Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [46]
One would expect investment banks that are obliged to perform due diligence appropriate to the circumstances to yell: Stop the money printing presses!
For example, Merrill Lynch (the previously mentioned deal was not a Merrill Lynch deal) was a part owner of California-based Ownit Mortgage Solutions. Mike Blum, Merrill Lynch’s head of global asset-backed finance, sat on the board of Ownit Mortgage Solutions. Revenue was up around 33 percent in the first three quarters of 2006, but Ownit was losing money. In November 2006, JPMorgan Chase told Ownit that its $500 million credit line would disappear on December 13. When Ownit imploded, Blum faxed in his resignation. Ownit made second-lien mortgages, issued 45-year ARMs, and originated no-income-verification loans. In the words of William D. Dallas, its founder and CEO: “The market is paying me to do a no-income-verification loan more than it is paying me to do the full documentation loans.”13 In this post Sarbanes-Oxley world, one might have expected Merrill’s Mike Blum to insist on a fraud audit of Ownit instead of faxing in his resignation. Warren Buffett points out, “[T]here are worse things than Sarbanes Oxley.”14 This is one of them.
Based on public information like this, the SEC should have taken immediate action and asked Merrill and other investment banks why they did not write down losses on mortgage loans and their securitization businesses. If the SEC was not alarmed by the newspapers, they should have been alarmed by an article that I wrote for risk professionals in first quarter 2007. There I emphatically stated that investment bank risk managers involved in securitizing subprime mortgages should get out and short the product, because the predators’ fall was in full swing. It was career suicide to be in a position of supposedly overseeing risk if one did not have the authority to stop the insanity. If, however, one did have the authority to do something about it, the time for action was past due. The SEC may not care about my views, but it ignored many voices from the business media and from investment professionals.
Tom Hudson and Beejal Patel of First Business Morning News (FBMN) broadcasting out of Chicago documented the troubles of subprime mortgage lenders. They were ahead of the pack in predicting massive write-downs at investment banks.With a shoestring budget and a half-hour broadcast, they presented the best overall coverage of the role of the Fed, mortgage lending, investment banks, and lax sophisticated investors. In fact, they presented great overall coverage on all aspects of finance. The show airs at 5:00 A.M. Chicago, and many Chicago traders—the largest volume of exchange traded derivatives in the world changes hand in Chicago—get up to watch FBMN ’s financial coverage.
In March 2007, Tom Hudson noted that “banks, brokers and auto companies” were writing down exposures to subprime lenders. In Chicago, Corus Bankshares, Inc. took a write-down on its shares of Freemont General, a large subprime lender. New Century was being sued in several states to stop it from giving new loans. Hudson noted that the Fed regulates banks and could have pushed to stop inflating the subprime market by allowing them to offer “teaser rates that weren’t explained to the borrowers.” I agreed, “The Fed seemed complacent about the risk.” I added that U.S. pension funds and mutual funds owned some of these risky products.“I don’t know anyone I hate enough to want to have a negative amortizing ARM (also called a pay option ARM). It is just a bad product.”Your loan amount