He Who Pays The Piper Calls the Tune

A reminder that, in real life: “He who pays the piper calls the tune”.

The mandatory implementation of fully-negotiated brokerage commissions [May Day 1975] and shortly thereafter, The U.S. Congressional approval of Section 28(e)* created an environment in which institutional ‘order flow’ became a vastly more important component in the profitability of full-service brokerage firms. [‘order flow’ = code words for undisclosed institutional soft dollar commissions]

Given the implications of fully-negotiated (retail client) commissions and 37 years of serial interpretations and uneven enforcement of Section 28(e), should anyone expect the brokerage industry to look any different than it does today?

* Section 28(e) of the Securities Exchange Act of 1934 [Also, go to linked letter requesting substantial revision or repeal of section 28(e). The letter is from past SEC Chairman Christopher Cox to former Chairman of the Senate Banking Committee, Senator Christopher Dodd, a similar letter was sent to then Chairman of the House Financial Services Committee, Barney Frank > http://www.scribd.com/doc/13752510/Cox-Requests-Legislative-Action 

Links to two related New York Times newspaper articles of interest follow:

Editorial

Not All Investors Are Equal

Published: July 17, 2012

* http://www.nytimes.com/2012/07/18/opinion/not-all-investors-are-equal.html?_r=1&nl=todaysheadlines&emc=edit_th_20120719

 

Surveys Give Big Investors an Early View From Analysts

By GRETCHEN MORGENSON
Published: July 15, 2012
* http://www.nytimes.com/2012/07/16/business/in-surveys-hedge-funds-see-early-views-of-stock-analysts.html

 

· Fair Disclosure, Regulation FD - SEC

http://www.sec.gov/answers/regfd.htm - 5k - similar pages

Aug 30, 2004 ... On August 15, 2000, the SEC adopted Regulation FD to address the selective disclosure of information by publicly traded companies and other ...

Private Equity on a Buying Binge with Other People's Money (OPM)

Bloomberg News

 

Private Equity Has Too Much Money to Spend on Homes *

By John Gittelsohn on June 13, 2012

 

From the article:


“You’ve got Warren Buffett saying he’d buy 200,000 homes if he could find the operational ability to do so,” Warren said. “The reverse of the conversation is, where the hell do you think you’re getting 200,000 properties?”

 

Gathering investment money in an artificially low interest rate environment doesn’t seem to be a major challenge. The challenge may be getting a decent rate of return after management fees, the costs of acquisition, rehabilitation, and management of the properties (I believe this is the operational ability to which Mr. Buffett is referring.

 It seems to me that traditional real estate management firms may have a better undertanding of the challenges of maintaining and managing a large number of widely dispersed single family residential rental properties.

I had to chuckle when I read, "Nobody’s ever done this on a scale before,” Michael Burns, chief executive officer of the Alaska Permanent Fund, which had $41.5 billion under management at the end of the first quarter, said in a telephone interview from Juneau, Alaska.“These people’s background is in public storage, which is about as close as we could find.”

Jingle Mail

Michael Burry, M.D. was one of the earliest investment fund managers to recognize the problems in the housing and mortgage market. Dr. Burry’s story is very well told in a chapter of the book The Big Short By Michael Lewis, and also in an article which was published in Vanity Fair Magazine titled Betting on the Blind Side, also written by Michael Lewis1 . This morning I was doing some searching and reading on the mortgage market and some of the key-players in the market. In that activity, I came upon a link to Dr. Burry’s published Scion Capital Investment Newsletters. As I was browsing through the letters, I discovered this very interesting comment (prediction) from Dr. Burry’s Second Quarter of 2003 Letter to Investors2. I thought you might like to see this comment from the Scion 2Q 2003 Letter to Investors:
When home prices begin to fall, a natural level of weak support may develop around a loan-to-value ratio of one. That is, when equity in a home approaches zero, the homeowner ought to become reluctant to sell. History suggests any such strategy should prove foolhardy. Trends in housing tend to be long and headstrong, and hence not easily resisted…The development of significantly negative home equity among the same homeowners that also comprise the world’s most voracious consumers would likely trigger several economic problems…banks would become reluctant to lend to home buyers. The effect would be to contract the credit available to would-be homeowners and therefore severely undercut the main late-cycle driver of demand…These problems would compound the worsening domestic employment situation, further reducing demand for residential housing and thereby producing the requisite positive feedback loop that historically has allowed burgeoning asset deflation to accelerate. As the real estate deflation wears on, it would not be unreasonable to expect that unemployment-induced income shocks mix in toxic fashion with the comparatively high mobility tolerance of the United States citizenry, motivating homeowners to start sending their keys to the bank in ever-increasing numbers. Many banks taking possession of increasing amounts of real estate will ultimately fail themselves. A catharsis could then take shape, and home prices would leg down yet again. After much pain both despair and disgust will settle in, and a bottom would begin to form.

-Scion 2Q 2003 Letter to Investors
Footnotes:
1. Betting on the Blind Side By Michael Lewis – published in Vanity Fare Magazine | April 2010 at> http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004

2. Scion Capital 2Q Letter to Investors at> http://www.scioncapital.com/PDFs/Scion%202008%201Q.pdf

A Mortgage Tornado Warning, Unheeded

BUSINESS DAY | February 05, 2012
A Mortgage Tornado Warning, Unheeded
By GRETCHEN MORGENSON
Inspired by a personal experience, a businessman began delving into the practices of the mortgage industry, including Fannie Mae. His findings have been prescient.
Ms. Morgenson:

Regarding MERS, a few months ago I read that MERS was actually conceived by Fannie Mae and the concept was described in a presentation given at a Mortgage Bankers Association convention in 1993 or 1994. The article claimed Fannie got positive feedback on the MERS concept from the mortgage bankers. The article claimed that Fannie Mae and Freddie Mac then funded the development of MERS with contributions of 2 million dollars each. After MERS was 'brought live' Fannie and Freddie invited large mortgage industry members to join MERS on a subscription basis.

I've searched again for the article(s) recently, but I haven't been able to find the articles that described the actual creation of MERS. Perhaps the articles have been "scrubbed".

What I read seems to confirm the leadership role that Fannie and Freddie had, and the ways these two GSE's influenced and led the industry, and how they shaped practices in the industry. You might find the two articles referenced below interesting:

Is FM Watch a Crusader With an Agenda? By Louis Sichelman – RealtyTimes, pub. 7/5/1999 at: http://realtytimes.com/rtpages/19990705_fmwatch.htm

New Alliance Confronts FM Watch, Champions Existing Housing Finance System By Broderick Perkins RealtyTimes, pub. 10/5/2000>  http://realtytimes.com/rtpages/20001005_fmwatch.htm

So, Who's a Lobbyist?

New York Times –Opinion | Editorial - pub. January 26, 2012

 So, Who’s a Lobbyist? *

Three step test for a duck: (1) If it walks like a duck (2) Looks like a duck (3) And, quacks like a duck.

It is, more than likely, a duck.

Inside the D. C. Beltway definition and semantics are tortured to death by people who strive to gain (or, strive not to lose) by blurring the lines of the meaning of what is . . . .

Do you remember: "I did not have sexual relations with that woman" William Jefferson Clinton – 1998
An aside: I discovered the nature of lobbying, twisted definitions, and semantic reclassification while studying the history of Section 28(e) of the Securities Exchange Act of 1934 (as amended in 1975). The amendment originally described the allowable uses of investment advisors’ clients’ ‘brokerage commissions paid-up above the fully-negotiated costs of brokerage transaction execution’ (soft dollars). When passed, this amendment never mentioned any difference in the treatment institutional agency brokerage commissions arrangements, as compared to institutional full-service bundled undisclosed brokerage commission arrangements.

The Means of Production

On the subject of capital investment, and the taxation of capital gains, it seems to me that almost all of the media has missed an important point, and several lesser points that flow from that central point.

The Central Point: 

Capital investment pays for (or finances) what Karl Marx called “the means of production”.

  

Other Points:

In a free capitalistic market individual investors decide where they want to invest their money, how much risk to take with their money, and whether they are going to invest in, for instance, the manufacture of cell phones or the activities of grocery stores. Or, they can decide if they want to invest in solar panel manufacturers (like, Solendra?).

If individual investors are not incented to invest their capital in “the means of production” it seems the alternative is for government to use taxpayer funds for investment and use some form of ‘central planning’ to decide in which enterprises the taxpayers taxes will be invested.

It’s been pointed out by several in the media that capital investment actually produces taxable revenue when the enterprise must pay a tax on revenue. And, it’s been mentioned that the investor then pays another tax (the capital gains tax) - if the investor is fortunate, or smart, enough to make a capital gain.

However, I’ve not seen any media (or reporters) mention that there is usually another source of taxable revenue which flows from capital investment. Capital investment generally contributes to job creation. Most of the people who are employed in the investors’ enterprise will have an income – some of which is taxed. And another point, which also seems subtle to the press, the part of those workers’ income which is not taxed can be used by the workers to consume, save, or invest. These worker activities (consumption, saving and investing) all add value to the economy, and they produce jobs and more (downstream) revenues which are taxed.

I believe myriad individuals participating in a relatively free market, and making judgments about products to be offered while making judgments about demand levels for those products, and evaluating risk-and-reward payoffs, is a far more efficient, objective, and practical way to finance ‘the means of production’ than any central planning scheme.

 

Mortgage Servicing, Foreclosure Practices and MERS

During a December 15, 2010 U.S. House of Representatives Judiciary Committee hearing witnesses gave testimony on issues relating to "Mortgage Servicing and Foreclosure Practices".1

A critical focus of the testimony and discussion was apparent problems with the recordation of land title and note ownership. Witnesses claimed that the Mortgage Electronic Registration System (MERS)2 has failed to reliably record changes in title and note ownership (chain-of-title). The accompanying video-clip is a segment from the C-SPAN video of the hearing:

If you are not familiar with MERS do a key-word-search for more information.

Footnotes:

1. see, C-SPAN Video Library, Mortgage Servicing and Foreclosure Practices House of Representatives Judiciary Committee December 15, 2010 at: http://www.c-spanvideo.org/program/297095-1

2. see, Washington Post - October 8, 2010 article titled, Reston Based Company MERS in Middle of Foreclosure Chaos By Brady Dennis and Ariana Eunjun Cha at: http://www.washingtonpost.com/wp-dyn/content/article/2010/10/07/AR2010100702742.html

 

 

Ron Paul's Chrystal Ball

Government Mortgage Schemes Distort the Housing Market

Congressman Ron Paul U.S. House of Representatives July 16, 2002*

Mr. Speaker, I rise to introduce the Free Housing Market Enhancement Act. This legislation restores a free market in housing by repealing special privileges for housing-related government sponsored enterprises (GSEs). These entities are the Federal National Mortgage Association (Fannie), the Federal Home Loan Mortgage Corporation (Freddie), and the National Home Loan Bank Board (HLBB). According to the Congressional Budget Office, the housing-related GSEs received $13.6 billion worth of indirect federal subsidies in fiscal year 2000 alone.

One of the major government privileges granted these GSEs is a line of credit to the United States Treasury. According to some estimates, the line of credit may be worth over $2 billion. This explicit promise by the Treasury to bail out these GSEs in times of economic difficulty helps them attract investors who are willing to settle for lower yields than they would demand in the absence of the subsidy. Thus, the line of credit distorts the allocation of capital. More importantly, the line of credit is a promise on behalf of the government to engage in a massive unconstitutional and immoral income transfer from working Americans to holders of GSE debt.

The Free Housing Market Enhancement Act also repeals the explicit grant of legal authority given to the Federal Reserve to purchase the debt of housing-related GSEs. GSEs are the only institutions besides the United States Treasury granted explicit statutory authority to monetize their debt through the Federal Reserve. This provision gives the GSEs a source of liquidity unavailable to their competitors.

Ironically, by transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges of Fannie, Freddie, and HLBB have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans.

However, despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government’s policies of diverting capital to other uses creates a short-term boom in housing. Like all artificially-created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged over-investment in housing.

Perhaps the Federal Reserve can stave off the day of reckoning by purchasing GSE debt and pumping liquidity into the housing market, but this cannot hold off the inevitable drop in the housing market forever. In fact, postponing the necessary but painful market corrections will only deepen the inevitable fall. The more people invested in the market, the greater the effects across the economy when the bubble bursts.

No less an authority than Federal Reserve Chairman Alan Greenspan has expressed concern that government subsidies provided to the GSEs make investors underestimate the risk of investing in Fannie Mae and Freddie Mac.

Mr. Speaker, it is time for Congress to act to remove taxpayer support from the housing GSEs before the bubble bursts and taxpayers are once again forced to bail out investors misled by foolish government interference in the market. I therefore hope my colleagues will stand up for American taxpayers and investors by cosponsoring the Free Housing Market Enhancement Act.

See transcript at: http://paul.house.gov/index.php?option=com_content&task=view&id=323&Itemid=60

Misaligned Incentives and The Shadow Inventory

During a December 15, 2010 House of Representatives Judiciary Committee Hearing, Representative Bobby Scott [D. VA] asked those testifying if there was anything in "accounting standards" that was causing the mortgage industry not to accept ‘short sale offers’ and to seemingly prefer going to foreclosure. No testifier apparently knew of the impact the delay in the implementation of mark-to-market accounting [FAS #157] has on loss recognition accounting; but Thomas Cox (an Attorney in Maine) explained another reason for the apparent rejection of 'short sale' offers.
You might want to review another article and video posted here, to see the context and the actual question asked by Representative Scott, see “Zombie Accounting and The Shadow Inventory” at:  http://billsplace.posterous.com/zombie-accounting-and-the-shadow-inventory

Zombie Accounting and The Shadow Inventory

I recently watched a U.S. House of Representatives Judiciary Committee Hearing on C-SPAN. The hearing, which was held on December 15, 2010, was titled “Mortgage Services and Foreclosure Practices”.1 The testimony and the questions and answers in the hearing provided a significant amount of interesting information about the processes, and the legal and practical issues surrounding the mortgage servicing industry, and the Mortgage Electronic Registration System (MERS).

Because I followed the history of Congress’s involvement in pressuring the Financial Accounting Standards Board (FASB) to delay the implementation of FAS #157 in early 2009.2 I found a question, which was asked by Congressman Bobby Scott (D. VA) troubling.

At approximately 1 hour 36 minutes into the hearing Congressman Scott asked, in essence, if there was anything in “accounting standards” that might provide incentives for mortgage investors and mortgage servicers not to agree to short sales and to prefer alternatives that might be less advantageous for all parties.

I was surprised by the question because of Congress’ significant role in pressuring the FASB for a delay in FAS #157 and I was also bit surprised that none of the witnesses could directly answer the question - from an accounting standards perspective. In general, the witnesses only discussed the mis-alignment of incentives, where mortgage pooling and servicing agreements provide ongoing revenue for servicers when a short sale is not agreed to and a foreclosure is delayed.3

Footnotes: 
1. The December 15, 2010 House Judiciary Committee “Mortgage Services and Foreclosure Practices” hearing may be seen at:  http://www.c-spanvideo.org/program/297095-1
2. See a Wall Street Journal article titled, Congress Helped Banks Defang Key Rule By Susan Pulliam and Tom McGinty pub. 6/3/2009 at: http://online.wsj.com/article/SB124396078596677535.html Also see, For Your Reading Pleasure By Jack Ciesielski pub. in the Analyst’s Accounting Observer 2/25/2010 at: http://www.accountingobserver.com/PublicBlog/tabid/54/EntryId/12583/For-Your-Reading-Pleasure.aspx
3. Under the typical mortgage securitization “Pooling and Servicing Agreements” mortgage investors agree to pay mortgage servicers fees for arranging: home inspections, arranging broker ‘opinion of value’, preparing and filing documents, general documentation, notifications, forced insurance fees, and etc.