan balances. These were geographically diverse U.S. subprime loans, but they were alike in risk characteristics.The servicer's staff worked frantic 13-hour days to salvage value. The servicer underreported delinquencies, overdue payments, which were usually reported one month behind prime mortgages already. The day a homeowner missed a payment, the servicer got on the phone trying to work out a new deal. The servicer allowed skipped payments and did not report them as delinquencies. The servicer discovered that if homeowners missed two payments, the loan was virtually doomed to default because most homeowners gave up after that. It aggressively ”re-aged” mortgages-ignoring missed payments urging borrowers to make even one payment so the loan could appear alive. If this practice was typical, the scope of the subprime problem was underreported.The servicer restructured loans doomed to fail in the future. It sold loans for pennies (3 cents to 6 cents) on the dollar. Some of the loans had negative equity (the homeowner owed more than the home was worth) at the time of delinquency. The servicer avoided foreclosure, because legal costs relative to low loan balances and long delays ate up more money than it recovered. a.s.sets included trailers, mobile homes, and homes in areas with depressed prices. after foreclosure fees and depressed a.s.set prices took their toll on recovery of relatively low loan balances. These were geographically diverse U.S. subprime loans, but they were alike in risk characteristics.The servicer's staff worked frantic 13-hour days to salvage value. The servicer underreported delinquencies, overdue payments, which were usually reported one month behind prime mortgages already. The day a homeowner missed a payment, the servicer got on the phone trying to work out a new deal. The servicer allowed skipped payments and did not report them as delinquencies. The servicer discovered that if homeowners missed two payments, the loan was virtually doomed to default because most homeowners gave up after that. It aggressively ”re-aged” mortgages-ignoring missed payments urging borrowers to make even one payment so the loan could appear alive. If this practice was typical, the scope of the subprime problem was underreported.The servicer restructured loans doomed to fail in the future. It sold loans for pennies (3 cents to 6 cents) on the dollar. Some of the loans had negative equity (the homeowner owed more than the home was worth) at the time of delinquency. The servicer avoided foreclosure, because legal costs relative to low loan balances and long delays ate up more money than it recovered. a.s.sets included trailers, mobile homes, and homes in areas with depressed prices.

If this sounds odd, consider that in 2008 a plethora of banks started recla.s.sifying loans on their balance sheets (Astoria Financial,Wells Fargo & Co., and others) or began using more optimistic data (Wachovia Corp. and Was.h.i.+ngton Mutual). If you don't like the numbers, just change the definition. If you don't like the numbers, just change the definition. In July 2008,Wells Fargo stock price jumped 33 percent when its losses were less than expected, but it announced that, as of April 2008, it would wait an additional two months before writing off a loan (180 days instead of 120 days) saying it did not affect its earnings announcement. At the time Wells Fargo's portfolio of home equity loans was $83.6 billion and it was showing signs of stress. In July 2008,Wells Fargo stock price jumped 33 percent when its losses were less than expected, but it announced that, as of April 2008, it would wait an additional two months before writing off a loan (180 days instead of 120 days) saying it did not affect its earnings announcement. At the time Wells Fargo's portfolio of home equity loans was $83.6 billion and it was showing signs of stress.2122 JPMorgan Chase's CEO Jamie Dimon is a master at balancing the short game of earnings announcements with the long game of running a bank. He steered away from most of the mortgage madness, but announced that ”jumbo” mortgages (large balance mortgages to good credits) showed increasing losses. Dimon announced that these prime mortgages to the bank's best customers had losses of 0.95 percent (up from 0.05 percent the prior year), and the losses could triple. For example in California, housing prices had collapsed leading to higher loan losses even for prime (good credit) borrowers. He said JPMorgan may have waded back into the mortgage market early: ”We were wrong.We obviously wish we hadn't done it.”23 [image]

The Federal Reserve kept interest rates low for years seemingly complacent in light of consumer lending problems in the late 1990s and the early part of the twenty-first century. In April 2005, then Fed Chairman Alan Greenspan said mortgage lenders efficiently judged the risk.24 Instead, Greenspan should have raised the alarm about foolish mortgage lending. The Fed compounded its errors when it bailed out Countrywide, the second largest subprime lender in the United States, which is regulated by the Office of Thrift Supervision. Countrywide is also a primary dealer, authorized to trade U.S. government and other select securities with the Federal Reserve System.The Fed should have revoked Countrywide's primary dealer status and let it fend for itself. Instead, Greenspan should have raised the alarm about foolish mortgage lending. The Fed compounded its errors when it bailed out Countrywide, the second largest subprime lender in the United States, which is regulated by the Office of Thrift Supervision. Countrywide is also a primary dealer, authorized to trade U.S. government and other select securities with the Federal Reserve System.The Fed should have revoked Countrywide's primary dealer status and let it fend for itself.

Countrywide posted its expanded interest-only programs on its Web site in September 2003 (and appeared to remove it in 2007). Few borrowers are savvy enough for interest-only loans, since mortgage borrowers paid no princ.i.p.al on loans, just interest. Many hoped housing prices would rise so they could refinance or take a profit.The program included NINA (no doc.u.mentation: no income verification, no a.s.set verification), No Ratio (no income information, so no debt to income ratio is calculated allowing the borrower to a.s.sume a greater debt load than would be allowed with a traditional mortgage), and SISA (stated income, stated a.s.sets) loans. The FHA guaranteed some Countrywide loans, and presumably they conformed to FHA's requirements. But FNMA and FHLMC were the chief buyers of Countrywide's loans, and many of these loans were problematic.

On August 5, 2007, I told CBS's Thalia a.s.suras that the mortgage lending relations.h.i.+p with investment banks is one of the largest ”Ponzi schemes in financial history” and ”risky mortgage products were made to people who couldn't afford them.”25 I misspoke. I meant to say it is I misspoke. I meant to say it is the largest Ponzi scheme in the history of the capital markets. the largest Ponzi scheme in the history of the capital markets.

By the end of 2006, Countrywide's loans showed signs of trouble. The week of August 6, 2007, rumors. .h.i.t the market that Countrywide was looking for a ”white knight,” a deep pocket investor to either take it over or to provide a liquidity injection, but it had no success. On August 7, 2007, the Federal Open Market Committee issued an economic outlook statement saying that inflation, not the mortgage market problems, were the chief concern, and it would not cut the federal funds rate (the borrowing rate) to inject more liquidity into the market. But just two days later, on August 9, the European Central Bank injected around $130 billion into the European banking system, and the Federal Reserve pumped $24 billion into the U.S. banking system through the Federal Reserve's Open Market Trading Desk.

On August 10, 2007,Warren and I spoke on a different topic, and-without naming names-he mentioned that two large companies had come to him hat in hand needing billions.There would be a couple of major blow-ups since they were running out of options. I independently guessed that Countrywide was one of the beggars.

One of the ways Countrywide got money was by issuing commercial paper (a.s.set-backed commercial paper or ABCP) backed by its loans. The week of August 13, 2007, investors shunned Countrywide's debt. Nervous investors demanded higher interest rates. Countrywide told its creditors (investment banks) it wanted to borrow money (by drawing on its credit card-like credit lines). Countrywide wanted to borrow $11.5 billion from a 40-bank syndicate. Countrywide was in a desperate situation. Market rumors were that the banks refused to lend the money, and asked the Fed for concessions. or ABCP) backed by its loans. The week of August 13, 2007, investors shunned Countrywide's debt. Nervous investors demanded higher interest rates. Countrywide told its creditors (investment banks) it wanted to borrow money (by drawing on its credit card-like credit lines). Countrywide wanted to borrow $11.5 billion from a 40-bank syndicate. Countrywide was in a desperate situation. Market rumors were that the banks refused to lend the money, and asked the Fed for concessions.

On August 15, 2007, I wrote Warren that investors were nervous because Canadian money market funds found their investments (not necessarily related to Countrywide) were backed by risky leveraged subprime products. Prices plummeted as investors realized they would lose princ.i.p.al on AAA rated products.26 The banks got their concessions, and lent to Countrywide. On Thursday, August 16, 2007, the stock market (Dow) fell more than 340 points as Countrywide borrowed $11.5 billion. It seemed to me that on Thursday, one or more of the banks leaked the news ahead of the Fed's announcement on Friday because, near the end of trading on Thursday, the market rebounded from the 340 point nosedive to finish down only 15 points. On Friday, August 17, 2007, the Fed announced its concessions-a cut of 50 basis points (bps) in the discount rate to 5.75 percent from 6.25 percent along with news of relaxed borrowing terms. The Fed agreed to accept investments backed with (Countrywide's) mortgage loans as long as they had the now-suspect AAA rating. The Fed also extended the ”overnight” discount window borrowings to 30 days. On Friday, August 17, 2007, the stock market marched upward.

The Fed's terms mirrored those that nervous investors refused when they stopped buying Countrywide's debt.The Fed bailed Countrywide out of its liquidity problems by lending to the banks who lent to Countrywide using Countrywide's collateral to back the loans. This ma.s.sive liquidity bailout was the first Fed bailout related to the subprime mortgage lending crisis (as far as I know). The Federal Reserve Bank could have exercised its authority to demand Countrywide modify mortgage loans.The Fed was a pushover. Ben Bernanke had dangled raw meat in the face of hungry wolves. More bailouts were coming.

Investors felt pressure from all angles. Quant funds reported losses. I told CNBC's Carl Quintanilla that quant funds put on Dead Man's Curve trades, and ”model masturbation makes quants go blind.”Warren Buffett and Charlie Munger warned this would happen. They talk about value and price; they don't talk about betas, correlations, and volatilities. Steve Forbes of Forbes Forbes magazine opposed any bailouts. He noted the Fed had kept rates low, fueling the problem. He cautioned that we should ”resist the temptation to bail these people out,” and specifically referred to the Fed's bailout of Long-Term Capital. magazine opposed any bailouts. He noted the Fed had kept rates low, fueling the problem. He cautioned that we should ”resist the temptation to bail these people out,” and specifically referred to the Fed's bailout of Long-Term Capital.27 On August 17, 2007, CNBC aired a series of stories that Warren Buffett might be eyeing Countrywide, but they were all incorrect stories. 28 28 ”It is better to be a bad manager of a good business,” Warren always says, ”than a good manager of a bad business.” ”It is better to be a bad manager of a good business,” Warren always says, ”than a good manager of a bad business.”29 He seeks good managers of good businesses. I told the He seeks good managers of good businesses. I told the Journal Inquirer Journal Inquirer that the Fed should have asked Countrywide for a quid pro quo in exchange for the bailout: ”Given Countrywide's contribution to the problems in the mortgage loan market, and given company head Angelo Mozilo's denial of that role, the Fed should have pressured Countrywide's board to replace him.” that the Fed should have asked Countrywide for a quid pro quo in exchange for the bailout: ”Given Countrywide's contribution to the problems in the mortgage loan market, and given company head Angelo Mozilo's denial of that role, the Fed should have pressured Countrywide's board to replace him.”30 Warren wrote me that he agreed with my comments. Warren wrote me that he agreed with my comments.

Less than a year after the August 2007 bailout, Daniel Bailey Jr. got a surprise email reply after asking Countrywide to modify the terms of his adjustable rate mortgage. Bailey Jr. wrote he had not understood how the loan worked; he had been told he could refinance after a year; and now he cannot deal with the payments. Mozilo apparently hit ”reply” rather than ”forward” when emailing. Mozilo wrote it is unbelievable that most of the letters Countrywide receives seem like form letters. ”Obviously they are being counseled by some other person or by the Internet. Disgusting.”31 I can understand the email SNAFU. One Sat.u.r.day, I sent my nephew, Kenneth, a link to a cheesy but oddly entertaining David Ha.s.selhoff video.Three hours later, Kenneth C. Griffin, CEO of Citadel Investment Group, replied, ”Did you hit my address by accident?” I know Ken Griffin is a gentleman. He promised not to embarra.s.s me by revealing my mistake. I now also know we are both fans of KITT (Knight Industries Two Thousand), the talking car in Knight Rider. Knight Rider. KITT protected Michael Knight, Ha.s.selhoff 's character, but no one seems to protect borrowers from predatory lenders. I understand how easy it is to miss-send an email. But I cannot understand why Mozilo was still CEO of Countrywide and in a position to send it. Mozilo stayed on as Countrywide's CEO until the week after its acquisition by Bank of America was approved by Countrywide's shareholders on June 25, 2008. KITT protected Michael Knight, Ha.s.selhoff 's character, but no one seems to protect borrowers from predatory lenders. I understand how easy it is to miss-send an email. But I cannot understand why Mozilo was still CEO of Countrywide and in a position to send it. Mozilo stayed on as Countrywide's CEO until the week after its acquisition by Bank of America was approved by Countrywide's shareholders on June 25, 2008.32 Warren is a fan of buying large positions in good stocks, and he is also a fan of Mae West, who once said: ”Too much of a good thing can be wonderful.” I am pretty sure Mozilo's delayed retirement is not what either of them had in mind. Warren is a fan of buying large positions in good stocks, and he is also a fan of Mae West, who once said: ”Too much of a good thing can be wonderful.” I am pretty sure Mozilo's delayed retirement is not what either of them had in mind.

By the spring of 2008, it was painfully clear that mortgage loan losses would be much higher than the Fed's earlier highest projections, and my numbers were closer to reality. The overall size of the U.S. residential mortgage loan market is around $11.5 trillion, of which a little more than 11 percent is subprime and more than 10.4 percent is Alt-A (with credit scores in between subprime and the higher prime borrowers). John Paulson of Paulson & Co. compiled data from LoanPerformance and the Mortgage Bankers a.s.sociation in a public presentation showing that between March 2007 and March 2008, subprime delinquencies had soared to 27.2 percent in the $1.3 trillion subprime market, an increase of around 163 percent, and in the $1.2 trillion Alt-A market, delinquencies soared to 9.1 percent, a year over year change of around 380 percent. Prime mortgage delinquencies were up to 3.2 percent, a 2.1 percent increase from fourth quarter of 2006 to 2007.

Given the gravity of the loan problems, investment banks should have been reporting large losses much earlier. For example, on October 8, 2007, I told clients that Merrill's mal de MER mal de MER was just beginning. At the time a friend asked me where Merrill stock would be in six months. I responded: ”In someone else's portfolio.” was just beginning. At the time a friend asked me where Merrill stock would be in six months. I responded: ”In someone else's portfolio.” Not mine and not Warren Buffett's. Not mine and not Warren Buffett's. Jeff Edwards, Merrill's CFO had made rosy statements in July 2007. Astute shareholders, not to mention the SEC and Merrill's board, might have wondered why the ma.s.sive losses reported in third quarter had not shown up much earlier. Stan O'Neal, the CEO, appeared to have a big problem. Jeff Edwards, Merrill's CFO had made rosy statements in July 2007. Astute shareholders, not to mention the SEC and Merrill's board, might have wondered why the ma.s.sive losses reported in third quarter had not shown up much earlier. Stan O'Neal, the CEO, appeared to have a big problem.

On October 10, 2007, I reminded David Wighton of the Financial Times Financial Times that Merrill was one of the lenders to the mortgage-backed securities hedge funds managed by Bear Stearns a.s.set Management that collapsed in August 2007. Creditors had challenged BSAM's mark-to-market valuations in April, and that is what got the ball rolling for the downfall of the funds: ”Merrill was not so finicky when it came to marking its own books.” that Merrill was one of the lenders to the mortgage-backed securities hedge funds managed by Bear Stearns a.s.set Management that collapsed in August 2007. Creditors had challenged BSAM's mark-to-market valuations in April, and that is what got the ball rolling for the downfall of the funds: ”Merrill was not so finicky when it came to marking its own books.”33 Merrill began reporting ma.s.sive losses, but in my view, they were quarters quarters late. I was amazed O'Neal was still in his CEO chair. On October 24, CNBC's Joe Kernen, with GE's former CEO, Jack Welch, covered Merrill's earnings report. I appeared on a segment with Charlie Gasparino, CNBC's online editor. late. I was amazed O'Neal was still in his CEO chair. On October 24, CNBC's Joe Kernen, with GE's former CEO, Jack Welch, covered Merrill's earnings report. I appeared on a segment with Charlie Gasparino, CNBC's online editor.

I led off: ”Way back in first quarter” I had called this and said Merrill's risk managers should ”get out and short. Short Merrill's positions.” Short Merrill's positions.”34 Gasparino a.s.serted: ”When we we were reporting this about three weeks ago, ahead of everybody . . . we reported there was going to be a larger third quarter loss.” were reporting this about three weeks ago, ahead of everybody . . . we reported there was going to be a larger third quarter loss.”

I countered that O'Neal has a big problem: ”They were not hedging properly in first quarter. first quarter.” I added: ”I laughed in disbelief” when I saw second quarter earnings. ”It is an Enronesque Enronesque kind of problem, it is a business management problem, not a risk management problem.” kind of problem, it is a business management problem, not a risk management problem.”

Gasparino said he wouldn't go that far and focused on the CFO (Jeff Edwards) and the potential ouster of a risk manager instead of picking up on my a.s.sertion about O'Neal. He said the problem with getting rid of Ahma.s.s Fakahany: ”Fakahany (the risk manager) and Stan O'Neal are very close.”

”I don't think O'Neal survives this,” I responded.There is no problem getting rid of O'Neal's friends if he is gone, and O'Neal will have to answer to shareholders and the board about failure to report losses in second quarter. Within a few days, O'Nal resigned. I added that the rest of Wall Street had underestimated how horrific the losses due to low recovery rates would be in subprime.35 [image]

After the collapse of the stock market technology bubble and the outing of Enron's and Worldcom's problems, Stan O'Neal wrote an opinion piece for the Wall Street Journal Wall Street Journal saying,”In any system predicated on risk-taking, there are failures, sometimes spectacular failures. But for every failure to be viewed as fraudulent or even criminal bodes ill for our economic system.” saying,”In any system predicated on risk-taking, there are failures, sometimes spectacular failures. But for every failure to be viewed as fraudulent or even criminal bodes ill for our economic system.”36 I agree with O'Neal's words on the face of it. It's great to have an open mind, but don't leave it so open that your brains fall out. O'Neal might have added that taking foolish risks and then failing to examine risk in one's own portfolio makes for poor financial management. CEOs can read the newspapers just like anyone else, and the implosion of mortgage lender after mortgage lender was well publicized.Warren Buffett is a voracious a.n.a.lytical reader, and he told me that he considers risk management one of his key responsibilities as CEO of Berks.h.i.+re Hathaway.

If O'Neal did not have time to read the papers, he might have asked a few more questions of his managers about Merrill's involvement with failed mortgage lenders like Ownit. How could Merrill resell or securitize those loans and earn the same profits healthy loans produce?

The Department of Justice and the Federal Bureau of Investigation (FBI) issued a press release on June 19, 2008: ”From March 1 to June 18, 2008, Operation Malicious Mortgage resulted in 144 mortgage fraud cases in which 406 defendants were charged.” Cases have been brought across the United States with losses of approximately $1 billion induced by alleged fraud.37 When Bank of America Corp agreed to buy Countrywide in January 2008, the all-stock transaction was valued at $4 billion. By the time Countrywide's shareholders approved the sale on June 25, 2008, the shares of Bank of America had slumped and the value was around $2.8 billion. But Bank of America may not have gotten a bargain. Also on that day, Illinois, California, and Was.h.i.+ngton State Department of Financial Inst.i.tutions filed lawsuits against Countrywide, and other states soon followed.3839 Illinois Attorney General Lisa Madigan was the first to file, and the Illinois suit named Angelo Mozilo in addition to Countrywide. She noted that Mozilo has a.s.sets. She alleged there was a ”pattern of deception.” Countywide had the ”worst practices” and the ”highest volume” of troubled mortgage loans in Illinois, and the ”most toxic product (option ARMS), which she said makes up one-third of Countrywide's portfolio. ”Countrywide broke the law. Homeowners did not.” Illinois Attorney General Lisa Madigan was the first to file, and the Illinois suit named Angelo Mozilo in addition to Countrywide. She noted that Mozilo has a.s.sets. She alleged there was a ”pattern of deception.” Countywide had the ”worst practices” and the ”highest volume” of troubled mortgage loans in Illinois, and the ”most toxic product (option ARMS), which she said makes up one-third of Countrywide's portfolio. ”Countrywide broke the law. Homeowners did not.”40 Eric Mozilo, the CEO's son, blamed the media, protesting, ”All we try to do is put people in homes.”41 He may be correct. That may be He may be correct. That may be all all Countrywide did for many borrowers. But if that is all Mozilo was trying to do, he would have served many borrowers better by inviting them to stay overnight at his place. Giving someone a bad mortgage loan only puts someone in a home temporarily, and, left many borrowers worse off than before they ever heard of Countrywide. Countrywide did for many borrowers. But if that is all Mozilo was trying to do, he would have served many borrowers better by inviting them to stay overnight at his place. Giving someone a bad mortgage loan only puts someone in a home temporarily, and, left many borrowers worse off than before they ever heard of Countrywide.

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Countrywide set up IndyMac (Independent National Mortgage) in 1985. The two thrifts split in 1997 and became compet.i.tors. In July 2008, IndyMac became the third largest bank to fail in the history of the United States, and in September 2008, $307 billion Was.h.i.+ngton Mutual (Sold to J.P. Morgan) became the largest to fail. The Federal Deposit Insurance Corporation (FDIC) is drawing on its $53 billion deposit-insurance fund.

Thrifts are regulated by the Office of Thrift Supervision (OTS). John Reich, head of the OTS, seemed to think U.S. Senator Charles E. Schumer bore some responsibility for IndyMac's failure because the senator wrote a letter to the OTS with concerns about IndyMac's solvency. He also made it public, which in my opinion is like yelling ”Fire! ” in a crowded theater. In my mind, it also begged the question as to why Senator Schumer did not seem compelled to speak up earlier about predatory lending and problems at other inst.i.tutions-say, Fannie Mae, Freddie Mac, or Countrywide. Senator Schumer countered that if the OTS had reigned in Indy Mac's ”poor and loose lending practices,” the thrift would not have failed, and that the regulator should ”start doing its job.” ” in a crowded theater. In my mind, it also begged the question as to why Senator Schumer did not seem compelled to speak up earlier about predatory lending and problems at other inst.i.tutions-say, Fannie Mae, Freddie Mac, or Countrywide. Senator Schumer countered that if the OTS had reigned in Indy Mac's ”poor and loose lending practices,” the thrift would not have failed, and that the regulator should ”start doing its job.”42 Instead of acting like a sheriff of Mortgage Lenders, the Office of Thrift Supervision behaved like the sheriff of Nottingham. Instead of acting like a sheriff of Mortgage Lenders, the Office of Thrift Supervision behaved like the sheriff of Nottingham.

The Office of Thrift Supervision had reason to intervene long before mortgage lenders started dropping like flies. If they did not read Berks.h.i.+re Hathaway's annual reports, they could read a report from the St. Louis Federal Reserve Bank. It noted in 2005 that all all loans (subprime, Alt-A, and prime) have a higher default rate when the homeowner has little to lose-a low or zero down payment, for example. The report suggested that subprime loans with no down payment are an especially bad idea: ”Serious delinquency (60 and 90 days) is especially sensitive to homeowner equity and origination.” loans (subprime, Alt-A, and prime) have a higher default rate when the homeowner has little to lose-a low or zero down payment, for example. The report suggested that subprime loans with no down payment are an especially bad idea: ”Serious delinquency (60 and 90 days) is especially sensitive to homeowner equity and origination.”43 Loosely translated, that meant that thrifts would have a much harder time getting paid back if they offered risky mortgage loans to people with no down payment and low credit scores. Loosely translated, that meant that thrifts would have a much harder time getting paid back if they offered risky mortgage loans to people with no down payment and low credit scores. So where was the OTS when no (or low) down payment subprime loans combined with other risky features were being made? So where was the OTS when no (or low) down payment subprime loans combined with other risky features were being made?

As of 2008, although subprime loans are only $1.3 trillion (over 11-13 percent depending on how you define subprime) of the $11.5 trillion U.S. residential market, they are the most troubled. In May 2008, Standard & Poor's announced that subprime loans originated in 2005-2007 looked awful, and loans made in 2007 were the worst of the bunch. Where was the OTS? Where was the OTS? Delinquencies for 2005 vintage subprime loans were 37.1 percent and had increased 2 percent from the previous month; 37.1 percent of 2006 vintage subprime loans were delinquent, a rise of 4 percent from March; 25.9 percent of subprime loans originated in 2007 were delinquent, a 6 percent jump from March to April 2008. The 2007 loans were ”unseasoned” or young but were already at least a couple of months late in payments. Delinquencies for 2005 vintage subprime loans were 37.1 percent and had increased 2 percent from the previous month; 37.1 percent of 2006 vintage subprime loans were delinquent, a rise of 4 percent from March; 25.9 percent of subprime loans originated in 2007 were delinquent, a 6 percent jump from March to April 2008. The 2007 loans were ”unseasoned” or young but were already at least a couple of months late in payments.4445 In the second quarter of 2008, a Mortgage Banking a.s.sociation survey revealed that 9.2 percent of mortgages for single family to four-family homes were a month or more overdue or in foreclosure. In the second quarter of 2008, a Mortgage Banking a.s.sociation survey revealed that 9.2 percent of mortgages for single family to four-family homes were a month or more overdue or in foreclosure.46 It was the worst result in the 39-year history of the survey. In the month of August 2008, foreclosure filings in the U.S. rose to a record high of more than 303,000 properties as the continued drop in home prices, combined with tighter lending standards, made it harder for homeowners to refinance their mortgages, with and an estimated supply of unsold homes of 11 months. It was the worst result in the 39-year history of the survey. In the month of August 2008, foreclosure filings in the U.S. rose to a record high of more than 303,000 properties as the continued drop in home prices, combined with tighter lending standards, made it harder for homeowners to refinance their mortgages, with and an estimated supply of unsold homes of 11 months.47 The direct and indirect costs to the U.S. taxpayer will be difficult to a.s.sess because of creative accounting that delays the recognition of the true problem. For example, banks and thrifts announced they were delaying their recognition of losses by allowing delinquencies of up to 180 days before taking a writedown on loans, and Fannie Mae and Freddie Mac said that in the past they wrote down loans when they were 90 days past due, but sometime in 2008 they decided to wait two years. two years.48 On July 16, 2002, Alan Greenspan commented on the corporate shenanigans after the tech-bubble burst saying ”infectious greed seemed to grip much of the business community,” and it was a once-in-a-generation frenzy of speculation.” On July 16, 2002, Alan Greenspan commented on the corporate shenanigans after the tech-bubble burst saying ”infectious greed seemed to grip much of the business community,” and it was a once-in-a-generation frenzy of speculation.” 49 49 That was after the mini-frenzies of Drexel Burnham Lambert, Long-Term Capital Management, charged-off credit card receivables, manufactured housing loans, and more. Perhaps Alan Greenspan has found a way to accelerate the human lifecycle. That was after the mini-frenzies of Drexel Burnham Lambert, Long-Term Capital Management, charged-off credit card receivables, manufactured housing loans, and more. Perhaps Alan Greenspan has found a way to accelerate the human lifecycle.

Fortunately for Berks.h.i.+re Hathaway shareholders, Warren Buffett is the CEO. At year-end 1999, Berks.h.i.+re Hathaway was Freddie Mac's largest shareholder; it owned around 8.6 percent.50 Warren Buffett may prefer to hold onto stocks forever but only if he finds an investment that can go the distance with him. In his 2000 shareholder letter he wrote: ”we sold nearly all of our Freddie Mac and Fannie Mae shares.” Warren Buffett may prefer to hold onto stocks forever but only if he finds an investment that can go the distance with him. In his 2000 shareholder letter he wrote: ”we sold nearly all of our Freddie Mac and Fannie Mae shares.”51 Warren later told me that Fannie Mae and Freddie Mac began emphasizing revenue targets of around 15 percent per year. He did not feel this double digit growth was sustainable just based on operating earnings alone. More than that, value investors are not impressed by revenues alone. Anyone can use leverage to inflate revenues.The Warren later told me that Fannie Mae and Freddie Mac began emphasizing revenue targets of around 15 percent per year. He did not feel this double digit growth was sustainable just based on operating earnings alone. More than that, value investors are not impressed by revenues alone. Anyone can use leverage to inflate revenues.The quality quality of the revenues is paramount, since that is what will sustain profitability. of the revenues is paramount, since that is what will sustain profitability.

Berks.h.i.+re Hathaway's Clayton Homes seems to have avoided the contagion. I toured one of the manufactured homes at the Berks.h.i.+re Hathaway annual meeting in 2006. Potential homeowners are not encouraged to buy a palace. Clayton Homes offers affordable housing at lending terms designed to help ensure the borrower will be able to pay off the loan. It is the chance for people to live a decent life, and there is dignity in being able to live within one's means while bettering one's circ.u.mstances. Most of Clayton's earnings come not from its manufactured housing, but from its loan portfolio. Warren reports its results in the finance section of the Berks.h.i.+re Hathaway annual report. At the end of 2007, Clayton had an ”$11 billion loan portfolio, covering 300,000 borrowers.”52 Berks.h.i.+re Hathaway provides the financing (instead of, say, an investment bank that would buy the loans, package them up, and resell them). In contrast to the rest of the mortgage loan market, ”[d] elinquencies, foreclosures and losses” have stayed constant and the ”Clayton portfolio is performing well.” Berks.h.i.+re Hathaway provides the financing (instead of, say, an investment bank that would buy the loans, package them up, and resell them). In contrast to the rest of the mortgage loan market, ”[d] elinquencies, foreclosures and losses” have stayed constant and the ”Clayton portfolio is performing well.”53 Unfortunately, for many others in the global financial markets, false promises and broken dreams were part of many investment portfolios.The MADness spread across the globe as if it were a hypercontagious flu virus.