My company has purchased loans before. We sent people to the
selling bank, parked ourselves in a conference room stocked with coffee and
snacks, and did something called “due diligence.” This means we spent a week
analyzing the loan files and repayment history. Sound exciting? Guess again.
But before we bought a portfolio, we wanted to understand the fundamentals of
each loan, and decide which ones we wanted, and which ones we didn’t.
My understanding is this $700 billion dollar bailout is to
purchase distressed assets from financial institutions, to reduce the
pressure on their reserve for loss provisions, reduce pressure on credit default swap (CDS) buyers so that they won't need funds to fulfill them,
reduce market pressure to sell mutual funds that purchased collateralized debt
obligations (CDOs) with these assets as the underlying security, prevent a
further deflation of M3, and thereby restore short-term credit market
stability. Fine.
But what exactly are we, the taxpayers buying here?
There isn’t a single mention of any due diligence in these
bailout proposals. There isn’t even a discussion as to how they came up with
$700 billion. Why not? Folks, this due diligence process is what the regulators
did in the S&L crisis. This is what JPM Chase may do with the WAMU assets
they were forced to buy by the regulators.
First, let’s assume those assets are primarily distressed
mortgages. So let’s just play with numbers for a moment to understand what I’m
asking and how much it might cost – at least I can provide a concrete example,
which is more than I can say for our leadership.
Let’s say there are 2.8 million homes now in the foreclosure
process. Let’s start there, then we can go to the ones that are 60-90 days
delinquent later.
In my due diligence trips, I look at 5-10 files per hour.
These were commercial mortgages and loans, with more complex cash flows,
multiple borrowers, and environmental reports to skim as well as appraisals.
I’ve also reviewed consumer mortgage files – they take much less time, once you
know where things are in the loan file. Let’s say a typical reviewer can
analyze 10 per hour. 80 per day. Let’s assume a 20-day working month; a single
person ought to be able to review about 1,600 files per month. To review 2.8
million files in a month, you’d need 1,750 people working at this pace. I bet
you can find that many in the financial sector right now who have been laid off
this year. So pay them $20 per hour; it would cost $5.6 million bucks.
Want it done in two weeks? Hire about 3,500 people. Etc.
Where to start?
The easiest place would be the bank(s) with both the highest
number of foreclosures and the highest dollar amount of foreclosures. Then the
bank(s) with highest dollar amount of foreclosures, then largest number of
foreclosures.
So what would we get with this little project? Is it worth
more than $3.2 million paid to Alaska to study the mating habits of King crabs?
I bet it is.
We should get:
- The
repayment history – vital, because it paints a picture of what the
borrower can handle and gives the reviewer an idea of how to work the loan
out.
- Credit
report – know how the borrower handled their past credit
- Collateral
value estimate, i.e. an appraisal – likely a high estimate, but this along
with www.zillow.com or a tax
assessment, you get an idea of what the home would sell for
- Debt
coverage - this tells you
what the lender thought the borrower could afford
- Source
of repayment – was it one income, or two? (hint – if the lender gave two
people a mortgage they can barely afford, and one loses a job…)
- Are
there other liens? (if the borrower got a purchase money second mortgage,
for example)
- Liquidity
– how much the borrower had to cover bad times (likely zero)
- type
of property – was it a rental property? Vacation home? Primary residence?
The disposition of the property could vary depending on the answers here.
- If it
was a rental, was it rented? Is it now? For how much? Are the rent
payments on time? How much of a vacancy has it had?
Once you have this data, you’ve got something real to go
back to the regulators with. You can see which mortgages may need a deferment,
so the borrower can get back on their feet, and which ones truly are due for
foreclosure. Put it in a database, and analyze it. Are there concentrations?
(We already know there are – California and Florida have the highest number of
foreclosures, Arizona, Ohio and Michigan, etc.)
{Here is an aside – many of these mortgages were done from
institutions regulated at the state level. So what are these states going to do
here? Can’t they foot part of this bill? If South Dakota has the lowest number
of foreclosures, why should their taxpayers pay a proportionately higher share
of the bill?}
OK, now for the other assets. Like I said about the
mortgages, we need to get to the core assets that are a problem. I have no
direct experience with what information changes hands when a CDS is sold or a
CDO is packaged and sold. Since the initial buyer of these swaps or CDOs can
(and frequently) does trade them, we’d need to get to the core of the problem –
the original seller. So can any TPM member with experience here comment if a
similar due diligence program can cut to the chase with these derivatives? What
are we being asked to pay for here?
Why hasn’t the President or the Fed or the regulators issued
an order to get this done? I don’t see the problem. If my company can buy
hundreds of loans this way, why can’t the Feds do the same thing here while the
bailout negotiations are in process. Even if it costs $20 million, that’s a
drop in the bucket compared to what they’re asking. This isn’t rocket science.
It’s in the trenches analysis. And it would seem that the legislators would
have a much better chance at crafting a bill that actually would work if we
knew what we’re getting.
So again, what are we buying here?
How about some real information instead of bloviation and
doom prognostication?
C’mon. Get cracking.
