In this interview Warren Buffett repeatedly cites the financial crisis as beginning in September of 2008 and gaining momentum in 2009. Framing the great financial crisis in this period ignores the root cause of the great financial crisis. The root cause of the financial crisis was the collapse of the housing bubble. Single family home prices and the mortgages backing home financing began a rapid and fairly constant decline in March of 2006. The significant loss of value in these two major (related) asset classes - single family homes and mortgages - translated, by September 2008, into the broader banking disaster due to the foreclosure crisis and because banks had been trading financial derivatives and interest rate swaps which were based on single family home values and mortgage values.
Any discussion of the great financial crisis should begin with the root cause of the crisis. That is, such discussions should include information about how cheap-and-easy single family home financing arrangements fueled demand for homes, which fueled rapidly escalating home prices, which led to the ill-fated single family home price bubble.
surprised you didn't include the classic example of ‘Directors Disappointing’
provided by the Board of Directors at Countrywide Financial.
Shouldn't that board have been suspicious of, and more reluctant to
approve, Angelo Mozilo's serial changes to his optioned stock liquidation program?
Should that board of directors have been less willing to approve and extend the
significant corporate 'stock buyback' program, contemporaneous to Mozilo's
option sales? And, should that board have recognized it was a buyback program
which gave artificial price support to Mozilo's significant sales of his
optioned stock? Should the board of directors at Countrywide have been more
curious about Countrywide’s mortgage sales (origination) procedures, the risks
of mortgage application falsification, and the non-verification of assets and
income of mortgage applicants? Should the Countrywide Board of Directors have
questioned, and perhaps even requested, the independent audit details for the
quality classifications of Countrywide's mortgage investment portfolio. Should
the Countrywide Board of Directors have wondered why Stanford Kurland, Angelo
Mozilo's heir apparent, abruptly resigned from Countrywide in 2006?
(1) An interesting point, Stanford Kurland is a long time friend (and
confidant?) of BackRock CEO, Laurence Fink.
seems Countrywide board members like Kathleen Brown(2) and Henry
Cisneros(3) should have had the financial sophistication to be more
concerned about what was happening, in general, in the mortgage market, and, in
specific, more concerned about what was happening at Countrywide
that board of directors subscribed to former Citibank CEO, Chuck Prince’s
business theory. You may recall what Chuck Prince said about the mortgage
bubble, ". . . as long as the music is playing, you've
got to get up and dance".(5)
But, I think it’s appropriate to ask, should a board of
directors be dancing, or should it be calling the
1. “Kurland left his job as president and chief operating
officer of Countrywide in September 2006, just as the housing market began its
descent. The previous year, in 2005, he was paid $19.2 million and made an
additional $13.7 million by exercising stock options, according to Reuters. See,
“Former Countrywide No. 2 Sees Opportunities in Troubled Mortgages” By Matthew
Padilla - pub. Orange County Register - June 10, 2008 - at: http://mortgage.ocregister.com/2008/06/10/former-countrywide-no-2-sees-opportunities-in-troubled-mortgages/
In late 2006 the company
developed a model that put a lower, more realistic number on the incomes
subprime borrowers were claiming on their "no doc" loans. The projections were
shocking: BlackRock figured that when the loans reset to their new, higher rates
in a couple of years, most borrowers would be spending more than half their real
incomes on mortgage payments. Foreseeing an avalanche of defaults, BlackRock
dumped subprime bonds in early 2007 when the prices were still lofty.
3. Henry Cisneros was the Director of The Department of
Housing and Urban Development (HUD) during Clinton's first term as president. In
that position he was very instrumental in the implementation of Clinton’s
Affordable Housing Initiative which is credited with ‘putting enforcement teeth”
into Jimmy Carter’s Community Reinvestment Act. see Henry Cisneros, Wikipedia:
When the music stops, in terms of
liquidity, things will be complicated. But as long as the music is playing,
you’ve got to get up and dance. We’re still dancing,”
background: Shortly after being inaugurated into his second term as
U.S. President, Bill Clinton discusses his Affordable Housing Initiative in a
PBS NewsHour interview. “Bill Clinton: Laying the Foundation for The House of
A couple of years ago I was reading Treasury Secretary, Timothy Geithner’s Wikipedia Bio.(1) I was surprised to read that Mr. Geithner served as a Treasury Department Attaché in the U.S. Embassy in Tokyo, Japan during the early years of what has become known as “Japan’s Lost Decade” (A “Lost Decade” which is now approaching its second decade anniversary).(2)
It’s widely recognized that Japan’s “Lost Decade” was a consequence of the deflation of an asset bubble.* Since reading how Geithner was in a unique position to witness the formation and the consequences of a severe asset bubble, and because I believe he has no doubt followed the efforts of the Japanese Government to stimulate its way out of its economic doldrums, I’ve found Mr. Geithner’s policy positions a little strange.
For me, the strangeness of Treasury Secretary Geithner’s policies took on an even more strange dimension this morning.
This morning I was watching a video of a May 11, 2009 New Yorker Summit presentation of a conversation between Nassim Taleb, Robert Shiller(3) and Nick Paumgarten. At about 4.5 minutes into the video Robert Shiller describes how, after being on the New York Federal Reserve Bank’s “Academic Advisory Panel” for 14 years, Timothy Geithner ‘fired’ him (presumably for Shillers presentation to the panel on asset bubbles). Shiller’s ‘firing’ took place shortly after the first meeting of the "Academic Advisory Panel" after Geithner’s appointment as President of the New York Fed.
* As much as most economists agree on anything, most economist’s attribute Japan’s “Lost Decade” to the [changed] wealth effect and loss of confidence which followed the late 80’s early ‘90’s bursting of the Japanese commercial real estate bubble, which had inflated excessively during the early-to-mid 1980’s.
I copied the portion of the longer video in which Professor Shiller describes what he interpreted as being fired by Timothy Geithner. If you are interested, you can see the video clip here:
The complete video of the May 11, 2009 New Yorker Summit discussion between Nassim Taleb, Robert Shiller and Nick Paumgarten can be found here:
(3) Robert Shiller is an economics professor at Yale University. He is the author of a book Irrational Exuberance (published in 2000) which describes the role of excessive confidence in the development of economic bubbles. Professor Shiller expressed concern about the stock market bubble before that bubble burst bubble, and he was one of the earliest, if not the earliest, to warn us of the real estate bubble. He is co-developer of the S&P Case-Shiller Real Estate Price Indeces. [see, http://www.irrationalexuberance.com/definition.htm ]
It would be interesting to know how many of the 'wrongfully' foreclosed borrower 'victims' were in judicial foreclosure states and how many such 'victims' were in states in which the mortgage / trust deed had a power-of-sale clause. And, in each case, it would be interesting to know what number of borrowers were actually in serious default when the foreclosure notice was served, and how many borrowers not in default were served with a notice of foreclosure.
It seems one of the issues which has seriously complicated the foreclosure process arose out of the mis-management of note holder, mortgagee and land title records in the Mortgage Electronic Registration System (MERS). The Mortgage Electronic Registration System was conceived by Fannie Mae, and the development of the Mortgage Electronic Registration System was overseen and financed by Fannie Mae and Freddie Mac.
MERS is apparently seriously flawed. The system has few controls, a peculiar (or non-existent) managerial hierarchy, and MERS doesn't seem to be properly audited (or auditable).
Part of the problem lies in changes in mortgage processing over the past few decades. Fannie and Freddie rolled out automated-underwriting systems in the mid-1990s that allowed lenders to punch borrower data into computer systems in order to receive faster approvals or denials.
The mortgage bust highlighted weaknesses. Fannie and Freddie did few upfront reviews of loans that they purchased; instead, they screened some of those that went bad, forcing banks to buy back any with obvious signs of negligence or fraud.
After the meltdown, the mortgage giants began hiring armies of auditors—called "bounty hunters" by bank executives—to conduct detailed reviews of loan files to spot errors that could justify a put-back.
In addition to the problems mentioned in Institutional Home Buying Bubble (see post below) there are few other reasonable concerns about the programs that facilitate such institutional bulk purchases.
In addition to the operational difficulties, the operational overhead, and the lack of ‘scalability’ in the bulk ownership and the property management of single family homes – which are presumably geographically disbursed - some commenters have mentioned a few other un-intended negative consequences which might flow from federal government sponsored, and large bank sponsored, programs for the bulk sale of Real Estate Owned (REO) and foreclosed single family properties. To read about some of the other (somewhat predictable) unintended negative consequences of the bulk sales of single family homes to institutional owners read the articles named and hyperlinked below.
I commented on an interesting article published September 14, 2012 in the Wall Street Journal, How Greenspan Misread the Risks at Fannie and Freddie. It’s an article based upon an excerpt (written by James Hagerty) from his new book The Fateful History of Fannie Mae: New Deal Birth to Mortgage Crisis Fall By James R. Hagerty.
In December of 2011 the SEC filed lawsuits against several former executives of Fannie Mae and Freddie Mac. One of the allegations in both of the two lawsuits is that former executives of Fannie and Freddie mis-categorized mortgage loans that were being bought by Fannie and Freddie and that they failed to inform investors and Fannie and Freddie’s regulator [The Office of Federal Housing Enterprise Oversight] of the true number (percentage and value) of Sub-Prime and Alt-A loans they purchased.
So, it’s not that shocking that most people who believed what Fannie and Freddie were telling them didn’t know of the significant default risk.
Only people like Michael Burry(2) Laurence Fink(3) John Paulson(4) and perhaps Stanford Kurland(5) who actually studied (or were aware of) the progressively diminishing mortgage qualification standards as the bubble formed, and who studied (or were aware of) the actual mortgage borrower income statistics, were prescient enough to become alarmed about Fannie and Freddie’s exposure to default risk.
Based upon what Fannie and Freddie were claiming as their mortgage loan quality, It should be no surprise that Alan Greenspan, John McCain, George W. Bush, Treasury Secretary, John Snow and the Office of Federal Housing Enterprise Oversight [OFEO] were more concerned about the impact of credit rate risk and accounting fraud at Fannie Mae and Freddie Mac than they seem to have been about default risk.(6)
LESSON 2: When investments get complex, do your homework:
. . . In late 2006 the company developed a model that put a lower, more realistic number on the incomes subprime borrowers were claiming on their "no doc" loans. The projections were shocking: BlackRock figured that when the loans reset to their new, higher rates in a couple of years, most borrowers would be spending more than half their real incomes on mortgage payments. Foreseeing an avalanche of defaults, BlackRock dumped subprime bonds in early 2007 when the prices were still lofty.
A. I was somewhat in a state of retirement. I left Countrywide in 2006 after 27 years. From the sidelines, I was watching the mortgage market meltdown and was in communication with associates of mine over what it was going to take to improve or revitalize the mortgage market. Wall Street firms were reaching out to me on whether I had an interest in participating with them. I got a call from the chairman of BlackRock, Laurence Fink, who asked if I would meet a group of executives who were talking about how to address issues in the mortgage market, and they were working with another company (Highfields Capital Management). I was very receptive to talking to Larry Fink. We had grown up together and have been friends since grade school days.
Q. Where did you and Mr. Fink grow up?
A. We grew up in Van Nuys. That’s the valley.
(6) See, YouTube video-clip, Timeline: George Bush, John McCain Warn Democrats of Housing Crisis, at:
Don't forget the role of the rating agencies in the financial crisis. In the 1975 the U.S. Congress designated the Nationally Recognized Statistical Rating Organizations (NRSRO's). When Congress passed the legislation anointing the NRSRO’s it gave this limited number of organizations oligopoly status and unique competitive advantage. At the same time, Congress appointed the Securities and Exchange Commission as regulator of the NRSRO's.
Most investment advisors and portfolio managers use rating agency guidelines (ratings) to assist their evaluation of the quality and risk associated with the securities they purchase* and fiduciaries are restricted by law as to the minimum rating level from which they can select the investments they can purchase and manage. So, the rating agencies provide a seal of approval, so to speak, for the securities and companies they rate.
* In most cases, the ratings securities an investment advisor, or a portfolio manager will use are defined in a prospectus, offering circular, or by some other form of disclosure.
If you would like to see a CEO of a rating agency squirm, watch and listen to, The Role of The Rating Agencies
In last quarter of 2008, U.S. banks and their lobbyists pushed the U.S. Congress to force the Financial Accounting Standards Board (FASB) to postpone the implementation of mark-to-market accounting (FAS #157).* The FASB eventually acquiesced. So, after the acquiescence, banks and other collateralized mortgage obligation [CMO] investors can continue to carry these investments at origination value, rather than at the investment’s current market value.
But, if a bank or other mortgage investor forecloses, renegotiates the mortgage, or sells the home (the collateral) the new ‘book value’ of the investment is based upon the new selling price (or mortgage value) - as determined by the terms of the new deal (auction, renegotiation, or sale).
By not foreclosing, renegotiating, or formally taking back properties (REO) banks and other mortgage investors can, to some extent, manage what their losses appear to be, and hopefully offset the losses - they recognize - against other revenue, over time.
I find that, when discussing The Shadow Inventory, almost all real estate specialists, lawyers, regulators and many financial analysts can’t tie one very significant cause into the conversation.
The very significant cause that is missed is a rational explanation of why banks and other mortgage investors are so reluctant to liquidate (or renegotiate) bad investments.
Why do they hold significant amounts of mortgage investments which have little hope of being profitable (over the long term)? When a mortgage is in serious default, why don’t mortgage investors accept a ‘short sale’ - and why do they allow a property to go into the potentially higher loss alternative of foreclosure?
I believe the key to understanding why mortgage investors appear to be behaving irrationally, is to understand the implications of the delay in the implementation of Financial Accounting Standard #157 (mark-to-market accounting).(1)
To understand the implications of the delay in the implementation of FAS #157 read an article from the Wall Street Journal titled, Congress Helped Banks Defang Key Rule By Susan Pulliam & Tom McGinty | pub. 6/3/2009.(2)
Then watch Georgetown University Law Professor, Adam Levitin’s Congressional testimony titled, Federal Regulators Don’t Want to Know . . .(3)
The point that I believe most commenters miss:
The postponement of the implementation of mark-to-market accounting (FAS 157) gives banks and other mortgage (product) investors the opportunity to delay recognition of their market losses until legal ownership of the property changes (foreclosure). Thus, for the investor, the hoped for offset of losses against future revenue is 'the gating factor’ for the liquidation of the shadow inventory.
Most mortgage investors are institutions. These institutions want to delay the recognition of, and the reporting reporting of, any losses to their investors - and to their regulators - for as long as possible.
As Professor Levitin explains in his Congressional testimony, these institutional investors hope to offset losses against income (fees and penalty revenue) over the next decade.
So, the shadow inventory seems to be a consequence of the rational ‘work-out’ in a world in which institutions can carry (and report) highly depreciated assets at (fantasy) origination value.
End Note: Even some fairly sophisticated observers can’t put the delay in the implementation of FAS 157 into its proper perspective. Why do mortgage investors prefer foreclosure over a short sale? Watch Congressman Bobby Scott (D-VA) question a panel of mortgage professionals asking, ‘Are there things in accounting principals that we need to change to get everybody to do what’s in everybody's best interests?’at:
Then listen to Thomas Cox, of Main Attorney’s Saving Homes Project, answer Rep. Scott. Mr. Cox emphasizes a different point (the conflict of interest created by servicer fee revenue) in The Short Sale Conundrum - Misaligned Incentives of Mortgage Servicers, at:and when James Kowalski, a Florida Trial Attorney for Saving Home Project, gets his turn he moves to The MERS Mess. Mr. Kawolskiexplains the increase in the shadow inventory as a documentation problem rather than an accounting problem, at: