Sometimes it’s all about time. Things take time. Time catches up to things.
In the case of the many crimes and misdemeanors that led up to the credit crisis, time seems to be finally catching up with some crooked institutions.
As for the real crooks, as in the individuals who lied, cheated, stole, and directed others to lie, cheat, steal, and more for their share of the almighty bonus pool… not so much.
But sometimes, you take what you can get.
This time it’s a rating agency’s turn… It’s not enough. But today I’m going to share this bit of good news.
Rated G… for Garbage
In February 2013, the U.S. Department of Justice slapped Standard & Poor’s with a $5 billion civil suit. Apparently, for fraud, filing criminal suits is not civilized, at least not if you want to keep getting political donations.
S&P and its parent, McGraw Hill Financial Inc. (NYSE: MHFI), pooh-poohed the 119-page suit – of course. They called it “meritless” and vowed to defend themselves “vigorously.”
The lawsuit charges S&P with egregiously rating residential mortgage-backed securities and related structured products it knew were garbage as USDA Choice or AAA Yummy Good. And believe it or not, a lot of people bought it.
S&P is only the largest rating agency in the world. It only rated some $2.8 trillion worth of residential mortgage-backed security (RMBS) junk and $1.2 trillion worth of structured dreck during the run-up. And then it subsequently downgraded all that supposed Prime Cut to “Oops, it’s stinky rotten. How were we supposed to know things would change?”
So, at least the economy and the American people weren’t affected. Because what’s a few trillion dollars of rot in an otherwise healthy buffet of Wall Street entrées?
Some serious stuff, as in smoking-gun internal emails at S&P, has surfaced. According to a Reuters article that came out after the suit was filed, “By July 5, 2007, as the credit crisis began taking hold, a new S&P structured finance analyst told an investment banking client: ‘The fact is, there was a lot of internal pressure in S&P to downgrade lots of deals earlier on before this thing started blowing up. But the leadership was concerned of p*ssing off too many clients and jumping the gun ahead of Fitch and Moody’s.’”
Of course, there is a lot more. In due course, we may get to see some of the more enlightening emails. I’ve seen some, and they are funny – while at the same time sickening.
So, with all the time that’s passed since the DOJ filed its suit, what’s happened?
S&P has stonewalled the government. It wants to break up the suit into different parts. It also wants to countersue the government, saying the lawsuit is retaliation for S&P lowering the U.S. credit rating down a notch from AAA during the debt-ceiling impasse in Congress. But S&P says it might negotiate a less than $1 billion settlement deal.
It’s ongoing. The thing that gives me hope is that we’ve seen successful cases won against big banks, including admissions of guilt, in a few circumstances.
If in time this case is won and S&P has to plead guilty, there will be more and more lawsuits all over the place. And because no one has gone to jail, which is a tragedy, at least stripping pigs of some of their money – though sadly it’s all shareholders’ money – is better than a stick in the eye.
The U.S. Securities and Exchange Commission is finally getting in on the game and may be going after S&P. A so-called Wells notice has been served to S&P. The SEC issues such notices when it wants to let a target know it’s being looked at.
It’s comforting to know the SEC is on the case, because without the SEC where in heaven’s name would we all be?
You also might be wondering about that other massive rating agency, Moody’s, and why it hasn’t been implicated in any wrongdoing. After all, the folks there were doing the exact same thing as S&P was being paid billions of dollars to do: lie.
Maybe in due time. But don’t hold your breath.
While all that was going on, a little old man everyone reveres – a man who chastises Wall Street and then comes to its aid, in the name of helping America of course – owned a giant chunk of Moody’s when it was making all that greasy money.
Of course, in time Warren Buffett got rid of the albatross around his neck. But as far as the government going after Moody’s and dragging in the venerable one himself, that’s going to take time.
Back in April I wrote about the initial public offering from Ally FinancialInc. (NYSE: ALLY). I told you about how they were loading up the truck with subprime auto loans, and how that lending game was too reminiscent of the subprime mortgage buildup and subsequent crisis to not warrant a déjà vu-all-over-again feeling.
I’m no longer one of the only muckrakers warning that the subprime auto loan space is sleazy and potentially dangerous to our economic health.
I usually don’t trust or link to pieces in the mainstream media. But this really caught my attention… so I wanted to share…
And the Next Subprime Bubble Is…
The DealBook blog from The New York Times had an absolutely brilliant piece the other day titled “In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates.”
As I write this, several housing stocks I recommended my Short Side Fortunes subscribers get in on are down fairly sizeably today. One stock is trading right now at $39.85. If it breaks below $38, that’s bad news. Another is trading at $23.75. If it breaks below $23, that’s bad news. And yet another is trading at $31.05. If it breaks below $30, that’s bad news.
That will be good news for the shorts, but bad news for housing.
Why are there still dark clouds over our supposed economic recovery? We’re five years on from the mortgage meltdown, after all, and housing prices have bounced back dramatically and interest rates at near record lows.
I’ve been saying it all along. The housing rally is fabricated. It is, as Pete Townshend sang in The Who’s last great single, an “Eminence Front”…
An Eminence What?
Housing’s so-called resurgence is not about individuals and families buying back into the market, though of course some have. Home prices have bounced back because of institutional buyers paying cash for “affordable” housing.
I’m talking about the homes that were bid up when banks were giving mortgages away. These are houses in the $200,000 to $450,000 range… you know, the ones that banks foreclosed on in the tens of millions.
Institutions with cheap borrowing capabilities have been buying, with cash, foreclosed homes hand over fist in order to rent them out. And now they’re securitizing packages of those homes and selling interests in pools of them to other institutional buyers looking for decent yielding investments.
It’s a trade.
Traders bid up those homes. It’s not about a real recovery in housing.
Like I said, it’s a trade.
As far as more expensive homes go, the buyers there are mostly foreigners taking money out of their respective countries – China, Russia, Ukraine, Latin America, Europe, South Africa, South Korea. These are people with money who want to park it here in real estate.
After all, there’s more to gain from homeownership than 2.5%-yielding 10-year U.S. Treasury securities.
And the high, high end?
I’m talking about homes well north of $1 million. When I’m not at home, I’m usually back and forth between Miami and the Hamptons. And the prices of “luxury” homes there are skyrocketing
The 1% never had it so good.
Anyone out there looking for a $10 million weekend home in the Hamptons? Good luck finding one. Inventory is tight because there are so many buyers.
That would be well and good if there was some trickle down to the rest of America. But there is no real housing “recovery.”
The housing recovery is an institutional trade. It’s a lot of cash-rich people trading foreign assets for U.S. assets.
Make that “trading up” because their portfolios are spilling over with gains.
The “recovery”… it’s an “Eminence Front.” The folks in Washington and Wall Street are so insecure that this is the pose – the front – they’re taking.
Well, they’re not only insecure – they’re transparent, and so I can see right through them.
That Yogi Berra Feeling
Sure, I could point to the lack of decent full-time jobs. Or that wages haven’t budged. Or that low interest rates haven’t trickled down to benefit average Americans. There are too many things to point to… but this isn’t about that.
This is about what happens next.
Where is housing headed?
Some of you might believe the recovery will pick up steam and middle-class Americans will come back into the market and that the American Dream is still alive.
It isn’t. It’s a Rental Dream now.
Middle Americans aren’t buying homes in droves again, even though last week the national average for a 30-year fixed mortgage was 4.33%. And for a 15-year mortgage, 3.41%. Or that a Federal Housing Administration-backed 30-year fixed loan would cost you only 4.04% annually.
It worries me a lot that middle-class Americans aren’t buying houses.
I’m feeling déjà vu – and it worries me.
Non-bank mortgage lenders (because the big banks aren’t lending like they used to) are growing their share of mortgage originations and refinancings. And they’re selling the loans they make to FannieandFreddie, as they all did before the crash.
The Federal Housing Finance Agency, which supposedly regulates Fannie and Freddie, just released its Office of Inspector General‘s latest report on non-bank lenders. And the folks there are worried.
They’re worried because in 2012 one of the top 20 sellers of mortgages to Fannie and Freddie, who they knew had previously engaged in “abusive lending practices” was found to have “deficiencies” and insufficient “fraud prevention” practices. Oh, what a surprise. They were cut off from selling their mortgages to F&F by the Federal Housing Finance Agency in 2013.
Probably a lot too late.
The Inspector General is worried that Fannie purchases from non-bank lenders rose to 47% of all purchased mortgages in 2013 from 33% in 2011. For Freddie, the numbers are just as troubling. From 2011 through 2013, the smallest mortgage lenders, those below the top 50 mortgage originators, increased their share in Freddie to 43% of mortgages sold from 24%.
What’s the problem with these smaller non-bank lenders making loans and selling them to the government-sponsored enterprises?
They’re not banks, they aren’t regulated like banks, they don’t have capital like banks, they aren’t going to be around when it comes time for them to repurchase crappy loans they’re making.
It’s déjà vu all over again.
All this is worrying me. As housing goes, so goes America. Remember that.
So what there was some momentary panic over some bank in Portugal yesterday?
So what if contagion fears spilled out across the globe and markets tanked?
It’s all better now. Everything has been cleared up. Really, it was nothing.
How do we know it was nothing? Because the bank’s regulators and the country’s central bank, Banco de Portugal, are telling us so.
It’s all contained, they say.
We got similar assurances from the Federal Reserve and U.S. bank regulators after Bear Stearns collapsed. After Lehman failed, we were assured everything would be contained.
If you are reassured, don’t read on, because I’m going to ruin your day.
Bring in the Clouds
Banco Espirito Santo SA is the largest lender in Portugal. It’s also the second-largest bank in Portugal in terms of its market valuation. Well, maybe not any more.
Whatever Banco Espirito Santo is – or was – it definitely isn’t transparent.
Banks are supposed to be transparent. At least that’s what we expect them to be.
And if we can’t see through them, and of course we can’t, we expect their regulators to have X-ray vision. After all, we count on regulators and central banks (the ultimate regulators) to safeguard us from bad banks.
Then again, some people depend on winning the lottery as their retirement plan.
Banco Espirito Santo is 25% owned by Espirito Santo Financial Group. Espirito Santo Financial Group is 49% owned by Espirito Santo Irmaos SGPS SA. Espirito Santo Irmaos SGPS is wholly owned by Rioforte Investments SA. Rioforte Investments is wholly owned by Espirito Santo International.
That’s transparent, right?
Espirito Santo International, the top dog in the food chain, said on July 8 that it missed payments to some investors holding its short-term commercial paper. Oops.
Panic ensued because Espirito Santo International controls Banco Espirito Santo, and creditors of International could go after assets of Banco Espirito.
That’s the tip of the iceberg.
The collective group of Espirito Santo companies and Rioforte has borrowed a lot of money from Banco, its clients and its depositors.
Retail clients of Banco Espirito Santo were sold 255 million euros of Espirito Santo International’s commercial paper, 342 million euros of Rioforte’s paper, 44 million euros of Rioforte subsidiaries’ paper, and 212 million euros of commercial paper and bonds issued by Espirito Santo Financial Group and its subsidiaries.
Institutional clients of Banco Espirito Santo are holding 511 million euros of Espirito Santo International’s debts and 1.5 billion euros of Rioforte paper.
And there’s the bank itself. Banco Espirito, in the spirit of lending to family, lent Espirito Santo Financial Group and Rioforte more than 1.1 billion euros.
So here’s why there’s nothing to worry about.
Despite Banco Espirito itself having a 517.6 million euro loss in 2013, it says it’s got a 2.8 billion euro cushion. It always says it’s cushioned up. In fact, back in 2011 when panic was sweeping the European banking system and the International Monetary Fund and the European Union rolled out a massive bailout fund, Banco Espirito was the only one of Portugal’s three biggest banks to not take any money on account of its determination to prove to markets it was in fine shape, thank you. Sound familiar?
Despite Banco Espirito having a 6 billion euro-plus book of loans to companies and borrowers in Angola (a former Portuguese colony), of which 84% are now characterized as “bad loans,” it says it’s got a 2.8 billion euro cushion.
Despite what may look like a lack of transparency, which hopefully I’ve cleared up for you, if Banco Espirito’s regulators and the Banco de Portugal say there’s nothing to worry about, and they should know because they obviously didn’t see any of this coming, then there’s nothing to worry about and this is already all contained.
On Tuesday market watchers got to pore over the minutes of the Federal Reserve’s June meeting. The “end of stimulus” shoe is going to drop, but no one knows when.
Shah Gilani talked about that, and other top stories, on Fox Business‘ “Real Halftime Report.” Find out when Shah thinks Janet Yellen will act to sends rates up and pull the market down.
In other news, much-vaunted momentum stocks took a beating. Shah reveals the 3 momentum names he wouldn’t touch with a ten foot pole. Also: learn what people have to say about American companies moving to Ireland to save on taxes.
Fourth of July fireworks came early this year, at least for the markets. The DOW hit its 12th record close of the year.
The S&P hit its 23rd record close. Netflix (NASDAQ: NFLX) saw a record high after Goldman Sachs upgraded the stock from ‘Neutral’ to ‘Buy.’
“Cloud Computing” also headed for the clouds as IT hosting company Rackspace (NYSE: RAX) fueled rumors of “going private.” Are they serious? Or is the Texas-based firm simply preening for potential buyers?
Shah sat in on Fox Business’ “Varney and Co.” on Tuesday to mull over the market’s biggest stories. Shah looks past the headlines and offers a word of caution.
Former Secretary of Labor Robert Reich took to Facebook to wonder aloud, “At what point does conspicuous consumption by the ultra-wealthy invite a revolution?” His comments didn’t go down well in certain quarters.
That was just one of the day’s stories that Shah Gilani pored over on Fox Business’ “Real Halftime Report.” The other topics were less inflammatory.
Such as: What’s behind La-Z-Boy’s (NYSE: LZB) first revenue drop in more than three and a half years? What does Janet Yellen have to offer the markets now that QE3 is unwinding?
And in a more serious note: How high can we expect oil to rise should hostilities escalate in Iraq?
It’s a mixed-up crazy world, especially when it comes to figuring out economics.
Just look at European stock markets. Many of them are making new highs today.
Why is that crazy?
Because stocks making new highs has nothing to do with economics – unless we’re talking about voodoo economics.
Apparently, things in Europe are so bad that the president of the European Central Bank (ECB), Mario Draghi, announced in a press conference today that the ECB was cutting the base lending rate from 0.25% to 0.15% and taking other “stimulative” measures.
That’s why stocks went crazy and made new highs.
Why is that crazy?
Because the ECB is resorting to desperate, never-tried-before measures to stem a Japanese-style deflationary spiral that could sink European economies, tank the euro, and destroy the European Union.
In other words, things are so scary in Europe that the ECB feels it has to take extraordinary measures to prevent another recession – or worse.
And stocks are making new highs on account of how desperate the outlook is?
Sure, it’s voodoo economics. Pump money into the system, and stocks rise. It’s bubble-icious.
It gets worse, though. Read on, and I’ll tell you exactly how crazy all this is …
Who’s Watching the Dam?
Dropping the base lending rate to a historical low isn’t that big of a deal. It’s what else The ECB is going to do that’s really crazy.
Since 2010, the ECB has been bailing out European countries by buying up their distressed government bonds when no one else would. This is when rates were rising to a point where if they were to go much higher some countries would have literally imploded.
However, the ECB insisted, this wasn’t quantitative easing. It was adamant the Europeans weren’t going to be as reckless as the U.S.Federal Reserve and engage in an experiment that could unleash massive inflation.
So that its bond purchasing program would not be viewed as quantitative easing, the ECB engaged in “sterilization.” Sterilization is basically a neutralization program that takes as much money out of the system as the ECB is pumping in when it buys government bonds and pays with cash. Theoretically, that then floats around in the economy.
To take money out, which it put in to buy bonds, the ECB paid interest to banks to park money at the ECB. That made sure that whatever money the bank flooded the system with was then taken out of the system and parked with it.
That’s gone by the wayside now. As of today, the ECB isn’t going to sterilize any more.
In fact, to flood even more money into the system, not only is the ECB not sterilizing by paying banks interest to leave money with them, it is now going to charge banks to park money with ECB!
The big brains at the ECB are now moving its deposit rate to negative 0.1%.
And that’s the “sensible” stuff they are doing.
They are also doing something crazy. The ECB will be taking in asset-backed securities, basically anything that’s asset-backed, including junk and distressed and underwater securities, as long as they are “asset-backed” and lending against that collateral.
Seriously, how desperate are things across the Atlantic?
The Fed did the same thing in 2008 when the financial system was about to melt down. Is Europe there now?
And stocks are making new highs?
And U.S. stocks keep making new highs?
It’s raining money.
As the lyrics of one of my favorite Led Zeppelin songs go, “If it keeps on rainin’, levee’s goin’ to break.”
Get ready. There’s more trouble ahead for home buyers, home builders, and especially homeowners who took out home-equity lines of credit before the housing crisis. Those heydays have turned into haymakers.
What’s already started to happen might not only knock out the formerly aspiring but now petering-out housing recovery, but also might knock the already weak economy to the ground.
Back in the good old days, when banks and mortgage shops were selling mortgage money and home-equity credit lines like carnival barkers wowing crowds into the big top, millions of homeowners steeped right in.
That circus tent was nothing but a trap, however. And now I’m going to tell you what that trap means for those borrowers … and the rest of the economy …
Intoxicated by rising home prices, in the years before 2007 or so, homeowners took out hundreds of billions of dollars in loans against the equity in their homes. What made the deals most enticing were the terms. Most of the so-called HELOCs were 10-year interest-only loans (that sounds nice …) that would “convert” into 15-year amortizing mortgages (uh-oh!).
(Remember when we all seemed to be using our homes as ATMs? What were we thinking?)
Well, those trigger dates have been firing indiscriminately, shooting a lot of homeowners where it hurts the most.
According to today’s Wall Street Journal, some 817,000 homeowners, with $23 billion in loans, will see their interest-only holiday come to a reality-busting end this year. And this is just the beginning. Over the next three years, an average of $50 billion a year in HELOCs will be converting.
What does that look like to homeowners? The Journal cited two examples. A real borrower had his monthly payments on the $70,000 he borrowed rise from $270 a month to $560 a month. Those payments are “adjustable” and could rise dramatically if interest rates rise.
In an another example from the WSJ, a $100,000 loan with an interest-only payment plan and a 3.5% rate subjects the borrower to current monthly payments of $292. Once converted, the monthly payments will jump to $715 on a 15-year amortizing mortgage note. That would rise further to about $865 if interest rates rise 3 points.
The consumer credit reporting agency Equifax and the U.S. Office of the Comptroller of the Currency recently reported that delinquencies on HELOCs made during the heydays doubled last year over the previous year.
Homeowners aren’t going to be able to refinance those HELOCs if they have less equity in their homes when the loans convert than when the loans were made – which is most of them.
Banks aren’t going to be lending generously if and when delinquencies rise. And if home prices stall out here or, heaven forbid, backslide, there’s no way there’s going to be a flood, or even a trickle, of mortgage money available.
The housing market may be facing another wall. That means home builders may not be putting up as many houses as they had hoped. Because housing makes up about 15% to 20% of GDP, a drop in housing starts puts home sales, construction, remodeling, and all the other businesses and consumption trails associated with housing in the line of fire.
That puts the entire economy is in the line of fire. And speaking of fire, the economy’s first-quarter growth – make that negative growth of -1% – is a fire.
That’s why we’re short a bunch of housing-related plays at my Short-Side Fortunes newsletter. We will be patient – our trades aren’t going to pop overnight – but when the roof comes down, our house will be rockin’.
Editor’s Note: To join Shah’s small circle of Short-Side Fortunes readers and learn how to use this trade for yourself, please click here.