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2 Countrywide exposes lost
virginity By Julian
Delasantellis
In the past few months, I've
elaborated on many of the proposed solutions to
the ever-more threatening subprime mortgage
crisis, from the private sector's proposed M-LEC
derivative "superfund", the various proposals to
greater involve the government's housing finance
agencies, to my prediction that the ultimate
resolution of the crisis will come from foreign
sovereign wealth funds.
California-based
Countrywide Financial Corporation, which led the
United
States in home mortgage finance in 2005 and 2006,
has come up with a simpler idea. When all else
fails, you can always try to get lucky with just
abject begging and groveling. It might just work -
it has so far for Countrywide.
If you're
interested in ringside seats to watch the titanic
prizefight as to whether in the near future
America will still have a fully functioning
financial system, otherwise known as the subprime
crisis, there are few better places than to be
following the continuing action at Countrywide, as
every day it falls ever farther behind on the
judges’ scorecards in its fight to keep being an
independent, operating commercial entity.
Back in the heady days of America’s
long-departed (although it was only last year, how
the mighty have fallen!) housing bubble,
Countrywide was the darling of the day, a hero of
both the political right and left. The Wall Street
right loved it for it was a highly profitable
enterprise, with an almost 38% operating margin
generating US$11 billion in profit in 2006. The
free marketers also found it appealing since, in
its endeavors to extend housing finance to areas
and demographics that had been effectively
abandoned by both the markets and conservative
governments, Countrywide seemed to be an effective
example of the free market successfully assuming,
and making good money from, its status as a wholly
private sector housing program.
Countrywide also found favor with the
political left for the same reason: if the US
Federal Government, starting with Ronald Reagan,
continuing with both George HW Bush, and, to a
slightly lesser extent Bill Clinton, then starting
up again with a vengeance under George W Bush, was
abandoning its New Deal era mandate to house the
less fortunate, at least Countrywide was picking
up a bit of the slack.
Countrywide's web
site quotes chairman and chief executive Angelo
Mozilo that "Nobody works harder to deliver the
American dream," although, with Mozilo last year
earning over US$140 million as the nation's
seventh-most lucratively paid corporate chief
executive, and with the company now planning to
lay off 12,000 of its employees, and with the
Securities and Exchange Commission now
investigating Mozilo for insider trading
violations in the sale of US$140 million of
personal stock, what is a dream for Mozilo may
very well be being seen as many other's nightmare.
We now know just how much of what we knew
of Countrywide in 2006 was a lie. Countrywide was
serving the poor, and those with poor credit
histories (essentially, these two groups were
mostly populated by the same people) in the same
manner a slaughterhouse serves livestock; in
reality, it was earning a whole lot of that fat
margin through collecting originating and
servicing fees through the writing of
inappropriate low initial floating rate mortgages
for clients it knew could never pay back the
loans. The only real hope these borrowers ever
really had to stay in their homes for the long
term was to be able to refinance into sounder,
floating rate mortgages before the higher rates
buried them, and with real estate values no longer
rising, the poor borrowers are finding that escape
hatch firmly shut.
Mortgage delinquencies,
defaults, and repossessions are up multiple-fold
over last year, and, as a result, Countrywide's
stock has fallen about 80% this year, from over
$45 in February to just below $10 this last week.
The stock is now trading at around a
remarkable 48% of book value, meaning that, for
every dollar of loans the company is carrying on
its books as an asset, Wall Street now only sees
48 cents of real value.
A couple of weeks
ago, yet another dour story crossed the wires
regarding poor Countrywide. No matter from what
side you look at this news, the picture for the
company, and for the American financial system as
a whole, just continues to look grimmer and
grimmer.
On November 9, Countrywide, in
essence, dropped to its knees. In a regulatory
filing with the US Securities and Exchange
Commission, the company pleaded with the corporate
financial ratings agencies, primarily Standard
& Poors, Moody's and Fitch, that the sword of
Damocles hovering above the company's head must
not fall from out of their grasp:
To retain access to the public debt
markets it is critical for us to maintain
investment-grade credit ratings. Among other
things, maintenance of our current
investment-grade ratings requires that we have
high levels of liquidity, including access to
alternative sources of funding such as deposits
and committed lines of credit provided by highly
rated banks. We must also maintain adequate
capital that exceeds current rating agency
requirements. While we retain our investment
grade ratings, all three rating agencies have
placed our ratings on some form of negative
outlook.
In the event our credit ratings
were to drop below "investment grade", our
access to the public corporate debt markets
could be severely limited. The cutoff for
investment grade is generally considered a
long-term rating of "BBB-" (or Baa3 Moody's
Investors Service), which is equal to our lowest
current rating. Furthermore, we expect that
renegotiation or replacement of our existing
financing arrangements beyond their current
maturity dates will involve more restrictive
terms and higher relative rates than those
presently in place. Our ability to place
custodial deposit accounts on deposit with our
bank subsidiary could be affected if our credit
ratings were reduced below investment grade. As
of September 30, 2007, up to $5.5 billion of our
custodial deposits may be subject to placement
with another bank if our credit ratings were
reduced below investment grade. We also expect
that a reduction in our ratings below investment
grade would have a negative effect on our
ability to retain our commercial deposits. In
addition, our broker-dealer may experience
difficulty in conducting its trading operations
if its parent is unable to maintain its
investment grade credit ratings.
In
real person language, this is somewhat comparable
to if you see a town's worst, odiferous,
pimple-faced rotund, still living with his parents
at age 45, unemployed loser approaching the most
pristine local Vestal Virgin asking for some
romance.
One of two things would be
happening here. Either the loser (yes, that would
be Countrywide) has become incredibly desperate,
or, maybe the town's pure and pristine Vestal
Virgin (the ratings agencies) aren't really that
wholesome, chaste and unsullied after all.
In this case, it's probably more than a
little of both.
Countrywide is not
bluffing here; another ratings downgrade would
definitely hurt. The company, its stock, debt, and
other financial investments, have been repeatedly
downgraded this year, although on January 25, and
April 23 brokerage firm A G Edwards actually
issued and re-issued buy recommendations on the
stock. In the case of the January recommendation,
investors who trusted and followed their broker's
advice are now sitting on an 80% loss. If the
company's paper did get downgraded below
investment grade, many investment organizations
and vehicles charged to act with maximum fiduciary
prudence, among them various college endowments
and pension funds, would be prohibited by charter
from investing in it.
This would set up a
classic vicious circle. Denied access to this pool
of investment capital, Countrywide would have to
pay higher interest rates to attract its share of
the market that could still place funds with it.
On October 26, the company reported its
first quarterly loss in 25 years, $1.25 billion of
bright red ink. The absolute last thing this
company needs now is to pay more to borrow
capital; like steel and rubber for a car company,
borrowed capital is a financial company’s raw
material from which it makes its final product,
loans.
If the market sees Countrywide
groaning and staggering under its burden of higher
interest rates its confidence in the company's
continued financial viability would grow ever
weaker. More money, whether diminishing large
deposits, or through lack of sales of the
company's commercial paper, would slip away, and
the company's operational funding requirements
would grow ever more challenging. Eventually, the
company's prospects would grow so dire that it
would be unable to continue as an independent
entity; it would either have to be taken over by
another company - one with absolutely great big
deep pockets and a stellar credit rating in order
to eat losses this big - or close its doors.
The last thing the United States economy
in general, and the real estate sector in
particular, needs now is the bankruptcy of a major
mortgage finance lender such as Countrywide. More
serious than Countrywide's vicious circle is the
one the entire US real estate sector, and it now
appears, the entire economy is in as well. If
Countrywide pulls out of the market they'll be
commensurately less mortgage finance available in
the US real estate market.
Monetarists
such as former Fed chief Alan Greenspan always
talked of inflation as a money supply problem, in
that prices of things rise along with expansions
in the supply of money, but the tautology works
just as well in reverse. Prices of things, such
as
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