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As the credit world was unraveling around them, email communications between analysts at S&P seems to be pretty damming to their neutrality position. And finally now the lawsuit. There’s a fascinating re-write of the great Talking Heads song “Burning Down The House” by an S&P analyst.

I’ve got the entire Talking Heads catalogue on my iPhone and I’ll bet that David Byrne and the rest of the ‘Heads never imagined their music would used to describe a global credit bubble.

Here is the S&P email with the revised lyrics – as the credit world was imploding…

“With apologies to David Byrne…here’s my version of “Burning Down the House”

“Watch out
Housing market went softer
Cooling down
Strong market is now much weaker
Subprime is boi-ling o-ver
Bringing down the house

Hold tight
CDO biz — has a bother
Hold tight
Leveraged CDOs they were after
Going — all the way down, with
Subprime mortgages

Own it
Hey you need a downgrade now
Free-mont
Huge delinquencies hit it now
Two-thousand-and-six-vintage
Bringing down the house.”

Wow. Their other songs like “Wild Wild Life”, “Road to Nowhere”, and “Psycho Killer” might have also done the trick.

Tags: Talking Heads, S&P, Sub-Prime

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American Banker has a great slideshow on catchphrases that evolved during the financial crisis. Check it out. Some of my favorites are:

Structured By Cows – “We rate every deal. It could be structured by cows and we would rate it,” said an S&P analyst discussing a questionable securitization that a colleague called “ridiculous.”

High Speed Swim Lane, or HSSL Countrywide’s way of describing the way they stripped QC of loans going to Fannie Mae and Freddie Mac.

Friends of Angelo Named for Countrywide’s CEO Angelo Mozilo in which government officials like Chris Dodd (ie Dodd-Frank) got better mortgage terms than they should have.

Close More University Subprime lender New Century (out of business) brought together mortgage brokers to encourage them to throw away any standards to bring more volume.

Jingle Mail When borrowers mailed their keys to the bank if they were hopelessly underwater.

Liar’s Loans Standard mortgage industry practice that encouraged borrowers to exaggerate their qualifications in order to get the loan.

Incredible and hard to conceive of now but this was common practice only a mere 5 years ago.

Tags: American Banker, Fannie Mae, Sub-Prime, Freddie Mac

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Guest Columnist:
Todd Huttunen

Todd Huttunen began appraising more than 20 years ago with a few years off in between to pursue a career in cabinet making. He relegated that to hobby status and is currently an appraiser in an assessor’s office. His best friend dubbed him The Hall Monitor because of his rigidity and respect for rules. He offers Matrix readers tongue-in-groove insight on appraisal and housing issues. View his earlier handiwork on my first blog, Soapbox

Jonathan Miller

In estimating the value of a house, appraisers are concerned with answering two fundamental questions.

1 – What is the value of the land, as vacant?

2 – What contribution, if any, does the existing improvement make to the underlying value of the land?

A recent study (pdf) conducted by the Lincoln Institute of Land Policy suggests that in the higher priced regions of the country, the land-to-value ratios range from 50% to 75%. In areas where “teardowns” are common, land values can actually exceed 100%, since the buyer looking to construct a new house has to add the cost of demolition to the price paid for the existing house before she can build the new one.

Although this is the reality in many parts of the New York metropolitan area, Boston, Southern California, and other regions, for a long time now banks and the appraisers who work for them have pretended otherwise. For some reason banks want to believe that the mortgages they make are on properties where the land represents between 25% and 35% of the market value and that the improvement represents the bulk of the value, 65% to 75%. Even as far back as 1985 when I started appraising and the land-to-value ratios were not as high as they are today, we were required to add a comment to our reports stating that “land values in excess of 30% of market value are common in this area,” whenever we estimated land value above that “magic number”.

Appraisers I’ve spoken to say the reason they estimate land values at say, 30 – 35% of overall value, irrespective of the fact that it may be much greater, is that they are under pressure from lenders and underwriters who won’t approve loans on properties whose land-to-value ratio is more than roughly one-third. Conventional wisdom says banks don’t want to make loans on land, so they instruct their appraisers to say the land is 30 – 35% of market value (the fact that it may really be 80 – 90% doesn’t seem to bother them, as long as the appraiser says otherwise). The reality however, based on this Land to Value Ratios study from the Lincoln Institute of Land Policy, is that in many of the country’s higher priced locations, it is the land which comprises 50% to 75% or more of the value of the property.

This is important for a couple of reasons, one of which is the fact that appraisal forms are geared toward the notion that most of the value is in the improvement, and not the land. The adjustment grid, wherein the appraiser compares the subject property to the comparable sales, gives short shrift to factors relating to the land value and focuses instead on the improvements such as square footage of the house, number of bedrooms and baths, condition, and on the amenities such as fireplaces, patios and pools. Most of the dollar adjustments appraisers make are for differences in the improvements and amenities. But if 75% of the value is in the land, then why are we bothering to make an adjustment for the fact that one property has a fireplace and the other does not? Shouldn’t the focus be on factors relating to the land instead? These would include site size, shape, views, elevations, topography, frontage, etc.

Appraisers have been subject to scrutiny in recent years, given their role in the mortgage lending process, and some have been implicated for their unethical participation in the sub-prime debacle. I believe most appraisers are ethical, professional, and serious about the work they do. But I do think it’s time to recognize reality when it comes to the allocation of value between land and improvements. If the land value represents 50% or 75% or 100% of the value of the property, as it does in many parts of the country, then appraisers have an obligation to their clients to say so in their reports. And if that means the appraisal form itself needs to be redesigned to reflect the market as it is now, and not as it was in 1930, so be it.

Editor’s note: I find it amazing how so few consumers realize that changes in value during a period like we just went through is in the land, not the building (improvements) – jjm.

Tags: Todd Huttunen, Appraisal Institute, Sub-Prime, The Hall Monitor

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I’m a big fan of Michael Lewis’ writings starting with Liar’s Poker (think onion cheeseburgers for breakfast and traders owning more speed boats than suits) and much of his other work including Money Ball, Panic (a collection of his favorite news accounts of the credit crisis) and The Blind Side (Academy Awards), but I am very much anticipating reading his new work “The Big Short: Inside the Doomsday Machine.“

Admittedly I am growing weary of Wall-Street-what-went-wrong books and I still need to read Andrew Ross Sorkin’s “Too Big Too Fail” compendium on my nightstand (worrying its becoming “Too Big To Read”) but I definitely will. But the Lewis book has got my attention for some reason. It’s weird to sound like I am recommending a book I haven’t purchased or read yet but I guess I am relying on past experience.

In the book acknowlegements, the WSJ Deal Journal blog points out that Lewis:

praises “A.K. Barnett-Hart, a Harvard undergraduate who had just written a thesis about the market for subprime mortgage-backed CDOs that remains more interesting than any single piece of Wall Street research on the subject.”

And my favorite quote referring to the idea of making the numbers say what you needed them to say.

“If you just randomly start regressing everything, you can end up doing an unlimited amount of regressions,” she said, rolling her eyes.

Read the thesis.

She was able to track down information and cover the looming CDO disaster completely on her own through basic research.

Perhaps most disturbing about these losses is that most of the securities being marked down were initially given a rating of AAA by one or more of the three nationally recognized credit rating agencies, essentially marking them as “safe” investments.

A lot can be said for taking a detached or neutral look at a complicated situation. Sometimes the collective mindset takes on blinders, or in this case, blind folds.

A couple of charts to peak your interest.

Tags: Sub-Prime

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I always thought “The Appraiser” was a good name for a reality tv show. Unfortunately, the reality is real and the appraisal process is one of those accidents waiting to happen.

There is a tongue in cheek style article by Sheree Curry in the recently ramped up HousingWatch page on AOL

Are Appraisals the New Organized Crime?

that essentially takes some of the burden off of other parties in the real estate transaction such as mortgage brokers, and places it on the shoulders of appraisers. In many cases, rightfully so.

Of course this doesn’t apply to all appraisers and in fact many appraisers aren’t really…appraisers. More like form fillers.

And some are appraisers are going to have their day in court – but not enough of them.

Here’s a related article I authored for American Banker last summer called:

Then Don’t Call It An Appraisal.

Hey, you got a problem with that?

Tags: Sub-Prime

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American Casino movie trailer from Leslie and Andrew Cockburn on Vimeo.

I was listening to the C-SPAN Q&A podcast which was an interview with producers Leslie and Andrew Cockburn on their new independent film called American Casino which chronicles the breakdown of subprime lending via Wall Street. The starting point is subprime mortgage lending in poor neighborhoods of Baltimore.

The foil is Phill Gramm, Chairman of the Senator Finance Committee who in a masterstroke of politcal management, on December 15, 2000 at 7pm, appended a 260 page financial de-regulation bill to an 11,000 page appropriations bill just before the holidays, and because it was in the 11th hour, it was likely few read it and Clinton signed it. The bill exempted the financial instruments used in the credit boom from federal and state regulations – free of any supervision.

Gramm is now Vice Chairman of UBS.

This topic is nothing we haven’t heard before but its focus on Gramm is an interesting angle. I listened to the entire C-SPAN interview and while I enjoyed it, the story feels a bit tardy (although certainly very important because the pain is still playing out).

This systemic breakdown will continue to facsinate many for generations to come – hopefully serve as case study fodder at MBA programs as well.

The film credit pronouces:

“AMERICAN CASINO IS A POWERFUL AND SHOCKING LOOK AT THE SUBPRIME LENDING SCANDAL. IF YOU WANT TO UNDERSTAND HOW THE US FINANCIAL SYSTEM FAILED AND HOW MORTGAGE COMPANIES RIPPED OFF THE POOR, SEE THIS FILM.”

-Joseph Stiglitz, Nobel prize-winning economist

A few days after I heard the podcast, a federal judge threw out the lawsuit by the city of Baltimore against Well Fargo:

ruling that the city could not prove that the bank’s lending practices had resulted in broad damage to poor neighborhoods.

Perhaps a case of bad timing for the film makers? But but still a compelling story.

ASIDE: Speaking of film making (sort of) check out my friend Andrea Powell‘s home improvement series for Lowe’s.

Tags: Sub-Prime

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David Leonhardt had a fantastic front pager in the New York Times yesterday that was such a compelling read, I re-read it to try and absorb anything I missed the first time. The article Fed Missed This Bubble. Will It See a New One? looked at the case made by the Fed to enhance its regulatory power.

David asks the question for the Fed:

If only we’d had more power, we could have kept the financial crisis from getting so bad.

But power and authority had nothing to do with whether they could see a bubble.

In 2004, Alan Greenspan, then the chairman, said the rise in home values was “not enough in our judgment to raise major concerns.” In 2005, Mr. Bernanke — then a Bush administration official — said a housing bubble was “a pretty unlikely possibility.” As late as May 2007, he said that Fed officials “do not expect significant spillovers from the subprime market to the rest of the economy.”

I maintain that because of human nature, mob mentality, or whatever you want to call it, all regulators drank the kool-aid just like consumers, rating agencies, lenders, investors and anyone remotely connected with housing. Regulators are not imune from being human.

Once the crisis was upon us, the Fed and the regulatory alphabet soup woke up and began drinking a lot of coffee.

David concludes:

Which is why it is likely to happen again.

What’s missing from the debate over financial re-regulation is a serious discussion of how to reduce the odds that the Fed — however much authority it has — will listen to the echo chamber when the next bubble comes along.

Exactly.

I think this whole thing started with the repeal of Glass-Steagal where the boundaries between commercial and investment banks which were set during the Great Depression, were removed. Commercial banks had cheap capital (deposits) and could compete in the Investment Banking world. But Investment banks could not act like commercial banks. Their access to capital was more expense motivating them to get their allowable leverage ratios raised significantly. One blip and they go under.

Tags: Alan Greenspan, Ben Bernanke, Sub-Prime

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Here’s a great piece in WaPo by Steven Pearlstein that outlines the trouble with rating agencies.

One thing you learn from booms and busts is the importance of gatekeepers — those professionals who are supposed to safeguard the system and keep markets honest. When gatekeepers are compromised or fall down on the job, confidence evaporates and markets collapse.

And its been wrong for a while…

starting in the mid-1970s, following a number of high-profile bankruptcies, people decided it was important to make credit ratings publicly available to all investors. Companies that issued bonds began paying for the ratings themselves, and it didn’t take long before agencies figured out that it was better for business if their ratings were a bit higher and their analysts were a bit slower to issue downgrades

Finally, after more than a year

the SEC rolled out a bunch of new rules and proposals meant to purge conflict of interest and ineptitude from the credit-ratings agencies—that group of companies whose greatest hits include considering Enron investment-grade until four days before it went bankrupt and, most recently, the “AAA-rated” CDO.

In 2005, I had lunch with a bunch of investment bankers and they spent most of the meal ripping the incompetence of the rating agencies – how they couldn’t keep up with the new financial products and the disrespect for their “hand in the cookie jar” arrangement.

As it stands now, you can’t really build investor confidence in the secondary mortgage market until you (substantially) remove self-dealing. Rating agencies were paid by the banks whose paper they rated. Crazy.

The Commission approved a series of proposals designed to strengthen its oversight of credit ratings agencies, enhance disclosure and improve the quality of credit ratings. The proposals would improve the quality of ratings by requiring greater disclosure, fostering competition, helping to address conflicts of interest, shedding light on rating shopping, and promoting accountability.

And thats not all – California is going after the agencies themselves.

The three top agencies — McGraw-Hill’s (MHP, Fortune 500) Standard & Poor’s, Moody’s (MCO) Investors Service and the Fitch unit of France’s Fimalac — raked in huge fees in exchange for assigning high ratings to “complicated financial instruments, including securities backed by subprime mortgages, making them appear as safe as government-issued Treasury bonds,” Brown’s office said in a statement Thursday morning.

Tags: SEC, Sub-Prime

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I try my best to keep an even keel on what I observe about our regional housing market – the benefit is it enables me to be criticized by more people as too negative and too positive. 😉

It’s been quite a fascinating year to observe how so many became so wedded to their original beliefs despite how much the world is changing around them.

This applies to TV pundits.

Here’s a few Peter Schiff clips that many of you may have seen, but its worth refreshing your memory. What is particularly interesting in this clip is the lack of content within any responses given by all those who disagreed with Schiff. Just disbelief, distrespect and misinterpretation of historical trends.

…such as Ben Stein’s description of the subprime problem as tiny, Arthur Laffer’s penny bet and and Mike Norman’s disrespectful tone and lack of understanding about bank underwriting and housing despite being a business radio host (his show was cancelled in 2009 and he blamed “Schiff and cockroaches who believed Schiff”) stand in stark contrast to reality.

While on this topic, I continue to have regular exchanges of emails with some real estate agents who suggest that Manhattan, Fire Island, The Hamptons, etc. (high end enclaves) are basically immune from the world’s economic problems because “They are an island, can’t be expanded, there’s nowhere like them, etc.”

Here’s a recent exchange:

As a real estate broker, I know what I see. I see Manhattan being an island, indeed. Once value was perceived, people began buying. I haven’t been happy about some of your negative statements, not because I am in denial but because I truly see a different reality.

This agent later told me in the exchange that their spouse was laid off and times are tough for everyone (but not their customers?).

Of course there are many agents who have adapted and have been successful in this market. It’s not about being more positive, it’s about helping customers navigate it and finding opportunity.

Tags: Sub-Prime, Radio

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This weekend I ripped through a terrific book The Secret Life of Lobsters by Trevor Corson written back in 2004. Even if you’re not a lobster fan, I marveled at how he could take a mundane subject and weave an interesting (true) story on how the lobstermen of Maine have kept the production elevated for the past several decades, despite consistent claims of overfishing. (Incidentally my lobster pots were stolen this weekend, lines probably cut by commercial fisherman, plus we had 30 family members over to our house for the 4th for a lobster/clam bake.)

No one really knew whether cyclical declines in the number of pounds caught were natural or induced by man.

In other words, this is all about subprime lending.

While trying to find my interview on NPR about last week’s market reports (I was unsuccessful) I stumbled upon a WNYC interview with the Trevor Corson last week (the day our report was released) without using keywords such as “lobster,” “fishing” or “Maine”.

He correlated the sharp drop in Lobster prices this year with the collapse of the Iceland banking system via subprime lending. It’s worth a listen.

And here’s his related piece in The Atlantic magazine. Fascinating.

Basically, lobster prices have maintained a high price level for the past decade. A large portion of the catch was diverted to processing plants in Canada keeping supply of fresh lobsters restrained in the U.S. The Canadian plants shipped lobster products all over the world and were mainly financed by Icelandic banks who provided them revolving lines of credit. When the subprime crisis hit, these banks collapsed because of their heavy investment in financially engineered subprime mortgage products. As the lines of credit dried up, so did the processing plants and the excess harvests were stuck in the U.S. driving down wholesale lobster prices.

Sound familiar?

Oversupply of housing driving down prices correlates to the “V-notch” technique to increase the lobster population. I won’t even bring up the V-shaped recovery“, since I’m still full from our lobster bake.

Somehow it all comes back to lobsters.

UPDATE On a side note, the wholesale cost to restaurants has fallen sharply but the consumer is largely unaware of the drop, so restaurants have enjoyed a larger spread between what they charge you and what it costs them. Have you ever noticed how many lobster related items appear on a typical mid to upscale restaurant menu? It seems to be 4-5 items now have lobster in them. Menus used to contain one lobster item, a whole steamed version. Now lobster mac & cheese is a popular favorite. Thank synthetic CDOs for that.

Tags: subprime lending, lobster, Trevor Corson, The Atlantic, PBS, Sub-Prime, Canadian Housing Market, Icelandic Banks

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Tags: Sub-Prime, Robert Shiller, Case-Shiller

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Professor Robert Shiller took time out from his busy schedule when he was in New York to pay me a visit and let me interview him for The Housing Helix Podcast.

I invited him after I read his recent Op-ed piece in the New York Times, Why Home Prices May Keep Falling.

Dr. Shiller is well known for many things, including his New York Time’s bestselling book: Irrational Exuberance and his widely referenced monthly state of the housing market tool, The Case-Shiller Index. But he also continues to write about the housing market, having released two books over the past two years:

Last year’s The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It

and this year’s

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism

I hope you enjoy his insights.

Check out this week’s podcast.

You can subscribe on iTunes or simply listen to the podcast on my other blog The Housing Helix.

Tags: Sub-Prime, Robert Shiller, Case-Shiller

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