Wednesday, March 25, 2009

Why the Countrywide guys should be allowed to get mega-rich

Pimco is a bond management firm which has come through this crisis almost unscathed.  The monthly letters from Pimco are amongst the few must-reads of Wall Street.  I have no reason to believe that Pimco has ever acted with anything but integrity.

A few days ago I posted about cumulative loss data at Fannie Mae and Freddie Mac.  I pointed out that Fannie's credit on qualifying mortgages was consistently worse than Freddie's and asked for comments.  One comment suggested – and I have since confirmed – that the main difference was that Countrywide largely originated for Fannie – and was Fannie's largest source of loans.

Given that they used the same sort of computer data as everyone else it is likely that they were at best aggressive in how they confirmed mortgagee income and employment.  Its a culture thing. 

And given that the losses at Fannie and Freddie now appear to belong to the US Government these guys were not nice to taxpayers.

The guys from Countrywide have started a new firm – Penny Mac – which will deal in scratch-and-dint mortgages.  They clearly have some experience in the area.  The New York times wrote a story which was – at least editorially – a little sickened by how guys that manage to cause the crisis are now profiting from it.  The tone rings politically true.

The terms for the Geithner funds were written so that Pimco could (almost certainly) run one of the funds.  Indeed the terms appear to be written in a way as to maximise conflicts of interest.  This is a problem – because say $10 billion that Pimco puts up will give Pimco power to buy maybe $200 billion in bonds.

Pimco owns a lot of debt of large banks.  If they were to use that $200 billion for say $80 billion of overpayment as suggested by Steve Waldman then they could make good their huge holdings of bank debt.  They are conflicted.  The conflict is large.

By contrast if the Countrywide guys are to put in the bulk of their personal fortunes they are not conflicted.  (It would be almost everything they had – and they have no other remaining interests.)

The treasury should refuse Pimco's application and accept Penny Mac's if Penny Mac makes a decent submission.

Its an outcome that politically stinks.  It will deliver a fortune to the Countrywide guys.  It will sure play badly in the New York times.

But agency problems are at the core of how we got into this crisis – whether it be mortgage brokers with an incentive to say one thing and do another or whether it is traders who got paid huge bonuses when they lied about their mark-to-market profits or rating agencies who were paid by issuers of dodgy debt..

The Treasury should be writing the criteria to minimise agency problems – and instead they have written them to maximise agency problems.

This is not good.



babar ganesh said...

hear hear

Anonymous said...

John, isn't it entirely possible that Treasury is intentionally maximizing the agency problem? If one wanted to transfer billions of taxpayer funds to the financial system surreptitiously, this is one way to do it. It kicks the can down the road and 99.5% of the populace can't tear themselves away from American Idol long enough to understand what's going on.

"Shaking hands with the government" indeed.

Anonymous said...

Though consider:

The rumor I've heard is that Stan Kurland (the Countrywide guy) was perfectly content to stay retired and surf the Southern California shores but was approached BY BLACKROCK and made an offer of a huge sign-on bonus which he couldn't rationally refuse.

I too read the NYT article and made note of the large personal investments of the principals. I just assumed they took their BlackRock money and put it in the firm, giving them a free option on the success of their venture.

Of course, PennyMac's birth far predates the origin of the PPIP, but after reading Waldman's (great) post and now this one, I wonder if this isn't exactly the template Geithner has in in mind. It's a certainty that BlackRock was an influential "advisor" in the process (i.e., they probably wrote it themselves, with PIMCO, et al).

I'll feel better about what's happening if all of these potential conflicts are disclosed and carefully managed. If not, you're right, this could be a bad thing.

John Hempton said...

The suggestion that the government is intentionally maximizing the agency problem is - I think - false...

When in doubt I usually choose incompetence of malevolence - being of the view and experience that incompetence is far more common in the world than malevolence.

However Iraq and WMD has given me pause. It was either incompetence or malevolence that led America into war on the basis that Hussein had WMD. The more you look the more it looks like malevolence.

So - yes - maybe it is malevolence.

Hope not.

babar ganesh said...

your point seems to be that agency problems are not a matter of who you are dealing with and what they have done before but their conflicts of interest in the situation presently at hand.

imho agency problems -- especially issues like pimco being able to basically pay themselves -- ruin any rationale the program has. with legacy assets it's a zero sum game: they will pay out what they pay out and the losses will go to the banks and then the treasury (assuming a guarantee).

if you introduce a third party and give them a bet which is highly likely to make them money, that takes money away from the other two. so you had better get something valuable in return. i was thinking that you would get some information about marks -- at least a decent upper bound for a private bid -- in order to take some of the ambiguity out of the situation. but the 'auction' specified here produces marks that are so dirty that they won't accomplish that.

John Hempton said...

If you have not worked it out - I have teased Pimco because it is probably the most honest large firm on the street.

But conflicted they are. They are playing the moral hazard game in a big way - buying agencies and other areas of emerging government support. (See Bill Gross's last letter...)

But yes - if the Countrwide guys put the bulk of their wealth in then the non-recourse nature of the contract would not really matter (they would have an incentive to preserve wealth). And they clearly have the experience!

Oh well...


Anonymous said...

It sounds like the helicopters are starting up, either way.

Charles Butler said...


From the outset, there has been widespread over- and mis-identification of players in the financial system with the system itself. It may be true that if you save the players you save the system, but that is not the only available strategy. And it's far from the best because it opens up the door to having the players design the bailout. Losers should not be given the means to remain profit maximizers. Their priorities are naturally elsewhere.

John Hempton said...

I agree whole heartedly with the sentiment that we should not confuse the system with players in the system - and I would dearly like to bail out the system whilst punishing the malefactor players.

The most obvious suggestion is to appoint Bronte Capital as one of the funds of the Geithner plan.

Not going to happen though.


Anonymous said...

Well I think that Bronte Capital should be called in.
After all the Aussie troops stand shoulder to shoulder in Afghanistan with the US troops where the going is really tough.
Diversity of opinion / action is what is needed for Wall Street.
Then the home runs can be counted !
Bronte Capital could provide "embedded" commentary to counter the Wall Street spin.

investmentgardener said...

So we are going to inflate banks that are too big to fail until they are too big to save? Not the best risk management.

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.