[Rhodes22-list] Accounting

Thu Oct 2 10:10:34 EDT 2008

Wally,

If all goes well, we should close on our rent house tomorrow
afternoon.  I sold this house in 2002 to a mortgage broker who was
also a real estate agent.  One day before closing she calls me and
says she can't get financing?  Huh?  Her story was she can't get
financing on the extra lot so I volunteer to finance it for her.  No
deal, she wants her earnest money back and I tell her to go pound sand
(what really happened is she found another house).  We get sued for
$30,000 + over a $2000 earnest money deposit and have a hearing set
for freezing our assets for $200,000 for possible punitive damages.
She asserts in her suit that we fraudulently represented the extra lot
as a buildable lot when it wasn't. My attorney convinces me to follow
expediency over principle and we settle the deal with a return of the
earnest money on the courthouse steps.  The rest of the story gets
even more convoluted and repulsive but I filed a complaint with the
whatever TN state department covers mortgage brokers and the TN Real
Estate Commission.  You know where that went - the foxes guarding the
hen house.

And now the good news.  The whole episode pissed me off so badly that
I built a spec home on the extra lot in 2002 just to prove it could be
done and made some money. Now if everything goes OK tomorrow, I'll be
done with the whole thing.  Other than our house and our business
location in Gulfport, I'm done with real estate in this country.

Brad

On Thu, Oct 2, 2008 at 8:54 AM, TN Rhodey <tnrhodey at gmail.com> wrote:
> Brad, I really wasn't arguing just for the sack of argument. I promise. :-)
> I had stayed out of the fray but having actually had work experience that is
> directly involved I had to pipe in. Now keep in mind I do agree that there
> was a bunch of fraud  and defaults in CRA loans.....just drop in the bucket
> compared to the true sub-prime dogs.
>
> The worse of the worse sub-prime Lenders was Ameriquest. Around 2005 hey
> were doing super bowl commercials, they sponsored the Rolling Stones tour,
> and sponsored the Ranger's baseball stratum in Texas. There were rolling big
> time . Even in Knoxville their so called loan originators were making 200K
> plus!!! After a couple of class action lawsuits they were shut down.
>
> Before I understood their methodology I tried to hire some of these guys.
> Unlike a broker First Horizon (First TN) requires credit check, criminal
> background check, fingerprints, and drug test. I gave up after I figured out
> they were successful because they were crooks. They couldn't pass the
> background checks. Interviewing these scammers was a real eye opener. Many
> were quite proud and would brag on the amount of fees and points they tacked
> on a loan. No I never hired on of these guys.
>
> Sub-prime + broker = disaster. Well not always but most of the fraud, high
> pressure tactics, elevated appraisals, and so on were from Brokers. Brokers
> were typically not involved with CRA programs. Now many banks also broker
> loans but in my opinion there was usually a higher level of integrity in the
> bank process. Defaults rates support my conclusions. Of coure there are
> crooked bankers. .....
>
> Note to beome a licensed Mortgage Broker in TN requires no education, no
> testing, and no background check. You send a $100 check to the State.
>
> Brad if you saw what I saw you would know why I was crying chicken little.
> The shit I saw every day scared the hell out of me from a financial risk
> stand point.
>
> Wally
> On Wed, Oct 1, 2008 at 6:28 PM, Brad Haslett <flybrad at gmail.com> wrote:
>
>> Wally,
>>
>> This article from a tax blog just showed-up on the scan and supports
>> some of your points (note to self - Brad, get a life, leave the house,
>> go to the hangar, go sailing).
>>
>> -----------------------------
>>
>> September 30, 2008
>> 7 The Financial Crisis: What Went Wrong?
>>
>> The ongoing turmoil in the financial markets has diverted me from my
>> usual tax academic pursuits, including this blog, for which I
>> apologize. This post explores the causes of that turmoil. My next post
>> will explore solutions currently under consideration, including
>> aspects of the so-called "$700 billion bailout."
>>
>> The current financial crisis has many causes, some long-term and
>> structural. I focus here, however, on three immediate aspects of the
>> crisis: the trigger, how problems generated by that trigger spread
>> through the markets, and how this produced the liquidity freeze that
>> persuaded Mr. Paulson and Mr. Bush to act (unsuccessfully thus far).
>>
>> The Trigger: Teaser-Rate Mortgages
>>
>> The media talks about "sub prime mortgages" – by which it means
>> mortgage loans to borrowers with less than stellar credit. The real
>> problem, however, was the advent and widespread use of teaser-rate
>> mortgages in both the prime and sub prime markets. A teaser-rate
>> mortgage allows a borrower to make relatively small payments for
>> several years. At some point, the rate jumps dramatically, and the
>> borrower faces much higher monthly payment obligations.
>>
>> Not surprisingly, borrowers loved this innovation. Teaser-rate loans
>> allowed folks who otherwise could never have afforded to own a home to
>> buy one, at least until the rate reset. But it wasn't just sub prime
>> borrowers who liked teasers. Teasers sold like hotcakes; loan
>> originators made correspondingly fabulous profits.
>>
>> (Some have tried to blame teaser-rates on the Community Reinvestment
>> Act of 1977, which encouraged lending to minorities and lower income
>> Americans. But that act only applied to commercial banks. A majority
>> of this crisis's teaser-rate loans were made by unregulated
>> originators not subject to the act. More fundamentally, there is no
>> evidence the present crisis started in 1977. Teaser-rate mortgages
>> first became widespread after Mr. Bush took office in 2001.)
>>
>> In any event, it's not hard to predict what happens when rates reset.
>> All of a sudden, buyers who have been paying $1,000 per month face
>> monthly payments of $4,000. Many, perhaps most, go into default.
>>
>> The possibility that this would become a major problem became apparent
>> as early as 2005. (I actually wrote that fall predicting the current
>> crash.) Mortgage economists began publishing reset schedules –
>> schedules of how many billions or trillions of dollars of mortgages
>> would reset and when. In effect, those tables offered a rough schedule
>> of how many mortgages would go into default and when.
>>
>> As defaults increased in number, lenders ended up holding large
>> amounts of foreclosed property. When they tried to convert the
>> property into cash, they put downward pressure on housing prices. And
>> this, in turn, made financing and refinancing more difficult and
>> further defaults more likely – even of non-teaser loans. (A perfect
>> vicious cycle, and we're not remotely near the end of it. In parts of
>> the country, more half the homes offered for sale are now
>> foreclosures. Banks are desperate to get those homes off their balance
>> sheets and are dumping them much faster than the market can absorb
>> them.)
>>
>> The Spread: Securitization and Debt Chains
>>
>> But why did Lehman Brothers and AIG go under? After all, they don't
>> make mortgage loans. I turn next to how the problem spread.
>>
>> Assume that A borrows from B to buy a home, giving a mortgage on the
>> home to secure her debt. B then borrows from C, using A's mortgage as
>> security. C in turn borrows from D, using B's obligation as security.
>> And so on.
>>
>> Now assume that A's mortgage goes bad. What happens to B, C, and D?
>> Answer: all the loans up the chain go bad as well.
>>
>> And this isn't all. If the loan is secured (as mortgages and many
>> other links in debt chains are), the lender is typically less
>> interested in the creditworthiness of the borrower. The lender relies
>> primarily on the collateral, not the borrower, for assurance of
>> repayment.
>>
>> As a result, each financial intermediary can be thinly capitalized. So
>> a company with $10.1 billion in assets and $10 billion in debt may
>> have a small amount of net equity. Indeed, the more thinly capitalized
>> a company, the higher the return it can make on its capital.
>>
>> Unfortunately, what this means is that when A's mortgage goes bad,
>> it's not just the loans up the chain that go bad – financial
>> intermediaries in the chain often go bust as well. A thinly
>> capitalized intermediary cannot absorb many losses. And that is why
>> teaser-rate mortgage defaults triggered and are still triggering
>> defaults and failures across the entire financial sector. Almost
>> everyone was in the debt-chain business and extended themselves to the
>> max to take advantage of the extraordinary profit opportunities of
>> that business.
>>
>> I've explained the transmission mechanism in terms of debt because
>> readers have an intuitive understanding of how debt works. In fact,
>> however, many of the most important links in the chain were not
>> technically "debt." Some were shares in "mortgage pools"; some,
>> "derivatives"; some, "credit default swaps." What they all had in
>> common was that each transferred some risk of default up the chain to
>> someone else. Wall Street sometimes calls links in such debt chains
>> "toxic waste," because today no one wants them.
>>
>> AIG, for example, held about $500 billion in "notional exposure" on
>> credit default swaps. In English, it was at risk to the tune of about
>> $500 billion if mortgages down the chain went bad. When mortgages
>> began to go bad in large numbers, the market realized that AIG might
>> not be able to cover its obligations and began to sell AIG stock
>> seriously short. Lenders stopped lending. End of story.
>>
>> What made this more than just a corporate problem was that AIG was a
>> domino at the head of many long chains of dominoes. If AIG had gone,
>> some believed the world would have faced immediate economic collapse.
>> So the US government bought an 80% stake in AIG in exchange for enough
>> money to allow AIG to dissolve gracefully – over a couple of years –
>> instead of imploding overnight.
>>
>> The Crisis: Liquidity Freeze
>>
>> None of this, however, would by itself have led a free-market US
>> administration to propose a $700 billion general "bail-out." Real
>> estate is important, yes, but there are many parts of the economy not
>> dependent on the market for home mortgages. What happened?
>>
>> In ordinary times, most businesses borrow on a short term basis to
>> fund payroll, inventory, and other operating needs. There are two
>> principal sources of short-term money: banks and money-market funds.
>> In the past several weeks, each of these has substantially reduced the
>> amounts they are willing to lend. This is what's called a liquidity or
>> credit freeze.
>>
>> Why did banks and money-market funds stop lending?
>>
>> Let's start with money-market funds. Investors put money into
>> money-market funds when they want absolute safety and the ability to
>> pull their money out at will. Put in a dollar, get out a dollar,
>> whenever you want. In return, they accept a very low return. What
>> happened was that The Reserve, the oldest and most highly regarded
>> money-market fund sponsor, "broke a buck" – which means it paid back
>> only 97 cents for every dollar investors put in.
>>
>> The reason was simple: The Reserve had loaned short-term money to
>> Lehman Brothers, a major participant in the debt chain business.
>> Lehman Brothers went belly up, and The Reserve's short-term loans to
>> Lehman became uncollectible. (Remember that the Treasury and the
>> Federal Reserve Bank, having bailed out Bear Stearns, decided to let
>> Lehman Brothers go bankrupt to teach the market a lesson. In
>> retrospect, this was probably a mistake.)
>>
>> As a result, investor confidence in money-market funds plummeted.
>> Fortunately or unfortunately, investors always have a secure place to
>> park money, Treasury bills – short term obligations issued by the U.S.
>> government. When The Reserve broke a buck, everyone moved their money
>> into Treasuries. Money-market funds dried up. And that was the end of
>> one major source of business working capital.
>>
>> Another major source is the banking system. Unfortunately, banks and
>> other financial intermediaries became reluctant to loan to each other.
>> As a result, money in one part of the banking system stopped flowing
>> to where it was most needed.
>>
>> Why did banks stop loaning money to each other? When lenders lend,
>> they generally look at borrowers' financial sheets to determine how
>> creditworthy they are before giving out money. Unfortunately, most
>> banks and other financial intermediaries have large amounts of toxic
>> waste on their books.
>>
>> In situations like this, accounting rules require companies to "mark
>> assets to market." If an asset with a face value of $100 appears to
>> have a market value of $40, the company is supposed to record a loss
>> of $60 immediately, even before the asset is sold, and to carry that
>> asset on its books at a value of $40. So banks and other financial
>> intermediaries began reporting enormous losses on the toxic waste they
>> held, and their balance sheets crumbled. (The head of the Securities
>> and Exchange Commission was pressured to waive this rule, but refused.
>> It was for this reason that Sen. John McCain demanded that he be
>> fired.)
>>
>> But recognizing market losses isn't the most serious problem. If a
>> lender can be confident that the asset in question really has a value
>> of $40, it may still conclude that the prospective borrower is likely
>> to repay the loan – notwithstanding the reported loss. If no one knows
>> how much the toxic waste is actually worth, however, lenders can't
>> assess the creditworthiness of any prospective borrower with
>> significant amounts of toxic waste on its books. Almost all banks hold
>> toxic waste. So banks stopped lending to other banks. (Waiving the
>> mark-to-market rule would not have solved this problem; it would
>> simply have hidden the accrued losses. Banks are sophisticated enough
>> to worry when accounting rules do not correctly reflect what's going
>> on in the market.)
>>
>> But why is the unavailability of short-term money so bad?
>>
>> Remember what businesses use short-term money for – to meet payroll
>> and put inventory on their shelves. When businesses lose access to
>> working capital, they stop operating, not because there is anything
>> fundamentally wrong with their products or markets or business plans,
>> but simply because they can't get the cash they need on a daily basis.
>>
>> You might think of short-term money as the lubricant that keeps the
>> world's economic engine turning over smoothly. If there's no
>> lubricant, the engine freezes. No paydays, no goods on the shelves.
>> Seriously.
>>
>> This was the possibility that persuaded Mr. Bush and Mr. Paulson to
>> change course and support a general "bail-out." And it remains a very
>> real possibility.
>>
>> The $700 Billion Bailout
>>
>> I will discuss the details of possible solutions in my next post.
>>
>> What is important to emphasize here is that current proposals are
>> primarily intended to solve the liquidity freeze part of the problem –
>> to prevent the world's economic engine from seizing up.
>>
>> Mr. Paulson's original proposal hoped to accomplish this in two ways.
>> First, by buying up toxic waste at fair market value, Mr. Paulson
>> could take toxic waste off financial intermediaries' balance sheets.
>> This would allow lenders to assess borrowers' creditworthiness with
>> greater confidence and, hopefully, get banks to start lending to each
>> other again.
>>
>> Equally importantly, however, Mr. Paulson requested authority to buy
>> up that waste at whatever price he thought best. By buying toxic waste
>> at higher prices than private buyers were willing to pay, he hoped to
>> bolster the financial intermediaries' balance sheets – to make them
>> more creditworthy.
>>
>> This aspect of the proposal was what made it a "bail-out." And this
>> was part of what led to its defeat in the House.
>>
>> Note that Mr. Paulson's proposal was not intended to solve the
>> teaser-rate mortgage problem, either now or in the future. In the
>> transactions that created the teaser-rate mortgages in the first
>> place, both parties made bad decisions – the lender and the borrower.
>> Mr. Paulson's proposal was not intended to help either. One of its
>> unavoidable side effects, however, was to relieve lenders of the
>> consequences of their bad decisions, while leaving borrowers to suffer
>> the consequences of theirs. This made it politically less palatable.
>>
>> In addition, at least $500 billion more of teaser-rate mortgages are
>> scheduled to reset over the next several years. In all likelihood,
>> they too will go into default and become toxic waste. Nothing in Mr.
>> Paulson's original proposal was intended to do anything about this
>> next $500 billion installment – or, indeed, to prevent lenders from
>> making more teaser-rate mortgages in the future.
>>
>> Similarly, Mr. Paulson's proposal was not intended as a general Wall
>> Street bail-out, although to some extent it would have had that
>> effect. Note that the outstanding overhang of credit default swaps
>> alone is estimated to be between $45 and $60 trillion – three to four
>> times the size of our annual gross domestic product. The requested
>> $700 billion, although the single biggest appropriation request in
>> U.S. history, was miniscule when compared with the toxic waste problem
>> as a whole. Mr. Paulson's proposed solution was to cost just 1% of the
>> size of the problem and was aimed only at a small part of that
>> problem. (It is unnerving to realize that the U.S. government – the
>> "beast" we have been starving for so long – may now lack the borrowing
>> capacity to solve the problem as a whole. We need to get our financial
>> house in order.)
>>
>> All Mr. Paulson's proposal aimed to do was to put lubricant back into
>> the engine, to get short-term money flowing again to prevent our
>> economic engine from freezing up. Now that the proposal has gone down
>> to defeat, we can only hope that Mr. Paulson was wrong.
>>
>>
>> On Wed, Oct 1, 2008 at 8:10 AM, TN Rhodey <tnrhodey at gmail.com> wrote:
>>  > "A sharp CPA could design a believable computer
>> > model that could make the value come out wherever his boss wanted it
>> > to be. He could also convince outside auditors and regulators of the
>> > soundness of his model. "
>> >
>> > Brad, I am with you but wondering how they determine new (long term)
>> value
>> > for this big pile of crap?  One thing the article mentions that often
>> gets
>> > lost. Most people are paying their mortgages. The properties that are
>> > bundled in these securities are not worthless. At some point they all
>> will
>> > be worth something to somebody.... but when?
>> >
>> > Are there computer models that accountants trust? Not poking a stick I
>> have
>> > no idea. I can see how it would ease credit. I also see how it led to
>> past
>> > problems.
>> >
>> >  I thought we were rushing into the bail out. I am all for any plain that
>> > reduces government intervention.
>> >
>> > Wally
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