Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [48]
MAD is the military term for mutually assured destruction, and unsound mortgage lending practices guaranteed that the housing market would be damaged along with the balance sheets of investors that participated by ignoring the risk or by being suckered into unknowingly taking excessive risk. By turning a blind eye to the massive rape of the mortgage loan market, investment bankers assured damage to the U.S. housing market and to their own balance sheet when they were stuck with enormous exposure to their own mischief.
Most of the “early post-signing” defaults in loans, originated through the early months of 2007, had been on “stated income loans,” (also known as liar loans) especially with loan-to-value ratios approaching 100 percent, whether they were subprime or not. This suggested stated income was overstated. Future defaults would kick in as resets on coupons occurred in a soft housing market.
Throughout most of 2007, the Federal Reserve seemed to be in denial, using reverse moral suasion by minimizing estimates of potential damage. On August 3, 2007, I told CNBC’s Joe Kernen: “The market is nervous because everyone feels like they are being lied to. Chairman Ben Bernanke seems to have been doing his homework on Wall Street.” Earlier Bernanke reported subprime loss estimates of only $50 to $100 billion. Credit Suisse First Boston had been projecting $50 billion and Citigroup projected $100 billion for subprime losses. I felt every one underestimated ultimate default rates and equally important “they are grossly overestimating recovery rates in subprime. . . .Wall Street really screwed Main Street.” I had projected $270 billion to $340 billion in subprime losses and around $450 billion to $560 billion for all risky mortgage loan products including Alt-A and prime mortgages.19 My estimates represented only principal losses, and predatory securitization of predatory loans would amplify these losses.
The day the segment aired, a client asked,“Are you saying Bernanke is incompetent, or are you saying he’s a lying coward?”
“Can’t you think of any other possibilities?” I asked in reply.
“What else could there be?”
“He may be brave in support of the wrong cause.”
My client later reminded me of those words when Associate Justice of the Supreme Court, Antonin Scalia, told 60 Minutes that torture (such as waterboarding) is not “punishment,”20 implying that the constitutional prohibition against cruel and unusual punishment wouldn’t apply to torture. My client joked that investment banks would like to waterboard me to prevent me from talking.
My loss projections were higher than anything coming out of the U.S. government or Wall Street. It turns out I was predicting the greatest losses, and I was too optimistic. Housing speculators and overreaching homeowners took risk, seemingly with “eyes wide shut.” Many others were lured with the promise of homeownership. Predatory lenders targeted minorities and lower-income people who were intellectually and financially mugged, then dumped on the side of the road. The motto of predatory lenders is “every minority left behind.”
Before meeting Warren, I wrote about industry problems, but only in a general way. Warren’s subtle encouragement helped me find my voice. Now I specifically challenged the Federal Reserve Bank and major investment banks on national television.
I told CNBC’s Joe Kernen that I advocated a temporary moratorium on subprime foreclosures, followed by mortgage restructurings.That meant first reappraising to lower values reflecting the devastation caused by predatory lending and then restructuring mortgages to an affordable fixed rate. In some areas, the reappraised values will be drastically lower and the mortgage terms radically different.This protects misled homeowners. Borrowers complicit in fraud, or who willfully overleveraged, should not