Tuesday, July 15, 2008

No Speech: The New Free Speech

Thomas Jefferson would blush, or at least roll over in his grave.

Seems the authorities are shifting the responsibility for individual actions from corporate CEOs and their Boards of Directors squarely where it belongs: rumor-mongering traders.

So much of this blame-shifting is going on that even a loud-mouthed U.S. Senator is being blamed for the collapse of a lending institution rather than the incompetents who ran the lending institution.

In light of all this blame-shifting, we here at NotMakingThisUp thought it worth reminding readers of something the Powers That Be appear to have entirely forgotten about.

But before we get to that, we first want to tell the story of Eddie the Real Estate Broker.

In these parts of down county Vermont (not the actual state), Eddie (not his real name) is The Guy to go to when it comes to real estate. And Eddie recently told us about a “short-sale” he helped out on for a client.

A “short-sale” in real estate involves property worth less than the loan balance. Rather than foreclose on the property, the bank holding the mortgage agrees to take whatever it can get by selling the property in satisfaction of the loan balance.

The bank eats the difference between the actual sale proceeds and the loan balance.

These “short-sales” are happening more frequently nowadays, thanks in large part to the massive amounts of home equity loans that homeowners applied for, and banks agreeably provided, in recent years.

In this particular case, Eddie’s buyer paid $500,000 (not the real number) for the house and later got the thing reappraised at $750,000 (not the real number, but, yes, it was a 50% increase in the appraised value) for a home equity loan.

Eddie’s buyer twisted no arms to get the higher appraisal: the bank in question, which shall remain nameless, did what Eddie called a “drive-by” appraisal. According to Eddie, the place was never worth more than $500,000, and if the bank had bothered to stop and look around, they would have figured it out.

So the buyer is losing his house, and the bank is eating a good fat number on their loan.

Now, why do we here at NotMakingThisUp tell the story of Eddie the Real Estate Broker and the Short-Sale?

Because it is the story of this real estate cycle.

It was a cycle driven, as all cycles are driven, by human greed on each side of the transaction. On the one side was a guy who bought the house and got it reappraised so he could borrow more money against the house strictly so he could buy more stuff.

On the other side was a bank that willingly and eagerly loaned him the money on the basis of a “drive-by” appraisal, not because it was a good long-term thing to do, but so the bank could show higher short-term earnings.

But, as it turns out, the authorities wish it known that the problem at Fannie Mae was not Franklin Raines’ management of the company; and the problem at IndyMac was not that it led the field in “Alt-A” mortgages; and the problem at the bank here in Vermont was not drive-by appraisals.

It was, we now know, rumor-mongering traders and loud-mouthed U.S. Senators.

Which is why we say, “No Speech is the New Free Speech,” and offer this reprinting of the first article of the Bill of Rights as a public service:

Bill of Rights
Amendment I

Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof; or abridging the freedom of speech, or of the press; or the right of the people peaceably to assemble, and to petition the government for a redress of grievances.

Last we knew, that First Amendment wasn't a rumor.

Jeff Matthews
I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.


GrizzlyRock23 said...

Love it! Oh and oil has nothing to do with supply & demand only wall street speculators...

S Sams said...

I think you're missing the point regarding Schumer. No one said that Schumer somehow made a good bank go bad. It was a sickly bank that was at a fragile stage and was more likely to fail than not. Schumer's error was to make a very bad situation... worse. Yelling fire in a theater is NOT an effective form of crowd control. Likewise, at a critical moment for IndyMac, the last thing ANYONE needed (depositors, mgmt, regulators) was to have Schumer leak his own letter to the press. There is no defense for that.

Chris said...

Love the blog, and this comment might not matter too much to your main point: but Thomas Jefferson wasn't present when the Constitution and Bill of Rights were drafted and ratified, as he was in France at the time. Maybe James Madison (the drafter of the Bill of Rights) would be rolling in his grave?

Christopher said...

A Senator does not "leak his own letter." A Senator releases his own letter.

See the difference?

Sam E. Antar said...

Next, they will blame the Sith Lord.

BelowTheCrowd said...

This speech by Michael Perry, CEO of Indymac, less than a year ago is a must-watch for anybody who wants a lesson in seeing through self-serving CEO doublespeak. I shorted his stock a day later. Feel free to ignore all my commentary, but note the simple, core problem in this whole mess, highlighted by the quote at the top, taken directly from the now-disgraced Mr. Perry himself:

Heck no they're not saving, because their net worth is growing. If your net worth is growing, in financial assets and other assets, you can spend more than your annual income!

Ooops. Maybe not.


Kevin said...

I agree with S. Sams. The first amendment doesn't protect all speech. It is not an abridgement of constitutional rights when the law prohibits someone yelling "fire" in a crowded theater. It is a sensible policy that balances the right to free expression with public safety. There are other examples - like laws that prohibit commercial enterprises from making false and misleading statements in their advertisements or laws that prohibit issuers of public securities from manipulating their stock price by publishing misleading financial statements. You rarely hear a free speech objection raised in that context (notwithstanding the occasional food store CEO who has thing for anonymous blogging in his spare time).

What Schumer did was irresponsible and hypocritical. Irresponsible because it was the proximate cause for a run on the bank that will wind up costing taxpayers and depositors millions of dollars. Somebody should mail him a copy of "It's a Wonderful Life." Hypocritical because barely a year ago Mr. Schumer urged that regulatory standards be loosened so that America's financial markets can remain globally competitive. I quote:

"While the US remains the center of innovation for leveraged lending (i.e., the lending of capital to companies with a rating below investment-grade) and securitization, it is facing challenges to its leadership in these markets as well. The US controlled over 60 percent of leveraged lending issuance by value and approximately 70 percent of revenues in 2005. America’s leadership in securitization is even more striking, with the US market representing approximately 83 percent of global issuance by value and 87 percent of revenues in 2005. However, European lenders are beginning to embrace US-style credit terms, critical to the leveraged lending and sub-prime consumer finance markets. This should position Europe to enjoy explosive securitization growth in the near future, similar to what occurred in the US over the past decade. Further, European control of the credit derivatives markets is beginning to shape and drive the structure of the underlying cash lending markets. Whereas historically US markets and financial institutions often benefited from the ability to set market standards, this trend could lead to a deterioration in US competitiveness if markets and institutions fail to follow the pace increasingly set by their European competitors.

Compounding matters, US regulators’ proposed amendments to the Basel II standards (i.e., the recommendations agreed upon by numerous international bank supervisors and central bankers to revise the international standards for measuring the adequacy of bank capital) could put US banks at a capital disadvantage relative to their international competitors. This could put a brake on US leadership in these markets and even reduce the likelihood that future innovations in the credit arena will occur in the US. Finally, London is transforming itself into an increasingly sizeable and attractive talent hub for people with the kind of structuring and pricing skills that used to be available only in New York, thereby reducing America’s talent advantage and further increasing the likelihood that tomorrow’s debt innovations will occur in London rather than New York."

Hmm. I kind of wish some of that innovation took place on Mars and not in New York. Anyway, here you have a Senator urging regulators to relax their oversight so we can remain competitive one month, and a few months later he criticizes those same regulators for not doing their job. I'm not making that up. You can read the report here for yourself: