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Editor’s Note: The following Guest Commentary was written exclusively for FlippingFrenzy.com by Larry Rubinoff, branch manager of a Clearwater Beach, Florida office of Mortgage Lending Direct, a dba of MLD Mortgage, Inc.
Larry’s commentary is his and his alone and does not necessarily reflect the views or opinions of the management of FlippingFrenzy.com. You can read Larry’s thoughts here on FlippingFrenzy.com most Saturdays or Sundays.
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Below is the first (and sadly the last) email message I ever received from Richard Whitworth (it arrived in December 21, 2007). Even though it is a solicitation for MORsystems, after reading the copy, as reprinted in italics below, I felt compelled to excerpt it here as it exposes much of the causes to what has been called the “mortgage meltdown.”
As regular Flipping Frenzy readers know, I have written several articles on this topic and will write even more. It is probably one of the greatest economic disasters in this country’s history, and history may record it along with the Great Depression of 1929.
Richard Whitworth said the following, and I have added my comments below each of his. I admire his ability to see what is and report what he saw and knew. We need more like him, and with his passing this great country of ours loses an important voice.
Richard Whitworth: We are in a credit crisis brought on by a lack of confidence–so what’s next? The crisis has exploded beyond Wall Street, driving the dollar to record lows–and now it appears to be sending the prices of commodities, especially oil, to historic new highs. The results could be extremely destructive for the economy in general. The subprime crisis and the ripple effect in commodity and foreign exchange markets raise the odds of a recession.
Larry Rubinoff: The crisis truly has exploded beyond Wall Street and well beyond the mortgage industry. Little is reported on the effects it is having in world wide economics and finances. Recession is now being reported by major economists and Wall Street firms, yet I believe that we have been in a “silent” recession for the past six months. Major banks worldwide (Deutche Bank, UBS and HSBC to name just a few) have been impacted by what has happened here. You can add French banks, Australian banks and even the Chinese government investment fund.
Richard: Estimates from various sources show that the subprime mess will ultimately cause $250 to $500 billion of losses. It is inevitable that more players will have to revalue at least a portion of assets that are presently held. Another important point — the majority of these collateralized debt obligation or “CDO” assets do not reside in institutions; they are scattered through various pension funds, insurance portfolios, hedge funds, etc. Those losses haven’t even been addressed yet.
Larry: Mr. Whitworth makes some very good points here. I feel his estimates of losses to be conservative at this point in time, although it may not have been when he authored this. All players will eventually have to revalue and report their asset positions and write downs, but until it all comes out in their reports, we will not know the actual extent of the damage. We know that Fannie Mae delayed their reporting, and when delay was no longer an option, they reported write downs of almost two billion dollars with much more to come. Freddie Mac also will report billions in write downs and the so called safe, government-supervised buyers of conventional loans are racking up their losses as well. This is not and has not been just a sub prime crisis as we are being led to believe.
Mr. Whitworth referred to losses in pension funds, insurance portfolios, hedge funds, etc. which are now beginning to surface, but losses to stockholders of public corporations have not even been addressed or factored in yet. Just on example of stockholders’ losses would be American Home Mortgage, trading at over $42 per share and whose stock value went to 34 cents in one day after they ceased operations and closed all of their offices nationwide. They were one of the leading mortgage lenders at the time, not in subprime and in business for over 10 years as a real estate investment trust (RIET). There are many more examples of this in the over 200 mortgage companies that ceased operations since the end of 2006. This loss of equity has yet to be calculated into this crisis.
Richard: The banks are not forthcoming with any detailed information on their true positions, making it difficult for anyone to assess what the future really holds. Uncertainty is holding the financial and real estate markets in a huge vacuum, where it is difficult to function normally.
Larry: So true. Banks are not forthcoming and are hiding not only from the public and their depositors but to their stockholders as well. The uncertainty is not only making it difficult for us to “function normally” but making it difficult to function, period. This will only cause a prolonged resolution to this problem. Until we admit to it, how can we begin to resolve it?
Richard: So let’s see if we can get a clearer picture of the players, and the mistakes made by some of the most powerful institutions in America. How did the banks begin purchasing huge amounts of high-risk mortgage debt and bonds that most investors and analysts thought the firms were selling to their customers?
Larry: Here, Mr. Whitworth raises one of the most relevant questions.
Richard: Instruments of Doom: First on the list of instruments involved; the collateralized debt obligation, or CDO, a type of investment vehicle that buys and sell Bonds. Wall Street banks typically do not actually operate CDOs; instead, they create CDOs for their clients, take a fee, and then move on.
Larry: CDO stands for collateralized debt obligation, a security created for sale by investment houses. These CDOs were typically secured with mortgages on American real estate, which has always been considered to be one of the safest investments in the world. So, did Wall Street have a very beneficial, economic, self enriching motive to create and sell these?
Richard: This is the main point of departure and the critical mistake made by the Wall Street banks–greed and fear set in, and they began to change their normal mode of operation–they became huge investors in the funds they generated. A very risky move — more on this as we move ahead.
Larry: Probably more greed then fear. Let’s hear more.
Richard: Here’s how a typical CDO backed by subprime mortgages works. The game begins when a client comes to a Wall Street bank and requests financing for a CDO that will hold, for example, $2 billion worth of bonds backed by subprime mortgages. The banks also created a variety of bonds backed by the interest and principal payments the CDO collects. Wait — there’s more… the bankers also create tranches of securities with different interest rates and levels of risk.
Larry: OK now, let’s see if we can understand this. The “game,” and it was a game even Las Vegas could not duplicate, had a structure most could not understand or comprehend. The client went to Wall Street and wanted to finance a CDO, a financial instrument, which was comprised of bonds, another financial instrument, which was backed by mortgages, yet another financial instrument that had first or second lien positions on real estate. Whew! Do you get it? Let me see if I can explain it. Credit for credit backed by credit backed by more credit backed by an asset that was financed for more than its value. In other words, at the end of this pyramid there was very little compared to what was pledged all the way up the line, all paying interest to someone that owned any part of it. Down at the bottom of this pyramid were the homeowners who were paying some pretty high interest on property they could not afford, but they were sold on the fact that homeownership was a tradable commodity, not a necessity of life called shelter — a place to live and raise your children, retire, and pass on to heirs. The game, as Mr. Whitworth calls it, is the game of Monopoly. We all played it, not with real money or real property. The only winners in the game of Monopoly were Milton Bradley, the creators of the game. Who were the only winners of the real life version of Monopoly?
Richard: The banks then peddle their wares to hedge funds, pension funds, money market funds and other investors. The appeal to investors is simple: The CDOs pay better rates than corporate issues with identical credit ratings–which brings me to the rating agencies.
Larry: Hedge funds would borrow up to 20 times the money invested. Barclay Bank of England is suing Bear Stearns for their $400 million investment into one of their hedge funds. This is yet another example of borrowed funds used to loan to other borrowers who would loan to other borrowers. Getting confusing yet or are we beginning to see a clearer picture?
Richard: Here’s another genius move made by the banks–many of those instruments offered, in essence, guaranteed returns. The refund policies, technically known as “liquidity puts,” were crucial. Those guarantees allowed the credit rating agencies to bless the investments with AAA ratings. An example of the idiocy of this particular move: The two now defunct Bear Sterns hedge funds relied on guarantees from Citi to raise $10 billion from money-market investors for three CDOs, well derrr!!
Larry: “Guaranteed returns?” Guaranteed by what? Do I need to tell you that the only two things guaranteed in life are death and taxes, and I’m not too sure about taxes when it comes to the top 5 percent. Now, let’s look at the rating agencies — Fitch, Moody’s, and others. Oh, if they rate something good, then it must be good, right? Were they part of this, and are they complicit in some of this fraud? For the past few months, they have been downgrading to negative ratings almost everything they gave AAA rating to. Didn’t they know how all of this was structured? If they are so called financial experts and when “they speak, everybody listens,” then they knew and understood much better then you and I about the house of cards they were rating.
Richard: The rating agencies may be the main culprit in the game. They were extremely lax in their initial ratings on subprime mortgages — none of those offerings ever deserved an AAA rating. Never mind that now with the cat out of the bag, they are still slow to downgrade subprime paper and securitizations.
Larry: They were not lax they were negligent in their fiduciary responsibility knowing the extent to which their evaluations are relied upon as accurate and factual. We believe they do the research and let us know what they find. What research did they perform and what do they make from all of this?
Richard: This should not be a surprise to anyone, because the ratings agencies also prosper from the rising tide of credit issuances. Moody’s, Fitch, and S&P literally ignored the erosion in the credit quality of the offerings and basically elected to give the issuers the ratings they asked for. Amazing that issues that were rated AAA just months ago are now being re-written at junk bond status. Sadly, the rating agencies are great at passing the buck when things go wrong, and they will probably sneak by any SEC scrutiny.
Larry: Well public, let’s not let them get away with this. Everyone needs to bear the true consequences of their actions. They should be held accountable.
Richard: Back to the Banks…as the fees kept rising through the good times, the banks got greedy; they began buying big chunks of AAA paper themselves and loading the debt onto their own books. Even when the markets began to sour–foreclosures, home prices dropping, etc., the banks continued on their buying binge. All of a sudden, they found that they needed to feed those CDOs in order to keep the game alive. That was the kiss of death for Merrill’s CEO, Stanley O’Neal, and for Citi’s CEO, Charles Prince.
Larry: Well, I’m not so sure that it was the “kiss of death” for the CEOs. How much did they get in severance? Did I hear over $150 million for one? But even more important is that they were rolling the same dollar back into their balance sheets over and over again. They bought the paper they sold, got the deposits from all of the cash-out refinances, created more loans, sold more loans, helped create more CDOs, bought the CDOs, and so on in a never-ending circle–no real dollars in this game, all paper, all credit, all bookkeeping entries from money that was borrowed from the borrowers who borrowed from other borrowers who borrowed…
This could be the greatest Ponzi scheme in the history of the world, and the perpetrators have the nerve to blame it all on mortgage brokers.
Richard: Wall Street banks are now holding tens of billions of dollars in risky securities on their own books. At this point in the game, it is difficult to assign an actual value to them. The banks are changing their estimates of the value of these assets as frequently as they change their underwear.
Larry: They are holding paper. If these companies are public and under the regulation of the SEC, then the SEC should call for a major independent accounting that the SEC would oversee. Let’s account for what is actually there, like real cash values. The more I read and write, the more I want to play this game of Monopoly. Can I pay? Somewhere even if everyone loses, the house wins. My game, my house, I win!
Richard: The SEC is on the attack, requesting real numbers and information from Merrill and other banks on what they knew at the time they were telling investors and the public that all was wonderful and they were in control of the situation.
Larry: My message to the SEC is this: Don’t request, demand! You are our regulatory agency that we have charged with the responsibility of keeping things honest. Are you still on our side?
Richard: Bottom line, the subprime story is far from over… it will likely take a few years for the whole thing to shake out.
Larry: No this story is nowhere near being over. The problem will take more years to discover and many more years to fix. This cannot be done overnight, cannot be done by blaming and destroying an industry (mortgage brokers), and is so international in scope that the whole world needs to come together on this one in order for it to be fixed.
From Richard’s Office: Sadly, this is Richard Whitworth’s last economic report that you’ll receive. He was in a fatal motorcycle accident 12-8-07. Since he nearly finished this report the night before, we needed to share it with you. Thank-you for your support.
Larry: I wish to express my sympathy to the family, friends, and business associates of Richard Whitworth. I am sure he will be missed by all and by me as well. This one writing of his that I was privileged to have received showed me his true character as a person, a business man, and an American.
God bless you Mr. Whitworth. May you rest in eternal peace.
Larry Rubinoff
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