Nouriel Roubini's Global EconoMonitor

It is now time to downgrade the monoliners: a business model that cannot survive without an AAA rating is a business model that cannot fundamentally deserve an AAA rating Nouriel Roubini | Dec 20, 2007 The shocking and surprising revelation by MBIA – one the leading monoliners, i.e. bond insurers – that it has guaranteed $8.1 billion of collateralized debt obligations repackaging other CDOs and securities linked to subprime mortgages (i.e. it is holding the very risky CDOs of CDOs) – is the last drop in this monoliners’ farce: it is time for the credit rating agencies to downgrade most of these monoliners from their AAA rating status. One can spend a long time discussing the relative riskiness of each of these monoliners and whether the capital injections that some of them are now receiving is enough to prevent the downgrade that rating agencies are considering. But discussing these important details risks losing the vision of the forest while being obsessed with watching the trees or individual leaves on each monoliner tree. The forest issues is simple: a business – the monoliners’ insurance of securities and holding of risky ABS securities – that is fundamentally based on having a AAA rating is a business that does not deserve a AAA rating in the first place: it is clear to all that if a monoliner were to lose its AAA rating the essence of its business model would fail and such monoliner would have to close shop. But in any industry you have firms that can do business and thrive with an AA or A or even lower rating, even among major financial institutions. Here we have instead an industry that would go bankrupt as soon as its AAA rating is lost: by definition this is not an industry that can deserve a AAA rating. So the issue is not one of how sound these monoliners are managed or whether they have enough capital or whether they can raise new capital to maintain their AAA status. There is a fundamental and conceptual flaw in a business model that is conditional on a AAA rating and that is in a business that insures assets and firms that do not have a AAA rating. This is analogue to the voodoo finance of taking subprime and BBB mortgage backed securities and turning them into AAA by the black magic of CDO tranching. Add to this mess the fact that monoliners collectively insure $3,300bn of principal and interest (less than 30% of it ABS) with only a $22bn capital base. Of course a downgrade of monoliners will have a severe knock-on effect of potential downgrade on muni and other bond markets; analysts have estimated that such downgrades could cause losses writedowns of about $200bn. But these risks cannot be an excuse for not admitting that the monoliners don’t deserve an AAA rating. As long as monoliners were only in the muni bonds insurance business one could have made the argument that a prudent monoliner did deserve an AAA rating; but now that monoliners have vastly expanded in the ABS world of insuring toxic RMBSs, CDO, CDOs of CDOs and in some cases even holding these assets on their portfolios such an AAA rating does not make any sense. So enough of wasting time on dissecting the assets and liabilities and capital of individual monoliners; their business model is conceptually flawed in the first place; and their actual business practices have been even more flawed as they have now insured for years toxic RMBS, CDOs, and CDOs of CDOs. The wariness of rating agencies to downgrade the monoliners is understandable: such a downgrade will imply an instant death sentence for any monoliner that is downgraded; it will lead to loss of business for the rating agencies themselves; and it will trigger massive losses on muni bonds. But the current charade of pretending that the monoliners are under review to give them time to raise more capital to avoid such a downgrade is another case of rating agencies supporting a rotten business model. The actual behavior of such monoliners has proven that they are not transparent, that they hold or insure a mass of skeletons and toxic waste securities and they have been dishonest in hiding from investors the toxic waste that they hold and insure. So it is time to stop this charade of rating forbearance and admit that the emperor has no clothes: a business model that cannot survive without an AAA rating is conceptually a business model that cannot deserve under any circumstance an AAA rating; period! Arguing otherwise is believing in voodoo black magic.

Falling prices driving crisis Fed: Foreclosures not primarily due to high loan payments By Binyamin Appelbaum, Globe Staff | December 4, 2007 The recent spike in home foreclosures in Massachusetts is caused primarily by falling housing prices, and not by rising mortgage payments, according to research released yesterday by the Federal Reserve Bank of Boston. The contrarian report suggests the common understanding of the foreclosure crisis is somewhat mistaken. Unaffordable loans don't cause foreclosures directly. Even as subprime lending became more common, even when people fell behind on mortgage payments - during the economic downturn in 2001, for example - foreclosures were rare because house prices continued to rise. In part, people were able to escape trouble by selling their homes at prices high enough to cover their debts. But the research also suggests that troubled borrowers tried harder to make the necessary payments, in the expectation they would profit eventually. Conversely, when prices started falling, people struggling to make payments had less incentive to find the money. And the value of the home could drop below the outstanding debt, making it impossible to sell. Over the last two years, the number of foreclosures exploded. Housing price movement "plays a dominant role in generating foreclosures," the report concluded. One implication of the report is that current attempts by local and federal officials to help borrowers may be ineffective. US Treasury Secretary Henry Paulson is negotiating a deal to freeze monthly mortgage payments on some subprime loans by delaying scheduled interest rate increases. Paulson reiterated yesterday the plan could be announced this week. Meanwhile, states including Massachusetts have introduced programs to refinance troubled borrowers into more affordable loans. Those programs have struggled as most of the applicants are unable to qualify. But government efforts to make payments more affordable may not matter to borrowers mostly concerned about home values. Instead, the number of foreclosures will be determined mostly by "how far housing prices fall," said Boston Fed president Eric Rosengren, who introduced the report yesterday during a speech to the Massachusetts Institute for a New Commonwealth. Rosengren nonetheless endorsed government efforts to help subprime borrowers. Subprime borrowers are particularly likely to face foreclosure, because their grip on ownership is more tenuous. They pay more, they own less of the home, and they have fewer resources. The Boston Fed found subprime borrowers are about six times more likely to face foreclosure than conventional borrowers. Many subprime borrowers now face increased mortgage payments, as the interest rates on their adjustable loans reset to higher levels. Analysts predict widespread foreclosures will follow. "Getting people into other products may be much more straightforward and much less costly than helping people once they're already in trouble," Rosengren said in an interview. The Fed found one-quarter of subprime borrowers in New England are good candidates for more affordable loans. The evaluation is based primarily on these borrowers having sufficiently good credit, and that their homes are worth more than what they owe on their mortgages. The list of lenders serving subprime borrowers has diminished dramatically. Eight of the 10 companies that made the most subprime loans in Massachusetts over the last decade have stopped making loans. But Rosengren said he was hopeful other companies, including local banks, would step forward. Freezing the rates on subprime loans would also help, he said. Critics of the plan have questioned whether investors who own the rights to collect the mortgage payments will agree to forego a portion of those payments. Rosengren highlighted a reason for optimism. On a typical subprime loan, the interest rate increases after the second year. Historically, most borrowers either sell or refinance before the rate resets. Rosengren said investors were never counting on a long-term income stream. "It's not like they expected the borrowers to be there for 30 years," he said. Binyamin Appelbaum can be reached at bappelbaum@globe.com.

Bear Stearns duped by "G-money"

	December 21, 2007

PAGE ONE

Fraud Seen as a Driver In Wave of Foreclosures Atlanta Ring Scams Bear Stearns, Getting $6.8 Million in Loans By MICHAEL CORKERY December 21, 2007; Page A1 ATLANTA -- Skyrocketing foreclosures are a testament to how easy it was to borrow from mortgage lenders in recent years. It may also have been easy to steal from them, to judge from a multimillion-dollar fraud scheme that federal prosecutors unraveled here in Atlanta. The criminals obtained $6.8 million in mortgages from Bear Stearns Cos., including a $1.8 million mortgage to Calvin Wright, a New Yorker who told the investment bank that he and his wife earned more than $50,000 a month as the top officers of a marketing firm. Mr. Wright submitted statements showing assets of $3 million, a federal indictment alleged. In fact, Mr. Wright was a phone technician earning only $105,000 a year, with assets of only $35,000, and his wife was a homemaker. The palm-tree-lined mansion they purchased with Bear Stearns's $1.8 million recently sold out of foreclosure for just $1.1 million. Bear Stearns, meanwhile, posted the first quarterly loss in its 84-year history as it wrote down $1.9 billion of mortgage assets yesterday. (See related article1.) Fraud goes a long way toward explaining why mortgage defaults and foreclosures are rocking financial institutions, Wall Street and the economy. The Federal Bureau of Investigation says the share of its white-collar agents and analysts devoted to prosecuting mortgage fraud has risen to 28%, up from 7% in 2003. Suspicious Activity Reports, which many lenders are required to file with the Treasury Department's Financial Crimes Enforcement Network when they suspect fraud, shot up nearly 700% between 2000 and 2006. In 2006, losses from fraud could total a record $4.5 billion, a 100% increase from the previous year, says Arthur Prieston, chairman of the Prieston Group, which provides lenders with mortgage-fraud insurance and training. The surge ranges from one-off cases of fudging and fibbing to organized criminal rings. The FBI says its active mortgage-fraud cases have increased to 1,210 this year from 436 in 2003. In some regions, fraud may account for half of all foreclosures. "We've created a culture where a great many people know how to take advantage of the system," says Mr. Prieston. Yet the system itself bears blame. The evolution of mortgages into a securities instrument turned loan origination into a competition. Caution gave way to a push for speed and volume. Embroiled in an all-out war for market share, issuers reduced barriers to credit, for example, by offering so-called "stated-income" loans, which require no proof of income. "The stated-income loan deserves the nickname used by many in the industry, the 'liar's loan,' " says the Mortgage Asset Research Institute, which works with lenders to prevent fraud. A recent review of a sampling of about 100 stated-income loans revealed that almost 60% of the stated amounts were exaggerated by more than 50%, MARI says. It didn't take a rocket scientist to steal a fortune from mortgage lenders in recent years. That much is clear from the Atlanta scheme. It was perpetrated in large part by a 23-year-old college dropout named Gregory Jerome Wings Jr., aka G-Money. His accomplices included a young nightclub owner, along with the director of an underground documentary called "Crackheads Gone Wild," a cautionary tale about drug addiction. Their scam was garden variety: recruit borrowers with good credit to apply for gigantic loans, often of the stated-income variety, using false income and asset statements. Find a mortgage broker willing to submit false information, and find appraisers who will approve inflated values. The perpetrators line their pockets with the proceeds, using some as down payments or for future renovations. Some buyers diverted proceeds to themselves through shell companies. The brazenness of the scheme is illustrated by the case of Mr. Wright, the New York telephone worker who posed as a highly paid executive to obtain a $1.8 million mortgage from Bear Stearns. Recruited into the scheme by an acquaintance in Atlanta, Mr. Wright, with the help of ring leaders, diverted hundreds of thousands of dollars from that Bear Stearns mortgage to himself, to Mr. Wings and to others in the scheme, according to a federal indictment. In the very same week, Mr. Wright obtained a $1.9 million mortgage on a second value-inflated mansion near Atlanta, this time from BankFirst, a unit of Minneapolis-based Marshall BankFirst Corp. This deal also brought enormous spoils to Mr. Wright, Mr. Wings and other accomplices. "It was so easy, it's incredible," says Akil Secret, attorney for Mr. Wright, who has pleaded guilty to bank fraud and is awaiting sentencing. 'Seemed Clean and OK' As profits from the scheme fattened their wallets, these young men became the envy of their peers, especially since their actions involved none of the dangers of street crime. "You see a guy who is 23 and he's driving a fancy car. You go into clubs and everyone seems to know him, and you kind of want to be like him," says defense attorney Rickey Richardson, explaining how his client, Daryl Smith, got involved in the scheme. "This wasn't drugs. This wasn't guns. This seemed clean and OK." Residents of some fancy Atlanta suburbs spotted the scheme. They became suspicious when new homes in their neighborhoods sold for sky-high prices, then remained vacant. After the same individual bought several such homes in one ritzy development, neighbors alerted authorities. One homeowner who helped expose the fraud and other schemes in his neighborhood now carries a loaded handgun in his truck. "This is serious stuff," he says. "We are putting people in prison for many, many years." Since federal authorities issued an indictment in April 2006, Mr. Wings, Mr. Smith, Mr. Wright and about 10 others have pleaded guilty to various counts, including bank fraud, and are awaiting sentencing. Another ringleader was convicted in federal court last month. Their sentences could be lengthy: In an unrelated case, an Atlanta attorney with no prior criminal record was sentenced in August 2005 to 30 years in federal prison on a mortgage-fraud conviction. Mr. Wings declined to comment for this story, as did Messrs. Wright and Smith. In the wake of their downfall, debate has been intense about how such an unaccomplished group could defraud top-tier financial institutions out of millions. Prosecutors call the scheme sophisticated, noting its reliance upon forged and falsified documentation. Lenders agree. Bear Stearns says the scheme evaded its antifraud efforts by supplying false information at every step of the application process. "We as an industry cannot eliminate fraud entirely," Tom Marano, head of mortgages and asset-backed securities for Bear Sterns, said in a statement about the Atlanta ring. "We can and do continue to develop systems and detection techniques that evolve with the complexity of criminal schemes.'" But others contend that the Atlanta case illustrates the recklessness with which lenders were issuing mortgages in recent years. "This case should have been an indictment of the mortgage industry," says Patrick Deering, an Atlanta defense attorney involved in the case. In an eye-opening setback for prosecutors, Mr. Deering and other defense attorneys successfully defended three home builders against charges that they had participated in the scheme. Prosecutors had attacked the home builders for failing to raise red flags when they witnessed mortgages being issued far in excess of what the builders were being paid. Artificially Raised Values In some neighborhoods, the fraud scheme itself may have artificially raised values. Another explanation is that the appraisal market is fiercely competitive. Experts say some appraisers may offer inflated values in exchange for their standard fee of several hundred dollars -- a strategy that can win business without exposing an appraiser to charges of fraud. "Appraisers get sucked into these schemes because they are starving for work and many of them don't know what the heck they are doing," says Carl Heckman, co-founder of the Georgia Real Estate Fraud Prevention and Awareness Coalition, composed of appraisers, lenders, mortgage brokers and residents. In the neighborhoods where the Atlanta scheme operated, values have plummeted. Many homes associated with the scheme are now in foreclosure. Some have sold for as low as 50% of what buyers in the fraud ring paid. "The banks are getting more and more aggressive in their pricing because they don't want to own these homes," says Warren Lovett, a real estate agent with Coldwell Banker in Atlanta. Mr. Lovett has taken listings for about 60 foreclosed properties this year. He estimates that half of the foreclosures he's encountered are due to fraud.

Ben Stein's Money

Voltron Says: Ben Stein (The guy from Win Ben Stein's Money, Ferris Bueller's Day Off and the Visine Ads) is big enough to admit when he's wrong, and he appreciates the military and their families. The article is edited.

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December 9, 2007

Everybody's Business

Lessons From the Pits of Investment

By BEN STEIN

AS I went through my financial records for 2007, I realized that — as usual — I had made a great many mistakes. I’d like to help you to avoid making the same mistakes, so here they are. They might be considered New Year’s resolutions. Or they might be called Lessons Learned.

As I was looking at my stock statements for 2007, I noticed I had done fabulously well — by my very modest standards — on my large, broad-market index funds (especially Fidelity Spartan Total Market and Vanguard Total Stock Market), on my Canadian and Australian index funds and on an emerging-market index fund and a developed-market index fund. But many of my individual picks had been clobbered.

My belief is that I am not alone here. Unless you are a thorough genius like Warren E. Buffett, buying individual stocks is tricky, especially in a wildly down market for financial stocks. My resolution for next year is that I will buy only broad indexes and Berkshire Hathaway, if I have any money left over after feeding our three dogs, six (yes, six) cats and my endless extravagance.

I especially got killed speculating on takeover candidates. I think I will leave that to bigger boys than me. Again, I will stick with the indexes.

Next, here’s a lesson I learned in a 12-step program and should have learned better: avoid contempt prior to investigation. When the financial stock meltdown started, I was on a television show with Peter Schiff of Euro Pacific Capital, who warned that Merrill Lynch could be in very bad shape. I glibly said that I thought that its problems were limited and that the stock was a buy. Mr. Schiff was completely right and I was wrong. I had no idea that Mother Merrill, where I have been a happy stockholder for years, had been turned into a such a wild house of high-stakes gambling. I apologize to Mr. Schiff for my dismissal of his views, which turned out to be far superior to mine in this area. (I could do without his acolytes sending me endless hate mail, though.)

In the same vein, I must remember that where Wall Street is concerned, a very healthy dose of skepticism is always merited. Just in the recent past, the movers on the Street have fooled us with junk bonds, savings-and-loan stocks, high-tech garbage, rotten collateralized mortgage obligations (although not as rotten as some think right now, perhaps) and their own highly questionable firms. The problem is always the same: nonsensical greed by the buyers and lack of fiduciary duty by the sellers. An extreme sense of skepticism is warranted whenever anything looks too good to be true anywhere. But if it’s coming out of Wall Street and looks complex, look out below.

Speaking of which, your humble servant expressed doubt about private equity and how it could keep making super returns by basically picking up a penny on the sidewalk, shining it up and selling it for a nickel, and then the next guy does the same and sells it for a dime. My doubts weren’t strong enough. It sure looks as if it was all a hot-potato game fueled by easy money. I got caught in it a bit with a few investments. It’s sort of terrifying that even I, a longtime investor, could be caught in that game. It was a small amount, but even that is too much.

On to spending: A famous Chinese philosopher famously said, “There is no calamity greater than lavish desires.” My own life is a sort of parable of national life. I spend way too much money, although it’s pennies by Wall Street standards. I think like a big baby: if I want it, it’s mine.

You cannot even imagine how many suits and jackets I have. It’s a bad joke, since I never wear any of them. I just wear the same pitiful shiny old clothes every day. This leads to endless self-laceration when I get my bills. On a national scale, it leads to low saving and poor preparation for the future. My goal for the future is to be a bit more careful about my spending. Maybe more than a bit.

Finally, this year as every year, I learn that there are a lot of people out there who are of more use to the planet than I am: my wife (the world’s best human), teachers, parents of autistic children, firefighters, nurses, doctors, police officers, social workers, the incredible superstars of the military and, most of all, their families.

I WILL say it until the day I die: the military family is the marrow in the backbone of America. And if it seems that I am too upset about financial fraud, I would just like to say that I often cannot sleep at night seething that men and women are giving their lives for us in faraway places while at home their country is being plundered by men in $3,000 suits who get multimillion-dollar severances when they are caught.

How many military families lost homes because of predatory lending? I know of at least two, and that’s just in my little world. My resolution for 2008 is to keep on plugging for those “little people” who are a lot bigger than the hucksters on Wall Street. And to stop being such an extravagant fool myself.

Ben Stein is a lawyer, writer, actor and economist. E-mail: ebiz@nytimes.com.

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December 14, 2007

Op-Ed Columnist

After the Money’s Gone

By PAUL KRUGMAN

On Wednesday, the Federal Reserve announced plans to lend $40 billion to banks. By my count, it’s the fourth high-profile attempt to rescue the financial system since things started falling apart about five months ago. Maybe this one will do the trick, but I wouldn’t count on it.

In past financial crises — the stock market crash of 1987, the aftermath of Russia’s default in 1998 — the Fed has been able to wave its magic wand and make market turmoil disappear. But this time the magic isn’t working.

Why not? Because the problem with the markets isn’t just a lack of liquidity — there’s also a fundamental problem of solvency.

Let me explain the difference with a hypothetical example.

Suppose that there’s a nasty rumor about the First Bank of Pottersville: people say that the bank made a huge loan to the president’s brother-in-law, who squandered the money on a failed business venture.

Even if the rumor is false, it can break the bank. If everyone, believing that the bank is about to go bust, demands their money out at the same time, the bank would have to raise cash by selling off assets at fire-sale prices — and it may indeed go bust even though it didn’t really make that bum loan.

And because loss of confidence can be a self-fulfilling prophecy, even depositors who don’t believe the rumor would join in the bank run, trying to get their money out while they can.

But the Fed can come to the rescue. If the rumor is false, the bank has enough assets to cover its debts; all it lacks is liquidity — the ability to raise cash on short notice. And the Fed can solve that problem by giving the bank a temporary loan, tiding it over until things calm down.

Matters are very different, however, if the rumor is true: the bank really did make a big bad loan. Then the problem isn’t how to restore confidence; it’s how to deal with the fact that the bank is really, truly insolvent, that is, busted.

My story about a basically sound bank beset by a crisis of confidence, which can be rescued with a temporary loan from the Fed, is more or less what happened to the financial system as a whole in 1998. Russia’s default led to the collapse of the giant hedge fund Long Term Capital Management, and for a few weeks there was panic in the markets.

But when all was said and done, not that much money had been lost; a temporary expansion of credit by the Fed gave everyone time to regain their nerve, and the crisis soon passed.

In August, the Fed tried again to do what it did in 1998, and at first it seemed to work. But then the crisis of confidence came back, worse than ever. And the reason is that this time the financial system — both banks and, probably even more important, nonbank financial institutions — made a lot of loans that are likely to go very, very bad.

It’s easy to get lost in the details of subprime mortgages, resets, collateralized debt obligations, and so on. But there are two important facts that may give you a sense of just how big the problem is.

First, we had an enormous housing bubble in the middle of this decade. To restore a historically normal ratio of housing prices to rents or incomes, average home prices would have to fall about 30 percent from their current levels.

Second, there was a tremendous amount of borrowing into the bubble, as new home buyers purchased houses with little or no money down, and as people who already owned houses refinanced their mortgages as a way of converting rising home prices into cash.

As home prices come back down to earth, many of these borrowers will find themselves with negative equity — owing more than their houses are worth. Negative equity, in turn, often leads to foreclosures and big losses for lenders.

And the numbers are huge. The financial blog Calculated Risk, using data from First American CoreLogic, estimates that if home prices fall 20 percent there will be 13.7 million homeowners with negative equity. If prices fall 30 percent, that number would rise to more than 20 million.

That translates into a lot of losses, and explains why liquidity has dried up. What’s going on in the markets isn’t an irrational panic. It’s a wholly rational panic, because there’s a lot of bad debt out there, and you don’t know how much of that bad debt is held by the guy who wants to borrow your money.

How will it all end? Markets won’t start functioning normally until investors are reasonably sure that they know where the bodies — I mean, the bad debts — are buried. And that probably won’t happen until house prices have finished falling and financial institutions have come clean about all their losses. All of this will probably take years.

Meanwhile, anyone who expects the Fed or anyone else to come up with a plan that makes this financial crisis just go away will be sorely disappointed.

MBIA on downgrade watch.

Voltron says: Bad news is always released on Friday night.

Moody's warns on ratings of some bond insurers

MBIA, SCA may be downgraded, but Ambac affirmed by rating agency

By Alistair Barr, MarketWatch

Last update: 9:00 p.m. EST Dec. 14, 2007

SAN FRANCISCO (MarketWatch) -- Moody's Investors Service warned late Friday that AAA ratings of four leading bond insurers could be downgraded after the agency re-evaluated the companies' exposure to potential subprime mortgage losses.

The AAA ratings of Financial Guaranty Insurance Company (FGIC) and XL Capital Assurance, a unit of Security Capital (SCA) , were placed on review for possible downgrade, Moody's said. FGIC is partly owned by private-equity giant Blackstone Group (BX) and CIFG Guaranty were affirmed, but the rating outlooks changed to negative.

The AAA ratings of Ambac (ABK) , and Financial Security Assurance were affirmed with a stable outlook, Moody's added.

Bond insurers agree to pay principal and interest when due in a timely manner in the event of a default. It's a $2.3 trillion business that offers a credit-rating boost to municipalities and other issuers that don't have AAA ratings.

Shares of bond insurers like Ambac and MBIA have slumped in recent months on concern they could suffer losses from guaranteeing complex securities backed by subprime mortgages. Most companies are now trying to boost capital to avoid losing crucial AAA ratings. Without such ratings, their business models may be imperiled.

Moody's grouped the bond insurers into two main groups after completing its update.

The first group -- Ambac, Assured Guaranty and Financial Security Assurance -- have enough capital to keep their AAA ratings, even under a stressed housing market scenario, the agency said.

"The rest of the companies we see as having insufficient capital for their current ratings," Ted Collins, a managing director at Moody's, said in an interview.

All the companies are working on plans to boost capital, but Moody's is more certain about some companies' plans than others, he added.

Insurers put on review for a downgrade - FGIC and Security Capital - have less certain plans for increasing capital. Those put with a negative outlook - MBIA and CIFG - have clearer capital plans.

Ambac's AAA rating was affirmed because the insurer has enough capital. That's even before the company announced this week that it was buying reinsurance from rival Assured Guaranty.

"Our analysis showed that Ambac had sufficient capital today, even without this additional factor," Collins explained. "But in this environment, any capital raising or support is a positive from a credit rating perspective."

Alistair Barr is a reporter for MarketWatch in San Francisco.

MBIA Could Be a Zero Faster Than Expected

By Whitney Tilson

Wow, some big developments that make me think MBIA (MBI) could be a zero even faster than I thought.

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December 13, 2007

Countrywide Subpoenaed by Illinois

By GRETCHEN MORGENSON

The Illinois attorney general is investigating the home loan unit of Countrywide Financial as part of the state’s expanding inquiry into dubious lending practices that have trapped borrowers in high-cost mortgages they can no longer afford.

Lisa Madigan, the attorney general, has subpoenaed documents from Countrywide relating to its loan origination practices, a person briefed on the matter said. Rick Simon, a Countrywide spokesman, said the company was cooperating with the investigation but declined to comment further.

The inquiry follows an investigation by Ms. Madigan’s office into One Source Mortgage, a Chicago mortgage broker that recently closed its doors. Ms. Madigan sued One Source on Nov. 27, contending that the company misled borrowers by promising low rates on mortgages without advising them that their payments would jump sharply shortly after the loans were made. Countrywide was One Source’s primary lender, according to the lawsuit.

Countrywide, the nation’s largest mortgage lender and loan servicer, is coming under increased scrutiny as the home loan crisis deepens. In addition to the Illinois investigation, the company is also fielding inquiries from the Securities and Exchange Commission about significant stock trades made by Angelo R. Mozilo, the chief executive, before Countrywide’s stock plummeted this year.

The United States trustee, which oversees the bankruptcy court system, is investigating Countrywide’s actions in two cases involving borrowers in South Florida whose loans were serviced by the company. The trustee is trying to determine if the company’s conduct in those cases represents abuses of the bankruptcy system.

The attorney general’s lawsuit contended that One Source put borrowers into loans with terms they did not understand, especially so-called pay option adjustable-rate mortgages. These loans allow borrowers to pay only a fraction of the interest owed and none of the principal, resulting in a growing rather than a shrinking mortgage balance. Countrywide was One Source’s main provider of pay option loans, documents in that case show.

“This company’s conduct is a prime example of unscrupulous mortgage brokers that has led to a foreclosure crisis for many Illinois homeowners,” Ms. Madigan said when she filed the suit against One Source.

Mark D. Belongia, a lawyer at Belongia & Shapiro in Chicago, represents One Source and its president, Charles G. Mangold. Mr. Belongia said his client denied all of the suit’s charges and expected to be vindicated in court.

Donald Wagner, a professor of Middle East studies and comparative religion at North Park University on Chicago’s North Side, is a One Source client who has talked to the attorney general about his troubles with a Countrywide pay option loan. In March 2005, he refinanced his fixed-rate mortgage to help pay for his daughter’s college education. He said the One Source broker did not tell him his low teaser rate — less than 2 percent — would jump after just one month.

“I kept asking them and checking on that,” Mr. Wagner said. “Then it jumped to more than 7 percent and now it’s up to 8 percent plus and it’s going to jump again. I am actually paying out over 60 percent of my monthly income, and it’s only so long that I can do that.”

Because Mr. Wagner cannot afford to pay both the interest and principal, the amount of his Countrywide loan has risen to $307,000, from $292,000 two and a half years ago. He has had to borrow against his 401(k) and university pension to meet his payments, he said. Making matters worse, when he tried to sell his house last summer to get out from under the mortgage, he learned that the loan carried a prepayment penalty of $12,000.

Mr. Wagner has asked Countrywide to drop the prepayment penalty, but it has declined to do so.

Of the 69 borrower cases examined by the attorney general’s office, 26 of the first mortgages and 4 of the second liens were made by Countrywide. Fremont Investment and Loan, a unit of the Fremont General Corporation, was One Source’s second-largest lender, with 20 loans. Last March, Fremont Investment consented to a cease-and-desist order issued by the Federal Deposit Insurance Corporation, which contended that the company had practiced unsound lending and had violated laws or regulations.

The Illinois suit against One Source Mortgage said the company lured borrowers with misrepresentations about the interest rates on their loans. For example, one borrower was told that he would have an interest rate of less than 1 percent for the first year of his mortgage, but the rate rose to 7.5 percent after a month, according to the complaint.

One Source also used high-pressure tactics to rush borrowers through their loan closings, according to the suit. Most of the closings took less than 30 minutes, the attorney general said, with some only 10 to 15 minutes. One borrower was told that “it would take two days to explain everything,” and that the closing had to take place before that.

Some borrowers told Illinois investigators that they did not know One Source brokers had inflated their incomes to get them a larger mortgage. One consumer provided pay stubs and tax returns to One Source showing her income to be $2,200 a month, the suit said. Only later did she discover that One Source had listed her monthly income as $9,000.

The Illinois attorney general has been aggressive in moving against mortgage lending abuses. State officials were part of the executive committee that negotiated the settlement reached in January 2006 between Ameriquest, a big mortgage lender, and 49 state attorneys general. Under that deal, the company, without admitting or denying the accusations of loan improprieties, agreed to pay $295 million to consumers in 49 states and more than $30 million to cover costs of the investigation.

A recent analysis by The Chicago Reporter, an investigative newsmagazine, found that the Chicago area ranks first among United States metropolitan areas in the number of subprime loans issued to homeowners from 2004 through 2006.

MBIA reflects perfection.

MBIA's stock price is assuming a successful government bailout and no ratings downgrade.

MBIA Out of the Water? Not So Fast.

posted on: December 11, 2007 | about stocks: MBI

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MBIA's (MBI) share price had a healthy 13% bounce after news that private equity firm Warburg Pincus will purchase up to a $1 billion stake, buying $500 million of common stock at $31 initially and receiving warrants to purchase up to $500 million more at $40 next quarter. This news cheered investors, indicating that MBIA may not suffer a downgrade in the next few weeks, which Moody's had earlier described as "somewhat likely."

CFC is hiding losses

Beware of more 'hidden' subprime losses

Commentary: Report says Washington Mutual, Countrywide most vulnerable

By Herb Greenberg, MarketWatch

Last update: 8:10 p.m. EST Dec. 9, 2007

This column first was published in the weekend edition of The Wall Street Journal.

SAN DIEGO (MarketWatch) -- The reality of Generally Accepted Accounting Principles, or GAAP, is that they give companies just enough rope to hang themselves and their investors, if they so please. Much of GAAP is so subjective that you could drive side-by-side snow plows through the gray areas.

That is something to keep in mind if, with the latest wave of write-offs, you believe it is time to start bargain hunting among the most beaten-down financial-services companies tied to the mortgage blowup. The time may very well be right, but a recent report by Gradient Analytics warns that financial-reporting practices of some of these companies yesterday and today could still come back to bite investors tomorrow.

Gradient, a Scottsdale, Ariz., research firm that caters to mutual funds and hedge funds, was early to spot accounting issues at Krispy Kreme Doughnuts Inc. and Children's Place Retail Stores Inc. , among others, and their stocks subsequently tumbled.

"I think for a number of years they played games," Donn Vickrey, a former accounting professor who co-founded and is now editor-in-chief of Gradient, says about the financial-services companies.

By "playing games" he means a tendency during the mortgage boom "to report numbers that were artificially high." There were a variety of ways to do that, all of them completely legitimate and blessed by the gods of financial accounting rules otherwise known as the Financial Accounting Standards Board.

One of the most-popular tactics was front-loading income and cash flows through what is known as "gain on sale" accounting, as loans were packaged and sold to other investors. The amount recognized largely reflected what the company expects to receive at some point in the future, based on predictions of such things as delinquencies, prepayments and interest rates. It is totally discretionary; the more conservative the predictions, the lower the gain.

Just as companies may have been reporting numbers that were too high, Vickrey believes some might now be reporting losses and charges that are artificially low, hoping they will somehow get bailed out before the situation worsens.

This is being done, he believes, by such things as deferring recognition of losses; transferring mortgages that are likely to default from one part of the balance sheet to another, where management has more discretion in determining the seriousness of the loss; somehow concealing "the aftereffects" of aggressive gain-on-sale accounting, and reliance on interest income from negatively amortized mortgages those in which the amount owed rises if payments don't cover all the interest due, which in this environment at best appears dicey.

Much of this, he says, involves meeting "the bare minimum letter of GAAP, but not adhering to the spirit of GAAP."

Among the five biggest companies involved in mortgage securities, Gradient believes Washington Mutual Inc. and Countrywide Financial Corp. have been the most aggressive, with Washington Mutual edging out Countrywide as having "the most risk for a material misstatement." Washington Mutual didn't respond to requests for comment. Countrywide said its accounting is appropriate and it has taken steps to reduce risk.

Gradient warns that Washington Mutual may not be properly valuing loans it is holding for investment purposes. As a result, reserves for future losses may be too low.

While the company boosted its loss provision in the third quarter, the Gradient report says "the increase appears to be too little too late as the allowance for loan losses has failed to keep pace with the increase in nonperforming loans."

Meanwhile, in recent years, interest from negatively amortized mortgages leapt as a percentage of interest income to 7.2% for the first nine months of this year from 1.8% in the same period two years ago. Not only is that income unsustainable, Gradient says, but more prone to write-offs, especially if there are increased delinquencies and defaults.

Then there's the high level of gain-on-sale income in prior years "that may signal additional risks to come."

Washington Mutual, the report says, ranked second behind only Countrywide in terms of its reliance on gain-on-sale. Countrywide has been on Gradient's screen for four years because of a variety of earnings-quality issues.

As with Washington Mutual, Gradient now wonders whether there could be "hidden losses" among loans held by Countrywide for investment. While reserves as a percentage of nonperforming loans have been rising, hitting 63.4% as of Sept. 30, Gradient says they still lag behind peers, including Washington Mutual. Countrywide disagrees, and says that "when all of the relevant factors are considered, our 'reserves' are comparable to our competitors."

Like Washington Mutual, Gradient says Countrywide suffers from "low quality income" related to negative-amortized loans. "Unfortunately," the report says, in trying to determine its exposure, "Countrywide does not provide as much detail as other firms we surveyed."

While the stocks of these companies and others have fallen considerably, Vickrey believes "a lot remains to be revealed." Can't wait.

Herb Greenberg is senior columnist for MarketWatch and contributor to CNBC television based in San Diego. He does not own stocks (except for shares of his employer), and he does not sell individual stocks short or invest in hedge funds.

Fraud starts to rear it's ugly head.

MORTGAGE MELTDOWN
Interest rate 'freeze' - the real story is fraud

Bankers pay lip service to families while scurrying to avert suits, prison

Sean Olender

Sunday, December 9, 2007

New proposals to ease our great mortgage meltdown keep rolling in. First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the bill. But that plan went south after Fannie suffered a new accounting scandal, and Freddie's existing loan losses shot up more than expected.

Now, just unveiled Thursday, comes the "freeze," the brainchild of Treasury Secretary Henry Paulson. It sounds good: For five years, mortgage lenders will freeze interest rates on a limited number of "teaser" subprime loans. Other homeowners facing foreclosure will be offered assistance from the Federal Housing Administration.

But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense.

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it.

I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse."

Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?

The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.

The problem isn't just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply - period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.

Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?

What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic - not five years from now.

Those selling the "freeze" have suggested that mortgage-backed securities investors will benefit because they lose more with rising foreclosures. But with fast-depreciating collateral, the last thing investors in mortgage bonds ought to do is put off foreclosures. Rate freezes are at best a tool for delaying the inevitable foreclosures when even the most optimistic forecasters expect home prices to fall. In October, Goldman Sachs issued a report forecasting an incredible 35 to 40 percent drop in California home prices in the coming few years. To minimize losses, a mortgage bondholder would obviously be better off foreclosing on a home before prices plunge.

The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"

The key is to refinance borrowers whose current loans involved fraud in the origination process. And I assure you it was a minority of borrowers whose loans didn't involve fraud.

The government is trying to accomplish wide-scale refinancing by tricking bond investors, or by tricking U.S. taxpayers. Guess who will foot the bill now that the FHA is entering the fray?

Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time.

As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006.

Paulson became the U.S. Treasury secretary on July 10, 2006, after the extent of the debacle was coming into focus for those in the know. Goldman Sachs achieved recent accolades in the markets for having bet heavily against the housing market, while Citigroup, Morgan Stanley, Bear Sterns, Merrill Lynch and others got hammered for failing to time the end of the credit bubble.

Goldman Sachs is the only major investment bank in the United States that has emerged as yet unscathed from this debacle. The success of its strategy must have resulted from fairly substantial bets against housing, mortgage banking and related industries, which also means that Goldman Sachs saw this coming at the same time they were bundling and selling these loans.

If a mortgage bond investor sues Goldman Sachs to force the institution to buy back loans, could Paulson be forced to testify as to whether Goldman Sachs knew or had reason to know about fraud in the origination process of the loans it was bundling?

It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it.

I suspect that such a group first sat down and tried to figure out how to protect their financial interests and avoid criminal liability. And then when they agreed on the plan, they decided to sell it as "helping working families stay in their homes." That's why these meetings were secret, and reporters and the public weren't invited.

The next time that Paulson is before the Senate Finance Committee, instead of asking, "How much money do you think we should give your banking buddies?" I'd like to see New York Sen. Chuck Schumer ask him what he knew about this staggering fraud at the time he was chief of Goldman Sachs.

The Goldman report in October suggests that rampant investor demand is to blame for origination fraud - even though these investors were misled by high credit ratings from bond rating agencies being paid billions by the U.S. investment banks, like Goldman, that were selling the bundled mortgages.

This logic is like saying shoppers seeking bargain-priced soup encourage the grocery store owner to steal it. I mean, we're talking about criminal fraud here. We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.

Sean Olender is a San Mateo attorney. Contact us at insight@sfchronicle.com.

Gov't more likely to crush cfc than bail them out.

HOUSE ON FIRE

By RICHARD WILNER

December 9, 2007 -- The heat Countrywide Financial Corp.'s Angelo Mozilo is feeling recently isn't from a nearby sunlamp.

Two bankruptcy judges have recently allowed federal investigators to grill Countrywide executives and pore over reams of mortgage contracts after allegations surfaced that the nation's No. 1 mortgage banker could have been running up fraudulent fee income by over-billing homeowners reorganizing under Chapter 13.

In just one court over just a few years, a court-appointed trustee claims Mozilo's Countrywide rang up thousands of dollars in phony fees in each of 293 court cases.

Countrywide created late fees by failing to timely cash checks sent to cover the mortgage payments and by posting the funds after the due date even though they had the money in hand prior to the due date, the trustee, overseeing Chapter 13 cases in Pittsburgh, claims in court papers.

Countrywide lawyers screamed and hollered and opposed having to open its books and records to examination and its officers to questioning - claiming the mistakes were human error and not part of a systemic plan to boost profits.

"The Trustee justifiably [questions] the integrity of the loan histories," Ronda J. Winnecour, the court-appointed trustee, Countrywide's chief protagonist, said in court papers.

Thomas and Maria Anne Balos, who have had money for their mortgage payments deducted from their paychecks and sent to Countrywide ever since they filed for bankruptcy, feel they may have been overcharged by Countrywide.

"I am very interested in the materials Countrywide is going to hand over and want to know if my clients have been billed for late charges or attorneys fees, because they shouldn't have," Michael S, JanJanin, the Balos' lawyer, told The Post on Friday.

Last Thursday, Countrywide short-circuited an order to hand over the materials by agreeing to do as much within 30 days.

Countrywide and its lawyers are also feeling the heat in Houston, where a judge will hold a hearing Dec. 12 to determine if the mortgage giant and its lawyers will be sanctioned for filing a motion for late fees.

The mortgage holder caught the mistake and Countrywide withdrew the motion. But not until the judge and trustee in the case became irked at the Countrywide pattern and ordered the mortgage company into court to explain its behavior.

To be sure, Countrywide, the nation's largest mortgage company, is not the only company being studied for possibly inflating fees. GMAC, Wells Fargo and others are also in the crosshairs of the U.S. Trustee, the arm of the Justice Dept. charged with overseeing the bankruptcy courts.

A study earlier this year by Katherine M. Porter, associate professor of law at the University of Iowa, revealed that collectively, mortgage companies could have padded their bottom lines by millions of dollars by inflating fees on mortgages held by folks in Chapter 13.

New Data

This chart goes further out than previous charts. Notice how the subprime resets give way to option ARM resets in 2010 and 2011. Option ARMS can blow up earlier by "recasting" to fully amortizing or PITI (principal+interest+tax+insurance) when the LTV (Loan to Value) ratio exceeds a certain threshold (usually 110-125%) due to minimum interest payments getting added to the principal and/or declining house values.

Countrywide still sux

	December 7, 2007

HEARD ON THE STREET

Countrywide Isn't Out of Woods Yet By JAMES R. HAGERTY and LINGLING WEI December 7, 2007; Page C1 Since a credit crunch engulfed mortgage lenders in mid-August, analysts and investors have had nearly four months to think about whether Countrywide Financial Corp. can survive. Their conclusion? It is too early to tell. So far, the nation's largest mortgage lender has managed to limp along, largely by increasing its borrowings from the Federal Home Loan Bank of Atlanta and receiving $2 billion from Bank of America Corp. for preferred stock convertible into a stake of about 16% in Countrywide. Its executives have vowed to return to profitability this quarter after a $1.2 billion loss in the third quarter. "I'd rather be breathing than dead," Countrywide's chief executive, Angelo Mozilo, quipped at a conference Monday in Washington. The company's stock and bond prices, however, suggest that investors see a serious risk that Countrywide eventually could seek bankruptcy protection or resort to huge sales of new stock that would slash the value of existing shares. In 4 p.m. composite trading yesterday on the New York Stock Exchange, Countrywide's shares were up $1.68 to $12.10 amid a generally upbeat trading session in the financial sector sparked by falling lending rates. So far this month, Countrywide's share price is up 11.8%, but down 71.5% for the year. The stock is trading at about 53% of the Sept. 30 book value of $23 a share. The company's bonds are selling at "junk" levels. For example, the 5.8% bonds maturing in June 2012 are trading at about 76 cents on the dollar, for a yield of 13.16% "The market is really concerned about the possibility of default," says Steven Persky, chief executive of Dalton Investments LLC, a Los Angeles fund-management firm with $1.3 billion in assets. Mr. Persky, whose firm doesn't have any exposure to Countrywide, has been thinking of buying some of the bonds. He thinks the company is so big and important to the economy that regulators wouldn't let it fail. Still, he says, buying Countrywide bonds now would be "a dangerous game to play. Lots of people didn't believe Russia would default, but it did. On the other hand, in the U.S., when was the last time a large financial institution failed?" Here are some sobering thoughts for people tempted to buy Countrywide stock now: The company's fate hinges on how much worse the housing slump gets. Falling house prices cut the value of collateral backing the $83.56 billion of loans held by Countrywide as investments. Some economists say a recovery may be several years away. "I don't know where we are in the cycle," Mr. Mozilo said at the conference. "I wish I did." Countrywide's savings bank holds $26.84 billion of option adjustable-rate mortgages, which allow borrowers to start with minimal payments and face far higher ones later, and $32.47 billion of second-lien "home equity" loans, potentially worthless in a default because the first-lien holder gets first dibs on the home. These two categories of high-risk loans account for three-quarters of the bank's loan holdings. Countrywide says some of that risk is covered by mortgage insurance. As of Sept. 30, the company carried mortgage insurance on $23.05 billion of its bank's residential loan portfolio, which totaled $79.46 billion. But it isn't certain that mortgage insurers will have enough capital to meet all claims if the housing slump worsens. Countrywide's bank portfolio doesn't include subprime mortgages of the type subject to a rate-freeze program announced by the Bush administration yesterday. More bad news, such as ratings downgrades, could scare away depositors. Countrywide managed to halt a run on its savings bank in August by bringing in Bank of America as a big shareholder. But the company still has to offer premium rates on certificates of deposit to attract funds needed to support further lending. The high rates it must pay for funds will squeeze Countrywide's profit margins on loans. Insiders aren't showing obvious confidence. The company hasn't reported any purchases of shares by its senior executives in recent weeks, even though the stock recently touched an intraday low last month of $8.21. By contrast, executives of another big mortgage company with a drooping stock price, Fannie Mae, have bought shares over the past two weeks. Countrywide needs to repay a total of $26.38 billion in borrowings over the 12 months ending Sept. 30, according to the latest quarterly filing. Countrywide officials have said they can meet these payments -- a point that Moody's Investors Service affirmed -- but may have to sell some mortgages or related securities to do so. Investors are so wary of mortgages that it is impossible to know how much of a discount Countrywide would have to offer to find buyers for these assets. Investors will be looking for chances to force Countrywide to repurchase many of the loans it sold in recent years. Provisions of those sales require repurchases in some cases, such as when loans default early or otherwise don't live up to the "representations and warranties" provided by Countrywide at the time of the sale. "It is our intention to defend our positions vigorously," the company said in a recent securities filing. Loan losses are likely to be a huge drag on earnings for years, and the more-conservative loans being made now don't produce huge immediate gains when they are sold, as many of the more aggressive loans did during the housing boom As if it didn't have enough exposure to mortgages already, Countrywide's insurance arm has sold reinsurance to insurers that cover mortgage-default risk, taking on a portion of their potential liabilities. Countrywide has said its maximum potential losses on these reinsurance contracts were about $1 billion as of Sept. 30. There are some bright spots, however. The company's loan-servicing business, which gets fees for collecting payments and handling foreclosure cases, produces about $1 billion of cash flow each quarter, says Craig Emrick, an analyst at Moody's. Distressed borrowers often end up paying hefty fees. For example, Countrywide says it collected $93.6 million of late-payment charges in the third quarter, up 27% from a year earlier.

Treasury Secretary's Plan is a joke

If stocks rise tomorrow, take advantage and add to your short positions.

The plan will help very few people but will permanently destroy investor confidence.

The media is catching on to the fact that it is declining home prices, not bad credit that is causing the problems. This is unstoppable. The question is, is the government going to let it self correct or will we have to suffer through 15 years of slow house price declines like Japan.

MBIA facing downgrade

On monday MBIA went up about 15% on monday on the announcement of the Treasury Secretary's bailout proposal. Today Moody's said that MBIA may get it's credit downgraded sending share prices down almost 16% because MBIA's business model is predicated on a AAA credit rating. The lesson here is SHORT any and every pop. Pops is the price will be caused by talk of government interventions. You can't predict when they will leak bailout proposals, but you can predict that they won't be beneficial to the stock price in the long run, so make the money on the way back down.

MBIA

As a basline, I assume that most financial assets will return to 2002 prices by the time this debacle is over. MBIA is already gone down to 2002 prices but this article raises some interesting points. The author has been short since 2002, so he must think it has farther to go.

---

December 1, 2007

Talking Business

Short Seller Sinks Teeth Into Insurer

By JOE NOCERA

“I’m going to try to give shorter answers,” said William Ackman, with an awkward smile.

It was Wednesday, and Mr. Ackman, a 41-year-old hedge fund manager, was in the middle of a surprisingly well-attended news conference. He had just finished an hourlong presentation at an investment conference in Midtown Manhattan, and if truth be told, the only reason it had been contained to an hour is that Mr. Ackman had rushed through it, burying his audience in a blizzard of facts, while flipping through an astonishing 145 slides.

If the presentation and ensuing news conference proved anything, it was that Mr. Ackman was incapable of giving short answers. Then again, that’s usually the way it is with obsessives.

Mr. Ackman is an emerging star in the “shareholder activist” division of the hedge fund big leagues. In the last few years, he has taken aim at McDonald’s, Wendy’s and, most recently, Target, usually emerging from these tugs of war with profits for his hedge fund.

His firm, Pershing Square Capital, which he founded in 2004, now bulges with over $6 billion in assets. “If I think I’m right, I can be the most persistent and most relentless person in America,” he says. But for sheer, obsessive doggedness, nothing he has ever done can compare with his pursuit of a company called MBIA Inc. In fact, I don’t think I’ve ever seen a fund manager grab a company by the tail and simply not let go the way Mr. Ackman has done with this once-obscure holding company, whose main subsidiary, MBIA Insurance, is the nation’s largest bond insurer.

Though he says he is not typically a short seller, Mr. Ackman has been shorting MBIA’s stock since 2002. He began his assault with a highly unusual move for a short seller — he posted a lengthy report, laying out his case against MBIA, on the Internet, for all to see. (“I believe in free speech,” he says now, by way of explanation.)

He purchased credit default swaps as a way to profit in the event of a bankruptcy by the holding company. He talked to the S.E.C., the New York State Insurance Commission and the New York attorney general’s office about the company. (He also claims that MBIA was behind a short-lived investigation by the attorney general’s office aimed at him. MBIA declined to comment on the accusation.)

And that’s not all. He held hours of meetings with analysts at Moody’s and Standard & Poor’s, the two big bond rating agencies, trying to persuade them to lower MBIA’s credit rating. He once buttonholed the chief executive of PriceWaterhouseCoopers, MBIA’s accountant, at a charity dinner, and sent him his report. He has made allegations of accounting shenanigans. He has talked to reporters and analysts, and given presentations like the one he gave this week. All the while, he has continued to dig into the company, searching for dirt he could use against it.

For most of that time, his efforts have come to naught. Despite the fact that MBIA, at one point, had to restate five years of earnings — after being tripped up on an accounting problem that Mr. Ackman brought to light — its stock continued to do well. The analysts and rating agencies continued to side with the company. Indeed, the more dogged Mr. Ackman became, the more the company seemed impervious to his slings and arrows.

And then came the subprime crisis, which in recent months has wreaked havoc on MBIA’s stock price, and raised questions about its business model. Sean Egan, the co-founder of Egan-Jones, an independent bond rater, believes that MBIA and the other big bond insurers will be saddled with billions of dollars in losses as collateralized debt obligations stuffed with subprime debt — so-called C.D.O.’s — they have insured continue to go south. So does Mr. Ackman, who believes that as losses pile up and the bond insurer has to pay them off, it will have to shut off the supply of money it sends to the holding company.

At the investor presentation he held this week, Mr. Ackman predicted that the holding company could be bankrupt by February, which MBIA says is preposterous. (“MBIA does not expect material losses in its C.D.O.’s because they were structured with high levels of subordination in excess of triple-A levels and other structural protections,” said its chief financial officer, Chuck Chaplin.) Mr. Ackman now stands to make, personally, hundreds of millions of dollars on his bet against MBIA — which he says he will donate to his charitable foundation. If you sense some defensiveness in that gesture, well, so do I. The question — and it’s the one that always seems to crop up when short sellers are involved — is whether Mr. Ackman’s single-minded pursuit of MBIA is something he should feel defensive about.

•

There’s no doubt about what drives Bill Ackman crazy about MBIA. For all the many issues he has raised, his objection really comes down to a single fact: MBIA has a triple-A rating, the highest any company can get — indeed, a rating more normally associated with Treasury bills, which are backed by the full faith and credit of the federal government. And it’s not just the fact of MBIA’s triple-A rating that drives Mr. Ackman batty; it’s its transcendent importance to the company’s business. As Gary C. Dunton, the company’s chief executive, told me recently, “Our triple-A rating is a fundamental driver of our business model.” No triple-A, no business.

This fact has been widely accepted on Wall Street and in the marketplace. “The model is the model,” shrugged one person who keeps close tabs on the company (and who declined to be quoted by name because he isn’t supposed to talk to the press). Mr. Ackman, however, thinks it is lunacy — and he’s right.

Think about it: if a company needs a triple-A rating just to stay in business, that fact alone probably means it doesn’t deserve the rating. After all, if triple-A-rated General Electric got a downgrade, would it really affect its business? Not really. Companies that merit triple-A ratings are those that are impervious to small — or even medium-sized — bumps in the road. Besides, MBIA takes on a lot of risk for a company with a triple- A rating.

It wasn’t always thus, which explains how MBIA got its rating in the first place. MBIA began life in the early 1970s guaranteeing nice, safe municipal bonds. (Its initials originally stood for Municipal Bond Insurance Association.) But while municipal bonds rarely default, most don’t get triple-A ratings — and the lower the rating the more a municipality had to pay in interest. By “wrapping” such bonds, MBIA could envelop them in its triple-A rating, and in so doing save money for towns and cities all over the country.

Gradually, though, the business model changed. In the 1990s, MBIA began to guarantee not just muni bonds but so-called structured finance vehicles, including those now infamous C.D.O.’s that are causing so much trouble. “If you analogize it to life insurance,” said Mr. Egan — who uses the kind of pithy language that escapes Mr. Ackman — “it is as if they once insured only 18-year-old women who didn’t smoke or drink. Now they are insuring the Evel Knievels of the world.” (He said this before Mr. Knievel died yesterday.)

Nonetheless, MBIA insists that the C.D.O.’s it guarantees are the crème de la crème — not just plain-vanilla triple-A tranches, but the so-called “super senior triple-As.” (“Super senior?” You gotta love Wall Street.) These C.D.O.’s, it says, are the least likely to default, and, according to its analysis, it would take an unprecedented cataclysm for it to have to pay off insurance claims.

Except that Merrill Lynch and Citigroup and a dozen other big investment banks held super senior C.D.O.’s, and they have indeed dropped in value — so much so that the banks have written down billions of dollars. The market has come to realize that the triple-A rating for these derivatives is pretty meaningless — that the rating agencies were just as blind to the coming subprime meltdown as everyone on Wall Street, and developed models for rating C.D.O.’s that were far too optimistic.

The problem for investors is that it is impossible to know what, exactly, is in the individual C.D.O.’s that MBIA insures. “The company is something of a black box,” said that same person who won’t be quoted by name. MBIA executives have been loudly making the case that the C.D.O.’s it insures are fine, that it has plenty of capital to cover any possible claims, and that its triple-A rating is safe — even though the rating agencies are currently reviewing their ratings of the bond insurers. But the rating agencies know full well how important the triple-A is to these companies, and they are loath to lower the ratings.

(When I spoke to Moody’s, its executives denied showing any special favoritism toward MBIA, and insisted that its rating system was as pure as the driven snow.)

Which brings me back to Mr. Ackman. On Wall Street, his nonstop assault on MBIA is highly controversial, and a number of people I talked to about MBIA spoke of it — and him — with distaste. Their central point is that MBIA is in a business that depends, to a large degree, on the market’s confidence in its ability to insure bonds — and that Mr. Ackman’s attacks are an effort to undermine that confidence. They pointed to his prediction that the holding company might soon be bankrupt as an example.

MBIA insists that the holding company has only $80 million in corporate debt and $500 million in cash and that it is completely healthy. Indeed, it says that his bankruptcy prediction “reflects a fundamental misunderstanding of MBIA Inc.’s capital structure and financial statements.” When Mr. Ackman uses the word bankruptcy, he is, in effect, tossing gasoline on a fire.

On the other hand, Mr. Ackman has been remarkably prescient. When I went back and reread his original report, “Is MBIA Triple- A?,” I could see a few incendiary claims. But I also saw him make the case that those C.D.O.’s MBIA insures would eventually come a cropper. And now they have. Companies that are knee-deep in C.D.O. exposure have routinely had their own debt downgraded in recent months, as the rating agencies have belatedly woken up to the problem. Why should the bond insurers be exempt?

It is easy to understand why MBIA’s executives are unhappy with Mr. Ackman. But the other participants in the marketplace — the analysts and rating agencies and institutional investors? They should be thanking him. He may be aggressive, he may be over the top, he may not be able to speak in short sentences. But he’s doing the hard work, and thinking the hard thoughts, that they refused to do for far too long.

Teaser Freezer

Treasury Secretary Paulson's proposal is not a bailout because no government money or government guarantee is involved.

The mortgage servicing companies generally have the authority to modify loans if it is in the best interest of the investors. The government could protect the mortgage companies from being sued by the investors in exchange for extending the teaser rates.

Teaser rates are generally negatively amortizing. If Countrywide and others have agreed to extend the teaser rates, you had better believe that the interest differential is merely deferred.

In order to defer immediate foreclosures, under this plan, cashflows to the investors will be partially deferred and risk of eventual default will increase because the loan-to-value ratio is decreasing, especially if house prices continue to decline.

There is already a bailout plan for insolvent homeowners. It’s called foreclosure. It’s a pretty good deal. You get out of your debt and you don’t even have to go to debtor’s prison.

Is Secretary Paulson trying to keep homedebtors slaves to debt for life, or just until after the election?

I don’t see how this plan addresses the basic issue of insolvency.