By Carolyn Betts
I am an attorney who was working in Washington with RTC during the S&L crisis, so I know something about “toxic asset” sales. I have been poking around the legal and contracting market to find out what work there is out there in reviewing, collecting data on and valuing the billions and billions (trillions?) of dollars of “toxic assets,” including the mortgage backed securities, CDOs and other derivatives created and backed by mortgages that are now “toxic.” I have several observations after reading media accounts of the Geithner plan for so-called public-private partnerships to purchase these vaguely described “toxic assets.”
POINT #1: We need to be defining exactly what these “toxic assets” are. One size does not fit all in this regard. It makes a difference whether we are talking about single family residential mortgages that are somewhere in the procedural process of being past due, in foreclosure or REO (i.e., real estate owned by the lender following foreclosure), which can be valued fairly readily, or, at the other end of the spectrum, derivatives based on derivatives that are subject to pooling and servicing agreements that put strict limitations on what work-outs can take place to resolve the “toxicity.”
POINT #2: If non-performing assets are to be sold to private investors, those private investors will only pay the best possible price if they have access to reliable data upon which to base their bids. I talked to a senior partner in a DC-based law firm who knows everything there is to know about what goes on in Washington having to do with mortgages. He said he is unaware of any significant efforts to hire government contractors to undertake the type of loan due diligence, review, data collection and valuation that would have to be done to conduct sales of the “TARP” assets that have been talked about since the fall of last year and earlier.
I talked to a national legal temp firm and asked whether there was any work available in toxic asset review. The recruiter said that her firm had expected to see a lot of that type of work coming down the pike, but there is nothing of that type out there so far. By all accounts, government regulators like FDIC and SEC are short of funds, and FDIC is hiring a lot of bank examiners. If you go on USAJobs and look for job openings with FDIC and the Commodity Futures Trading Commission, there are few or no openings for experts in valuing or otherwise dealing with non-performing loans.
We have been talking about the bursting of the housing bubble for over a year now, and there seems to be no one taking any initiative in categorizing, stress-testing, quantifying, defining, analyzing, valuing or otherwise collecting information to define the problem. And if any of this is going on secretly and behind closed doors in Washington, then shame on them. Real estate is all local. And if we don’t know what the problem is, any proposed solution will fail.
POINT #3: The New York Times article describing the new Geithner plan says that it is similar to what was done by RTC during the S&L crisis. Well, the Geithner “TOPS” plan not similar to anything I saw at RTC. RTC hired interdisciplinary teams of qualified major accounting, legal, investment banking and other financial advisory professionals to analyze and document all relevant information that an investor would need to value its multi-billion-dollar portfolio of non-performing commercial loans.
We knew what documentation existed and did not exist and what was the status of contractual cash flows, lien positions, bankruptcy cases, underwriting defects and local developmental approvals for the projects and often had pictures of them. We organized “war rooms” where investors could come to look at the loan and other legal documents and we performed various valuation-related calculations and provided them on a disk for a small fee to interested bidders. We interviewed potential wholesale and retail buyers to find out what kinds of sale terms would attract their interest. We provided seller (i.e., government) financing as an alternative to the cash price, with self-executing terms and government sharing in the up-side, so that there was as little future work on the part of the government as possible and the government would not be fleeced. There were very limited government representations and warranties and “put-back” rights and no government guarantees.
What was the result? The first few sales yielded fairly low prices, and the winning bidders made a killing. When others in the financial markets saw that, they bid up the prices in future sales and the government generally got respectable or even amazingly high returns for future sales. Gradually, local investors who knew of the specific projects came out of the woodwork and made informal work-out deals with owners of the projects, which allowed them to bid higher than the New York capital market investors like Goldman Sachs and GE Capital. We facilitated the formation of bidding groups comprised of smaller bidders interested in dividing up loan pools among themselves to bid against capital market bidders. This was the best outcome for the local communities, of course. Very few bidders took advantage of the seller financing, because they found private money cheaper and didn’t want to share the up-side with the government.
What Tim Geithner has proposed has virtually nothing in common with the transactions I worked on with RTC, although I admit that single family mortgage solutions are not the same as those for commercial mortgages. But we have as a model for non-performing single family mortgage sales the work of Hamilton Securities, together with Merrill Lynch, Ernst & Young Kenneth Leventhal, C & S First Boston and Cushman & Wakefield, as financial advisors to the Federal Housing Administration in the auctions of single family non-performing mortgage loans sold from FHA’s portfolio in the mid-90s. Those sales were similar to the RTC sales before, but employed more sophisticated relational databases and other digital tools as well as state-of-the-art optimization software for evaluating bids. In those sales, FHA increased its recovery rates from about $.35 on the dollar to $.70 – $.90 on the dollar, saving several billions of dollars for taxpayers. That was when a billion dollars was a lot of money. In none of these sales did the government provide guarantees, seller financing or puts or allow bidders to be in a heads-I-win-tails-you-lose position as appears to be the plan for the toxic assets in the twenty-first century housing bubble.
POINT #4: There needs to be a plan to figure out how to deal with some problems going forward. I see no sign of new government regulations that would prevent more of the same, including credit default swaps in the trillions of dollars.
- No Congressional or regulatory action is in the works, to my knowledge, to exercise regulatory authority over these “financial weapons of mass destruction.”
- For all we know, more credit default swaps are being issued as we speak to bet on future financial institution collapses.
- The Financial Accounting Standards Board is talking about loosening the mark-to-market rules that require banks to disclose to regulators and stockholders the actual current value of their assets, with no hue and cry from the SEC (which has the power of regulation over financial statement standards for public companies).
- Hedge fund investments are still unregulated by the SEC.
- The Chairman of the SEC says the agency doesn’t have enough money to do its job, including the conduct of investigations of things like the illegal naked short selling that appears to have brought down Lehman Brothers.
When I was an internal auditor of a NYSE member firm, there was a rule (apparently dropped at some point during the last ten years) that prevented short sales except on an up-tick, meaning that there had to be a purchase for every short sale. This prevented severe market drops as the result of massive short-selling. And, of course, my firm had to borrow a share of stock for each share our clients sold short. There was no naked short selling. And fails to deliver were investigated, with strict disciplinary action taken unless a good explanation was forthcoming.
POINT #5: In my view, the only hope we have to make good on, or reduce the losses on, the “toxic” mortgages at issue is to manage them on a local level with community involvement. I have a friend in the real estate business who is interested in purchasing houses in foreclosure and working out a plan to help the former owners get jobs or otherwise deal with the financial problems giving rise to their defaults. He would allow them to continue to occupy the houses as renters and repurchase the homes in the future after getting back on their feet if they so desire. If this type of action were taken on a community-wide basis with the cooperation of local governments and businesses, a lot of heartache in all sectors could be avoided. We cannot guarantee or borrow our way out of this as a society. We need to put people to work producing things of value.
