Joshua Rosner is a managing director at the independent research consultancy Graham Fisher & Co., where he advises regulators and institutional investors on housing and mortgage finance issues. Rosner has provided advice on monetary, fiscal, regulatory, and political developments to many of the world’s leading banks, mutual funds, hedge funds, and other institutional investors. Mr. Rosner was among the first analysts to identify operational and accounting problems in the government-sponsored enterprises (GSEs), the peak in the housing market, the likelihood of contagion in credit markets, and the weaknesses in the credit rating agencies’ collateralized debt obligation (CDO) assumptions.
What follows is his most recent commentary on Bank of America:
Ken Lewis must not have listened if his parents told him what mine told me:
-“Don’t buy something you can’t afford”;”
– “Chew before you swallow”;
– “You just got a new toy (Countrywide), you don’t need another now (Merrill)”.
These are lessons our grandparents learned, our parents preached and we forgot. Now, unfortunately, our children will learn it too. Perhaps, for the good of the Republic, the Treasury and our nation’s bankers will as well.
Back stopping Countrywide was premature, buying it was ego driven and, even at the time, buying Merrill seemed plain dumb.
The whole Treasury approach is as dumb as taking equity warrants in a company you may decide is better off in reorganization. How can you teach market participants the lessons of the importance of risk assessment and responsibility if every time a banker blows up his firm you bail him out and then finance his next trade.
Worse yet, Treasury bail’s him out and allows him, without restriction, to use the money to play CDS, not to hedge and put risk back into the market but to speculate.
We need to take large and aggressive action to stop a deflation but the crisis has moved to main street and we can’t keep pretending that bank losses, which will begin to accelerate again (with rising unemployment and commercial losses) can reverse if only we use money to hide them.
We keep hearing DC talk about “when we restructure we must better regulate the large banks”. Hello!?, it has been 18 months since I began loudly calling for the SEC to require more detailed disclosures about the structured holdings of banks and warning of risks for the failure to disclose (see link at bottom). Disclosure is better than regulation and easy to achieve yet we talk as though the Fed and SEC need new powers to achieve these confidence inspiring and risk assessing disclosures.
Is Bank of America the Next “Citi”?
The Department of Treasury sent out an announcement at 5p.m. yesterday titled:
“Treasury Provides TARP Funds to Local Banks”. Most recipients of last evening’s
email announcement probably left it unopened in their inbox or went further and erased
it. It would be understandable for most to think that it was unimportant news that
Treasury gave money to the ‘First National Bank of Tinytown USA’.
Had more people opened it they would have realized that Treasury has given Bank of
America and the American Express Company previously promised money. Even
with a shiny new $10 billion from Treasury, the money that they receive for closing the
ill-fated Merrill acquisition, I believe it all but certain that the Company will end up back
on the Treasury’s soup kitchen line. The Government, in repeating their mistake with
Freddie Bear, Lehman and Citi, appears to have missed the chance to require BofA to
raise capital and it now appears they are ‘ours’.
Ultimately, I expect larger than expected losses will come from inadequate reserves
relative to the risks in BofA’s HELOC, construction, commercial real estate and
commercial loan books and also from the poor timing and likely worse modeling of their
acquisitions of Countrywide and Merrill Lynch. Given our economic outlook, it seems
reasonable to consider BofA may be the next ‘Citi’. I do wonder if the Government
will approach things differently or take on their obligations without forcing BofA equity
holders to relearn the forgotten price of poor risk-taking in investments. I also wonder if
the government has learned it’s lesson or will it again push for non-workable openmarket
mergers of toxic, asset-laden, institutions.
“So, what is the number” one might ask. Any attempt to answer that would be the result
necromancy and not analysis. Neither BofA nor Merrill detailed their structured
exposures well enough for investors to analyze the appropriateness of the values assumed
in their marks or to assess the asset sensitivity to further economic weakness. Moreover,
we do not have enough granularity to assess the sector exposures of their commercial real
estate, their construction lending or their commercial loan books. Moreover, we believe
the real economic fallout is just beginning and, as unemployment rises, losses will
become a moving target.
At the time that BofA took a strategic stakeout position in Countrywide, I stated that it
appeared they were making a bet they could pick a bottom in the housing market. I made
it clear I was analytically on the other side of their housing outlook. It appears they
wrongly believed the housing market and broader economy were independent of each
The speed with which BofA swooped into their Countrywide backstop suggested that
they failed to do a thorough due diligence. Given the terms, I could not believe they
properly modeled how bad losses would get due to Countrywide’s shoddy underwriting
or the probability of increasing costs and in their servicing business.
Countrywide was the pioneering player that grew for much of this decade by taking risky
mortgage products, designed and tested in California (often by other California players),
and going on the road to sell those products door to door across our country. They were at
the forefront of the now proven to be false belief that: ‘once we sell the mortgage to an
investor or guarantor, either through private label securitization or GSE guarantees, we
no longer own the risk’.
By the time that BofA stepped into the morass and committed to fully take Countrywide
they indicated they might not assume all of Countrywide’s debt. Perhaps they realized
that they had miscalculated the level of losses, but also seeming to believe we were closer
to an economic bottom than we were. At the time BofA also appeared to expect that, as
the largest originator of conforming conventional loans, they would benefit in recovery
because the GSEs were increasingly ‘the only game in town’.
We now know that even if the GSEs were the only game in town that game is now a
schoolyard pick-up game and unable to offer much to a former major league player. We
also know that the GSEs, by being the only game, seem to have increasing leverage in
their put-backs of bad loans.
GSE seller-servicer agreements suggest the GSEs claim the right to push losses onto
servicers in cases where mortgage insurers choose not to, or are unable to, pay for any
reason, Unconfirmed sources suggest the GSEs are making claims that lenders were
specifically instructed not to use those systems as the basis for their own lending
decisions and using those standards as the basis to put loans back to various originators.
While these risks seem to expose more than just BofA, their size and ties to the GSEs
seem to suggest they are perhaps the most exposed.
Beyond significant problems in Countrywide’s residential and commercial mortgage
businesses are the risks of growing losses in BofA’s Merrill Lynch acquisition and in
their own commercial and construction books. I would suspect that by late in the second
quarter we will begin to recognize that commercial, construction and corporate loans will
be defaulting, industry-wide, in hockey-stick form. If there is one-thing BofA
shareholders can be thankful for it is that GE Capital had purchased Merrill’s middlemarket
commercial financial arm in late 2007.
As the problems continue their transition from capital and credit market issues to an
ongoing rationalization of capacity in the real economy we will be increasingly unable to
sneak $10 billion of taxpayer money to ‘band-aid’ deeply troubled financial institutions.
We will also recognized that, as Japan learned almost two decades ago and equity holders
should have recognized long ago, consolidating bad banks with worse banks without first
stripping away their combined bad assets is a recipe for long term deflation.
The 2007 report “Financial Services Exposures to Subprime, Why we are not ‘Seeing Red’” is available online.
Graham Fisher & Co., Inc.