The worst market crisis in 60 years
By George Soros
Published: January 22 2008 19:57 Last updated: January 22 2008 19:57
The current financial crisis was precipitated by a bubble in the US housing market. In some ways it resembles other crises that have occurred since the end of the second world war at intervals ranging from four to 10 years.
However, there is a profound difference: the current crisis marks the end of an era of credit expansion based on the dollar as the international reserve currency. The periodic crises were part of a larger boom-bust process. The current crisis is the culmination of a super-boom that has lasted for more than 60 years.
Boom-bust processes usually revolve around credit and always involve a bias or misconception. This is usually a failure to recognise a reflexive, circular connection between the willingness to lend and the value of the collateral. Ease of credit generates demand that pushes up the value of property, which in turn increases the amount of credit available. A bubble starts when people buy houses in the expectation that they can refinance their mortgages at a profit. The recent US housing boom is a case in point. The 60-year super-boom is a more complicated case.
Every time the credit expansion ran into trouble the financial authorities intervened, injecting liquidity and finding other ways to stimulate the economy. That created a system of asymmetric incentives also known as moral hazard, which encouraged ever greater credit expansion. The system was so successful that people came to believe in what former US president Ronald Reagan called the magic of the marketplace and I call market fundamentalism. Fundamentalists believe that markets tend towards equilibrium and the common interest is best served by allowing participants to pursue their self-interest. It is an obvious misconception, because it was the intervention of the authorities that prevented financial markets from breaking down, not the markets themselves. Nevertheless, market fundamentalism emerged as the dominant ideology in the 1980s, when financial markets started to become globalised and the US started to run a current account deficit.
Globalisation allowed the US to suck up the savings of the rest of the world and consume more than it produced. The US current account deficit reached 6.2 per cent of gross national product in 2006. The financial markets encouraged consumers to borrow by introducing ever more sophisticated instruments and more generous terms. The authorities aided and abetted the process by intervening whenever the global financial system was at risk. Since 1980, regulations have been progressively relaxed until they have practically disappeared.
The super-boom got out of hand when the new products became so complicated that the authorities could no longer calculate the risks and started relying on the risk management methods of the banks themselves. Similarly, the rating agencies relied on the information provided by the originators of synthetic products. It was a shocking abdication of responsibility.
Everything that could go wrong did. What started with subprime mortgages spread to all collateralised debt obligations, endangered municipal and mortgage insurance and reinsurance companies and threatened to unravel the multi-trillion-dollar credit default swap market. Investment banks’ commitments to leveraged buyouts became liabilities. Market-neutral hedge funds turned out not to be market-neutral and had to be unwound. The asset-backed commercial paper market came to a standstill and the special investment vehicles set up by banks to get mortgages off their balance sheets could no longer get outside financing. The final blow came when interbank lending, which is at the heart of the financial system, was disrupted because banks had to husband their resources and could not trust their counterparties. The central banks had to inject an unprecedented amount of money and extend credit on an unprecedented range of securities to a broader range of institutions than ever before. That made the crisis more severe than any since the second world war.
Credit expansion must now be followed by a period of contraction, because some of the new credit instruments and practices are unsound and unsustainable. The ability of the financial authorities to stimulate the economy is constrained by the unwillingness of the rest of the world to accumulate additional dollar reserves. Until recently, investors were hoping that the US Federal Reserve would do whatever it takes to avoid a recession, because that is what it did on previous occasions. Now they will have to realise that the Fed may no longer be in a position to do so. With oil, food and other commodities firm, and the renminbi appreciating somewhat faster, the Fed also has to worry about inflation. If federal funds were lowered beyond a certain point, the dollar would come under renewed pressure and long-term bonds would actually go up in yield. Where that point is, is impossible to determine. When it is reached, the ability of the Fed to stimulate the economy comes to an end.
Although a recession in the developed world is now more or less inevitable, China, India and some of the oil-producing countries are in a very strong countertrend. So, the current financial crisis is less likely to cause a global recession than a radical realignment of the global economy, with a relative decline of the US and the rise of China and other countries in the developing world.
The danger is that the resulting political tensions, including US protectionism, may disrupt the global economy and plunge the world into recession or worse.
Wednesday, January 23, 2008
The Business of Baseball
Santana not worth the tariff
By Vince Gennaro, Special to Yahoo! Sports
January 18, 2008
Any contending team in a major market would want Johan Santana to anchor its starting rotation. Yet the Minnesota Twins have not been able to trade the two-time Cy Young award winner despite months-long talks with the New York Yankees and Boston Red Sox, and more recently, the New York Mets.
An economic analysis of the potential trades indicates that the reluctance of the Yankees and Red Sox to make a deal is well-founded because the potential value of the young players the Twins want in return is so high. A trade makes somewhat more sense for the Mets.
A means of measuring the value of a star player such as Santana is to calculate the number of wins he produces. And wins, in turn, generate revenues. The protracted negotiations center on how much of the return on the asset – Santana – will go to the Twins in the form of young talent, rather than cash to Santana himself.
Free agents own their rights, so virtually all value accrues to the player. At the other end of the spectrum is a player such as Miguel Cabrera, who is under team control for another two years. The Florida Marlins were able to extract value from the Detroit Tigers because the Marlins were passing along control of a valuable asset. The Twins are caught between those two scenarios. Santana is only one season from free agency, so much of his value is shifting from the team to the player, yet the Twins seem to be pricing Santana as if he has two or three years remaining until free agency. This trade is basically free-agent signing with a tariff tacked on – a payment to the Twins in the form of promising low-salaried prospects in exchange for the right to sign Santana to a long-term contract without a bidding war.
If Santana had the patience to enforce his no-trade clause and insist on playing the final year of his contract in Minnesota, he could get all the spoils next offseason by becoming a free agent rather than sharing his bounty with the Twins. The Twins are demanding a substantial tariff for the right to pay Santana market wages. In effect, they're asking the team to pay twice. And in this case the tariff may cost nearly as much as the goods.
How can we place a dollar value on the tariff the Twins are demanding? Let's look at the financial implications to the Yankees of making Santana their staff ace, by breaking it down into two separate analyses – the free-agent value of Santana and the financial value of the Yankees players who reportedly would go to the Twins – promising starting pitcher Phil Hughes, center fielder Melky Cabrera, and one or two minor leaguers.
Santana's Free Agent Value to the Yankees
At the core of Santana's value as a free agent is his ability to improve his new team and the resulting financial impact of that improvement. I've analyzed the Yankees' revenue streams and statistically estimated the impact of winning on their revenues. (This topic is covered in-depth in my book, "Diamond Dollars: The Economics of Winning in Baseball.") One of the most important conclusions of this analysis is that not all wins are equal – the highest value wins are those which give the team a better chance of making the playoffs. In the case of the Yankees, maintaining their unbroken string of playoff appearances is worth an estimated $39 million in future revenues coming in the form of merchandise sales, retention of season-ticket holders, maintaining the high level of demand from their corporate sponsors, and continued top ratings on the YES Network, in which they own a stake.
Adding Santana could provide an insurance policy on their consecutive string of playoff appearances and help their chances of bringing the Yankees their 27th world championship. According to the win shares stats at "Hardball Times," Santana's stellar pitching has been responsible for about eight of his team's wins each of the past four years. By bumping the Yankees' fifth starter to the bullpen, we can expect Santana's presence in the rotation to add a net of five wins per year. If we consider the star-studded, A-Rod-anchored Yankees to be a 93-win team before adding Santana, then we can say that his presence projects the club to 98 wins. Based on an analysis of recent history in the highly competitive American League East, those five wins would raise the Yankees' chance of reaching the postseason from an already strong 62 percent to a comfortable 91 percent. The expected dollar value of this increase would be modest over the next two years while fans flock to see old Yankee Stadium for one last time in 2008 and sample the new stadium in 2009, regardless of the team's won-loss record. But by 2010, when the new stadium is passé, I estimate those five wins will be worth a cool $24 million per year in incremental revenue, driven by how Yankee fans historically respond to a playoff-bound ballclub, along with the impact of the new stadium's higher ticket pricing and additional luxury suites.
Beyond his impact on the Yankees' regular-season win total, there are two other ways Santana can add financial value. First, he can play an important role once the Yankees reach the postseason. Santana gives the Yankees a better chance of riding the back of a top pitcher deep into October, much like the role Josh Beckett played for the Red Sox in 2007. Each additional rung on the playoff ladder creates more financial value as a team sells more merchandise, takes a more aggressive ticket price hike and has higher broadcast ratings in the following season. The difference between advancing one additional round in the postseason – getting to the World Series versus losing in the league championship series – can mean as much as $15 million to the Yankees. It's difficult to predict how much value Santana will deliver as a postseason player, but if we make the assumption that his presence increases the Yankees' chances of advancing one additional round by 50 percent, we can credit him with another $7.5 million in expected value.
Beyond his regular-season performance value and potential playoff impact, the final dimension of Santana's worth to the Yankees is his marquee value – the value that accrues to high-profile, star players by helping to personalize the team's brand and support their winning image. This is the toughest value component to quantify.
However, given Santana's stature and his potential popularity as the ace on the highest valued team in MLB, we can ascribe about $4 million in additional value per year. This approach divides one-third of the annual appreciation of the Yankees franchise among the star players on the team. If we assume the Yankees appreciate in value by about $75 million per year, then collectively the star players – Rodriguez, Derek Jeter, Mariano Rivera, Robinson Cano, Jorge Posada and now Santana – could be responsible for about $25 million of the annual appreciation. (Figure 1 shows the projected revenues of Santana as a Yankee.)
On the cost side, we can expect the tab for Santana to be in the neighborhood of $25 million a year for six years. Since the Yankees are over the luxury tax threshold and A-Rod's contract virtually eliminates any chance that they will go below it in the near future, the Yankees will be on the hook for another $10 million per year in luxury taxes, raising Santana's cost to about $35 million per year. The net result is that Santana would be a value-added signing for the Yankees, even at his steep price – generating about $225 million in revenues and asset appreciation and costing about $200 million, yielding a rate of return of 24 percent on their investment, probably enough to compensate the Yankees for the injury risk associated with any free agent pitcher.
The Value of Hughes and Co.
Let's look at the price the Yankees would need to pay the Twins in order to secure Santana. A team's most valuable assets are its young major leaguers with five or six years of discounted wages ahead of them before free agency. Let's make the conservative assumption that Hughes pitches at the level of a number three starter – akin to the 2007 version of the Cubs' Rich Hill, or the Giants' Matt Cain – for each of the next six years. That means Hughes would be worth about three marginal wins above a replacement player per season. Hughes will be paid a modest (less than $500,000) annual salary over the next two years until he reaches arbitration eligibility. By looking at comparable players and adjusting for inflation, we can estimate that he should earn about $30 million in the next six years. Alternatively, his team would need to pay about $84 million in free-agent wages to buy the same wins. So Hughes' asset value is more than $50 million – the amount of payroll savings he will generate for the team that owns his contract versus buying his performance in the free-agent market. (See Figure 2.) By including Melky Cabrera in the trade, another $10 million in asset value is added, and another pitching prospect further bumps up the total cost of the deal.
The net impact for the Yankees is a contract extension for Santana that gets the Yankees about $25 million in value, but is more than offset by trading Hughes, Cabrera and one or two other minor league prospects, giving up about $60 to $70 million in value. What would need to happen to make this a good trade for the Yankees? If Santana signs with the Yankees at $5 million to $7 million per year below the price he would have gotten in an open bidding war as a free agent next winter, or if Hughes becomes only a fifth starter or bullpen reliever, the deal could make sense for the Yankees.
The Red Sox and Mets
For the Red Sox, a trade is even more difficult to rationalize, driven by the lower free-agent valuation of Santana in a sold-out Fenway Park. Santana's financial value to the Red Sox is in the range of $18 million to $20 million versus his annual value of over $30 million to the Yankees. Starter Jon Lester's value may be lower than Hughes' value because Lester has fewer years remaining until free agency, and outfielder Jacoby Ellsbury's value is likely less than Hughes' due to the premium paid to starting pitchers. However, neither of these facts changes the reality that the free-agent cost of Santana alone is likely more than his worth to the Red Sox. It may be that the only reason they are involved in trade talks is to bid up the acquisition price of Santana for the Yankees.
The discussions between the Twins and Mets may hold the most promise. Acquiring Santana and signing him to a long-term deal is economically viable for the Mets because they have a new stadium in the works, their revenue would spike if they reach the postseason and they could remain under the luxury tax threshold. Santana's potential revenue value to the Mets would average an estimated $40 million per year and would exceed his cost by about $100 million over six years, assuming the Mets can stay under the luxury tax threshold. This justifies the Mets packaging a combination of prospects from the list of Philip Humber, Carlos Gomez, Deolis Guerra, Kevin Mulvey and Fernando Martinez. If three of the five prospects materialize into a number three pitcher in the rotation, a starting outfielder and a solid relief pitcher, then the Twins and the Mets receive about the same value in the trade.
One factor working in favor of a trade is the Twins' unwillingness to pony up the dollars to sign Santana to a long-term deal, which eventually could prompt them to lower their demands. On the other end of the deal, a team desperate for Santana could ignore the dramatic financial value created by developing front line pitching internally and take on the injury risk associated with giving a long-term deal to a starting pitcher who has averaged 228 innings over the past four years.
Any team who makes this trade will likely set its farm system back while placing a tremendous investment – and therefore risk – in one player. But if Santana ends up taking the hill in Game 1 of the World Series, the deal will considered a good one.
Vince Gennaro is a consultant to several Major League Baseball teams and the author of "Diamond Dollars: The Economics of Winning in Baseball," an innovative look at the business of baseball. This followed a 20-year career at PepsiCo, where he was president of a billion-dollar division. Gennaro teaches a graduate course on the business of baseball in the Sports Business Management program at Manhattanville College. Send Vince a question or comment at vgennaro07@yahoo.com.
By Vince Gennaro, Special to Yahoo! Sports
January 18, 2008
Any contending team in a major market would want Johan Santana to anchor its starting rotation. Yet the Minnesota Twins have not been able to trade the two-time Cy Young award winner despite months-long talks with the New York Yankees and Boston Red Sox, and more recently, the New York Mets.
An economic analysis of the potential trades indicates that the reluctance of the Yankees and Red Sox to make a deal is well-founded because the potential value of the young players the Twins want in return is so high. A trade makes somewhat more sense for the Mets.
A means of measuring the value of a star player such as Santana is to calculate the number of wins he produces. And wins, in turn, generate revenues. The protracted negotiations center on how much of the return on the asset – Santana – will go to the Twins in the form of young talent, rather than cash to Santana himself.
Free agents own their rights, so virtually all value accrues to the player. At the other end of the spectrum is a player such as Miguel Cabrera, who is under team control for another two years. The Florida Marlins were able to extract value from the Detroit Tigers because the Marlins were passing along control of a valuable asset. The Twins are caught between those two scenarios. Santana is only one season from free agency, so much of his value is shifting from the team to the player, yet the Twins seem to be pricing Santana as if he has two or three years remaining until free agency. This trade is basically free-agent signing with a tariff tacked on – a payment to the Twins in the form of promising low-salaried prospects in exchange for the right to sign Santana to a long-term contract without a bidding war.
If Santana had the patience to enforce his no-trade clause and insist on playing the final year of his contract in Minnesota, he could get all the spoils next offseason by becoming a free agent rather than sharing his bounty with the Twins. The Twins are demanding a substantial tariff for the right to pay Santana market wages. In effect, they're asking the team to pay twice. And in this case the tariff may cost nearly as much as the goods.
How can we place a dollar value on the tariff the Twins are demanding? Let's look at the financial implications to the Yankees of making Santana their staff ace, by breaking it down into two separate analyses – the free-agent value of Santana and the financial value of the Yankees players who reportedly would go to the Twins – promising starting pitcher Phil Hughes, center fielder Melky Cabrera, and one or two minor leaguers.
Santana's Free Agent Value to the Yankees
At the core of Santana's value as a free agent is his ability to improve his new team and the resulting financial impact of that improvement. I've analyzed the Yankees' revenue streams and statistically estimated the impact of winning on their revenues. (This topic is covered in-depth in my book, "Diamond Dollars: The Economics of Winning in Baseball.") One of the most important conclusions of this analysis is that not all wins are equal – the highest value wins are those which give the team a better chance of making the playoffs. In the case of the Yankees, maintaining their unbroken string of playoff appearances is worth an estimated $39 million in future revenues coming in the form of merchandise sales, retention of season-ticket holders, maintaining the high level of demand from their corporate sponsors, and continued top ratings on the YES Network, in which they own a stake.
Adding Santana could provide an insurance policy on their consecutive string of playoff appearances and help their chances of bringing the Yankees their 27th world championship. According to the win shares stats at "Hardball Times," Santana's stellar pitching has been responsible for about eight of his team's wins each of the past four years. By bumping the Yankees' fifth starter to the bullpen, we can expect Santana's presence in the rotation to add a net of five wins per year. If we consider the star-studded, A-Rod-anchored Yankees to be a 93-win team before adding Santana, then we can say that his presence projects the club to 98 wins. Based on an analysis of recent history in the highly competitive American League East, those five wins would raise the Yankees' chance of reaching the postseason from an already strong 62 percent to a comfortable 91 percent. The expected dollar value of this increase would be modest over the next two years while fans flock to see old Yankee Stadium for one last time in 2008 and sample the new stadium in 2009, regardless of the team's won-loss record. But by 2010, when the new stadium is passé, I estimate those five wins will be worth a cool $24 million per year in incremental revenue, driven by how Yankee fans historically respond to a playoff-bound ballclub, along with the impact of the new stadium's higher ticket pricing and additional luxury suites.
Beyond his impact on the Yankees' regular-season win total, there are two other ways Santana can add financial value. First, he can play an important role once the Yankees reach the postseason. Santana gives the Yankees a better chance of riding the back of a top pitcher deep into October, much like the role Josh Beckett played for the Red Sox in 2007. Each additional rung on the playoff ladder creates more financial value as a team sells more merchandise, takes a more aggressive ticket price hike and has higher broadcast ratings in the following season. The difference between advancing one additional round in the postseason – getting to the World Series versus losing in the league championship series – can mean as much as $15 million to the Yankees. It's difficult to predict how much value Santana will deliver as a postseason player, but if we make the assumption that his presence increases the Yankees' chances of advancing one additional round by 50 percent, we can credit him with another $7.5 million in expected value.
Beyond his regular-season performance value and potential playoff impact, the final dimension of Santana's worth to the Yankees is his marquee value – the value that accrues to high-profile, star players by helping to personalize the team's brand and support their winning image. This is the toughest value component to quantify.
However, given Santana's stature and his potential popularity as the ace on the highest valued team in MLB, we can ascribe about $4 million in additional value per year. This approach divides one-third of the annual appreciation of the Yankees franchise among the star players on the team. If we assume the Yankees appreciate in value by about $75 million per year, then collectively the star players – Rodriguez, Derek Jeter, Mariano Rivera, Robinson Cano, Jorge Posada and now Santana – could be responsible for about $25 million of the annual appreciation. (Figure 1 shows the projected revenues of Santana as a Yankee.)
On the cost side, we can expect the tab for Santana to be in the neighborhood of $25 million a year for six years. Since the Yankees are over the luxury tax threshold and A-Rod's contract virtually eliminates any chance that they will go below it in the near future, the Yankees will be on the hook for another $10 million per year in luxury taxes, raising Santana's cost to about $35 million per year. The net result is that Santana would be a value-added signing for the Yankees, even at his steep price – generating about $225 million in revenues and asset appreciation and costing about $200 million, yielding a rate of return of 24 percent on their investment, probably enough to compensate the Yankees for the injury risk associated with any free agent pitcher.
The Value of Hughes and Co.
Let's look at the price the Yankees would need to pay the Twins in order to secure Santana. A team's most valuable assets are its young major leaguers with five or six years of discounted wages ahead of them before free agency. Let's make the conservative assumption that Hughes pitches at the level of a number three starter – akin to the 2007 version of the Cubs' Rich Hill, or the Giants' Matt Cain – for each of the next six years. That means Hughes would be worth about three marginal wins above a replacement player per season. Hughes will be paid a modest (less than $500,000) annual salary over the next two years until he reaches arbitration eligibility. By looking at comparable players and adjusting for inflation, we can estimate that he should earn about $30 million in the next six years. Alternatively, his team would need to pay about $84 million in free-agent wages to buy the same wins. So Hughes' asset value is more than $50 million – the amount of payroll savings he will generate for the team that owns his contract versus buying his performance in the free-agent market. (See Figure 2.) By including Melky Cabrera in the trade, another $10 million in asset value is added, and another pitching prospect further bumps up the total cost of the deal.
The net impact for the Yankees is a contract extension for Santana that gets the Yankees about $25 million in value, but is more than offset by trading Hughes, Cabrera and one or two other minor league prospects, giving up about $60 to $70 million in value. What would need to happen to make this a good trade for the Yankees? If Santana signs with the Yankees at $5 million to $7 million per year below the price he would have gotten in an open bidding war as a free agent next winter, or if Hughes becomes only a fifth starter or bullpen reliever, the deal could make sense for the Yankees.
The Red Sox and Mets
For the Red Sox, a trade is even more difficult to rationalize, driven by the lower free-agent valuation of Santana in a sold-out Fenway Park. Santana's financial value to the Red Sox is in the range of $18 million to $20 million versus his annual value of over $30 million to the Yankees. Starter Jon Lester's value may be lower than Hughes' value because Lester has fewer years remaining until free agency, and outfielder Jacoby Ellsbury's value is likely less than Hughes' due to the premium paid to starting pitchers. However, neither of these facts changes the reality that the free-agent cost of Santana alone is likely more than his worth to the Red Sox. It may be that the only reason they are involved in trade talks is to bid up the acquisition price of Santana for the Yankees.
The discussions between the Twins and Mets may hold the most promise. Acquiring Santana and signing him to a long-term deal is economically viable for the Mets because they have a new stadium in the works, their revenue would spike if they reach the postseason and they could remain under the luxury tax threshold. Santana's potential revenue value to the Mets would average an estimated $40 million per year and would exceed his cost by about $100 million over six years, assuming the Mets can stay under the luxury tax threshold. This justifies the Mets packaging a combination of prospects from the list of Philip Humber, Carlos Gomez, Deolis Guerra, Kevin Mulvey and Fernando Martinez. If three of the five prospects materialize into a number three pitcher in the rotation, a starting outfielder and a solid relief pitcher, then the Twins and the Mets receive about the same value in the trade.
One factor working in favor of a trade is the Twins' unwillingness to pony up the dollars to sign Santana to a long-term deal, which eventually could prompt them to lower their demands. On the other end of the deal, a team desperate for Santana could ignore the dramatic financial value created by developing front line pitching internally and take on the injury risk associated with giving a long-term deal to a starting pitcher who has averaged 228 innings over the past four years.
Any team who makes this trade will likely set its farm system back while placing a tremendous investment – and therefore risk – in one player. But if Santana ends up taking the hill in Game 1 of the World Series, the deal will considered a good one.
Vince Gennaro is a consultant to several Major League Baseball teams and the author of "Diamond Dollars: The Economics of Winning in Baseball," an innovative look at the business of baseball. This followed a 20-year career at PepsiCo, where he was president of a billion-dollar division. Gennaro teaches a graduate course on the business of baseball in the Sports Business Management program at Manhattanville College. Send Vince a question or comment at vgennaro07@yahoo.com.
Tuesday, January 22, 2008
Legal: Mortgage Insurer Attacks GE subsidiary-- subprime lender WMC Mortgage
(Editor's Note: GE purchased WMC from Apollo Management in 2004)
If Everyone’s Finger-Pointing, Who’s to Blame?
By VIKAS BAJAJ
Published: January 22, 2008
New York Times
Everyone wants to know who is to blame for the losses paining Wall Street and homeowners.
The answer, it seems, is someone else.
A wave of lawsuits is beginning to wash over the troubled mortgage market and the rest of the financial world. Homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists. And investors are suing everyone.
The legal and regulatory wrangles could dwarf the ones that followed the technology stock bust and the Enron and WorldCom debacles. But the size and complexity of the modern mortgage market will make untangling the latest mess even trickier. Some cases stretch across continents. Others are likely to involve state and federal regulators.
“It will be a multiring circus,” said Joseph A. Grundfest, a professor of law and business and co-director of the Rock Center for Corporate Governance at Stanford. “This particular species of litigation will be manifest in many different types of lawsuits in many different jurisdictions.”
The legal battles stretch from Main Street to Wall Street and beyond. Homeowners and subprime mortgage lenders are squaring off in scores of cases that claim some lenders engaged in predatory lending practices and other wrongdoing. Cleveland and Baltimore are pursuing cases against Wall Street banks, saying local residents are suffering because the banks fostered the proliferation of high-risk home loans.
Two questions lie at the heart of many of the cases. The first is whether lenders and investment banks alerted borrowers and investors to the risks posed by subprime loans or securities backed by them. The second is how much they were legally obliged to disclose. “Those are the two issues that are frequently raised,” said Jayant W. Tambe, a partner at the law firm Jones Day.
As defaults and foreclosures rise, the various players in the housing market are all pointing fingers at each other. State prosecutors like Andrew M. Cuomo, the attorney general of New York, are investigating whether investment banks that packaged mortgages into securities disclosed the risks to investors and credit ratings agencies. Investment banks, in turn, are accusing lenders and mortgage brokers of shoddy business practices.
“What strikes me here is that this a tainted system from A to Z,” said Tamar Frankel, a law professor at Boston University. “Everybody blames everybody else. If you look at what is being said, there isn’t one who doesn’t blame another and there is half-truth in everything.”
Wall Street banks that sold mortgage investments around the world face legal complaints from as far away as Australia and Norway. Lehman Brothers, the Wall Street bank with the biggest mortgage business, is being sued by towns in Australia that say a division of the firm improperly sold them risky mortgage-linked investments. Lehman has denied the charges and has said the unit, formerly known as Grange Securities, acted properly.
Closer to home, members of a New Jersey family have sued Lehman for $4.14 billion, saying the firm steered them into complex securities that have become difficult to sell, Bloomberg News reported Friday. Lehman denied the accusations.
In the United States, Lehman is suing at least six mortgage lenders and brokers like Fremont Investment and Loan and the Fieldstone Investment Corporation, claiming they sold Lehman dubious loans. Lehman claims that borrowers’ incomes were overstated, appraisals were inflated and the homes were in poor condition. In most cases, the lenders are fighting the allegations and Lehman’s demand that they buy back defaulted or otherwise problematic loans.
In another case, the PMI Group, a mortgage insurer, sued WMC Mortgage, a subprime lender that has stopped making loans, and its corporate parent, General Electric, in California Superior Court. PMI is trying to force the companies to buy back or replace loans that the firm was hired to insure and that it says were made fraudulently or in violation of the standards that the lender said it was using.
According to the lawsuit, a review of loans found “a systemic failure by WMC to apply sound underwriting standards and practices.” Reviewing a sample of the nearly 5,000 loans in the pool, Clayton, a consultant that reviews mortgage loans, identified 120 “defective” loans for which borrowers’ incomes and employment were incorrect or where the borrower’s intention to live in the home was incorrect. WMC offered to buy back 14 loans, according to the lawsuit.
Some of the loans have defaulted, and a trustee’s report on the pool of loans packaged and underwritten by UBS, the Swiss investment bank, shows that losses on some defaulted mortgages are as high as 100 percent. As of November, about 27 percent of the loans in the pool were either delinquent 60 days or more, in foreclosure or had resulted in a repossessed home.
PMI is on the hook for losses on defaulted loans, lost interest and principal payments to investors who own a $29.6 million slice of bonds backed by the mortgages. A senior vice president at PMI, Glenn Corso, said he was unsure how much the company had paid out so far.
A spokesman for G.E., Robert Rendine, declined to comment, citing the pending litigation.
Securities lawyers say cases involving mortgage-backed securities, which were generally sold privately to sophisticated institutional investors, are far more complicated than those involving stocks, which were sold publicly to everyday investors. Class-action lawsuits, a favorite tool of plaintiffs’ attorneys, will be employed less than they were after the plunge in technology stocks a few years ago because mortgage securities tend to vary in composition and disclosure.
“This is going to be much more complicated to prove, and it’s going to be case by case as opposed to class-actions,” said David J. Grais, who is a partner at the Grais & Ellsworth law firm in New York and an author of a recent paper on the legal liabilities of credit ratings firms. “This resembles the S&L crisis in the ’80s much more than it does the tech bubble in the ’90s.”
Class-action filings spiked earlier this decade, jumping to 497 in 2001, from 215 the year before, according to Cornerstone Research, which compiles the figures in cooperation with the Stanford Law School. As those suits were resolved, new filings fell to a low of 118 in 2006. But as of mid-December, filings had jumped to 169, with about 32 of the cases related to the mortgage crisis.
Through the end of 2006, settlements in technology- and telecommunications-related class-action suits brought by shareholders totaled $15.4 billion, with more than a third of that coming from one company, WorldCom, according to Cornerstone. Settlements in Enron-related cases have totaled about $7.2 billion so far; the figure does not include Securities and Exchange Commission fines and settlements.
Bringing securities fraud cases has been made harder by recent Supreme Court decisions that favored Wall Street, companies and professionals like accountants. The court ruled earlier this month that two technology vendors could not be held liable for taking part in a scheme designed by a cable company to inflate its revenue. Last summer, in a ruling favoring the company, Tellabs, the court said that securities cases could be dismissed if investors did not show “cogent and compelling” evidence of intent to defraud.
Some plaintiffs are using other legal avenues like the pension law, the Employment Retirement Income Security Act. Under that law, managers who handle pension funds must act in the fiduciary interest of their clients. State Street Global Advisors, which manages pension money, has set aside $618 million to settle claims that the firm invested in risky mortgage-related securities.
Some legal experts say that the recent Supreme Court decisions, which are largely based on cases bought by shareholders, may not have much bearing on the more complex cases that stem from securitization of mortgages.
“There will be a whole new set of claims that deal with the unique nature of the securitization market,” Mr. Tambe of Jones Day said. “There will have to be new decisions that deal with those claims and a learning process for the bar and judiciary in those cases.”
If Everyone’s Finger-Pointing, Who’s to Blame?
By VIKAS BAJAJ
Published: January 22, 2008
New York Times
Everyone wants to know who is to blame for the losses paining Wall Street and homeowners.
The answer, it seems, is someone else.
A wave of lawsuits is beginning to wash over the troubled mortgage market and the rest of the financial world. Homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists. And investors are suing everyone.
The legal and regulatory wrangles could dwarf the ones that followed the technology stock bust and the Enron and WorldCom debacles. But the size and complexity of the modern mortgage market will make untangling the latest mess even trickier. Some cases stretch across continents. Others are likely to involve state and federal regulators.
“It will be a multiring circus,” said Joseph A. Grundfest, a professor of law and business and co-director of the Rock Center for Corporate Governance at Stanford. “This particular species of litigation will be manifest in many different types of lawsuits in many different jurisdictions.”
The legal battles stretch from Main Street to Wall Street and beyond. Homeowners and subprime mortgage lenders are squaring off in scores of cases that claim some lenders engaged in predatory lending practices and other wrongdoing. Cleveland and Baltimore are pursuing cases against Wall Street banks, saying local residents are suffering because the banks fostered the proliferation of high-risk home loans.
Two questions lie at the heart of many of the cases. The first is whether lenders and investment banks alerted borrowers and investors to the risks posed by subprime loans or securities backed by them. The second is how much they were legally obliged to disclose. “Those are the two issues that are frequently raised,” said Jayant W. Tambe, a partner at the law firm Jones Day.
As defaults and foreclosures rise, the various players in the housing market are all pointing fingers at each other. State prosecutors like Andrew M. Cuomo, the attorney general of New York, are investigating whether investment banks that packaged mortgages into securities disclosed the risks to investors and credit ratings agencies. Investment banks, in turn, are accusing lenders and mortgage brokers of shoddy business practices.
“What strikes me here is that this a tainted system from A to Z,” said Tamar Frankel, a law professor at Boston University. “Everybody blames everybody else. If you look at what is being said, there isn’t one who doesn’t blame another and there is half-truth in everything.”
Wall Street banks that sold mortgage investments around the world face legal complaints from as far away as Australia and Norway. Lehman Brothers, the Wall Street bank with the biggest mortgage business, is being sued by towns in Australia that say a division of the firm improperly sold them risky mortgage-linked investments. Lehman has denied the charges and has said the unit, formerly known as Grange Securities, acted properly.
Closer to home, members of a New Jersey family have sued Lehman for $4.14 billion, saying the firm steered them into complex securities that have become difficult to sell, Bloomberg News reported Friday. Lehman denied the accusations.
In the United States, Lehman is suing at least six mortgage lenders and brokers like Fremont Investment and Loan and the Fieldstone Investment Corporation, claiming they sold Lehman dubious loans. Lehman claims that borrowers’ incomes were overstated, appraisals were inflated and the homes were in poor condition. In most cases, the lenders are fighting the allegations and Lehman’s demand that they buy back defaulted or otherwise problematic loans.
In another case, the PMI Group, a mortgage insurer, sued WMC Mortgage, a subprime lender that has stopped making loans, and its corporate parent, General Electric, in California Superior Court. PMI is trying to force the companies to buy back or replace loans that the firm was hired to insure and that it says were made fraudulently or in violation of the standards that the lender said it was using.
According to the lawsuit, a review of loans found “a systemic failure by WMC to apply sound underwriting standards and practices.” Reviewing a sample of the nearly 5,000 loans in the pool, Clayton, a consultant that reviews mortgage loans, identified 120 “defective” loans for which borrowers’ incomes and employment were incorrect or where the borrower’s intention to live in the home was incorrect. WMC offered to buy back 14 loans, according to the lawsuit.
Some of the loans have defaulted, and a trustee’s report on the pool of loans packaged and underwritten by UBS, the Swiss investment bank, shows that losses on some defaulted mortgages are as high as 100 percent. As of November, about 27 percent of the loans in the pool were either delinquent 60 days or more, in foreclosure or had resulted in a repossessed home.
PMI is on the hook for losses on defaulted loans, lost interest and principal payments to investors who own a $29.6 million slice of bonds backed by the mortgages. A senior vice president at PMI, Glenn Corso, said he was unsure how much the company had paid out so far.
A spokesman for G.E., Robert Rendine, declined to comment, citing the pending litigation.
Securities lawyers say cases involving mortgage-backed securities, which were generally sold privately to sophisticated institutional investors, are far more complicated than those involving stocks, which were sold publicly to everyday investors. Class-action lawsuits, a favorite tool of plaintiffs’ attorneys, will be employed less than they were after the plunge in technology stocks a few years ago because mortgage securities tend to vary in composition and disclosure.
“This is going to be much more complicated to prove, and it’s going to be case by case as opposed to class-actions,” said David J. Grais, who is a partner at the Grais & Ellsworth law firm in New York and an author of a recent paper on the legal liabilities of credit ratings firms. “This resembles the S&L crisis in the ’80s much more than it does the tech bubble in the ’90s.”
Class-action filings spiked earlier this decade, jumping to 497 in 2001, from 215 the year before, according to Cornerstone Research, which compiles the figures in cooperation with the Stanford Law School. As those suits were resolved, new filings fell to a low of 118 in 2006. But as of mid-December, filings had jumped to 169, with about 32 of the cases related to the mortgage crisis.
Through the end of 2006, settlements in technology- and telecommunications-related class-action suits brought by shareholders totaled $15.4 billion, with more than a third of that coming from one company, WorldCom, according to Cornerstone. Settlements in Enron-related cases have totaled about $7.2 billion so far; the figure does not include Securities and Exchange Commission fines and settlements.
Bringing securities fraud cases has been made harder by recent Supreme Court decisions that favored Wall Street, companies and professionals like accountants. The court ruled earlier this month that two technology vendors could not be held liable for taking part in a scheme designed by a cable company to inflate its revenue. Last summer, in a ruling favoring the company, Tellabs, the court said that securities cases could be dismissed if investors did not show “cogent and compelling” evidence of intent to defraud.
Some plaintiffs are using other legal avenues like the pension law, the Employment Retirement Income Security Act. Under that law, managers who handle pension funds must act in the fiduciary interest of their clients. State Street Global Advisors, which manages pension money, has set aside $618 million to settle claims that the firm invested in risky mortgage-related securities.
Some legal experts say that the recent Supreme Court decisions, which are largely based on cases bought by shareholders, may not have much bearing on the more complex cases that stem from securitization of mortgages.
“There will be a whole new set of claims that deal with the unique nature of the securitization market,” Mr. Tambe of Jones Day said. “There will have to be new decisions that deal with those claims and a learning process for the bar and judiciary in those cases.”
Friday, January 04, 2008
Obama wins Iowa: Promises to Check in 2012?
By AMY LORENTZEN, Associated Press Writer Fri Jan 4, 12:15 AM ET
DES MOINES, Iowa - A victorious Barack Obama portrayed his decisive first-place finish in the Iowa Democratic caucuses as a "defining moment" that he said would lead the way to change in Washington and an end to the war in Iraq.
The first-term senator from Illinois promised "a nation less divided and more united" and told those at a victory rally they could some day "look back and say this is the moment where it all began."
Obama, 46, is bidding to become the first black president. He garnered about 38 percent of the vote, comfortably ahead of former North Carolina Sen. John Edwards and Sen. Hillary Rodham Clinton, the former first lady.
"They said this day would never come. They said our sights were set too high. ... But on this January night, on this defining moment in history, you have done what the cynics said we couldn't do. You did what the state of New Hampshire can do in five days," Obama said.
If elected, Obama vowed, "I'll be a president that ends this war in Iraq and finally brings our troops home, who restores our moral standing, who understands that 9-11 is not a way a way to scare up votes but a challenge that should unite America and the world against the common threats of the 21st Century."
"Hope is the bedrock of this nation, the belief that our destiny will not be written for us but by us, by all those men and women who are not content to settle for the world as it is but who have the courage to remake the world as it should be," he said. "That is what we started here in Iowa and that is the message we can now carry to New Hampshire and beyond."
He appeared at the rally with his wife, Michelle, whom he called "the love of my life," and daughters Malia and Sasha.
As he came to the podium, he repeated "thank you" over and over to a crowd of supporters. Then, he added: "Thank you, Iowa."
An influx of new caucus-goers helped to boost Obama to victory in Iowa.
"We came together as Democrats, as Republicans and independents, to stand up and say we are one nation, we are one people and our time for change has come," Obama said as he launched his victory speech.
The freshman senator from Illinois was able to convince Iowans that he could do the most to shake up Washington, a feat that Clinton and Edwards had argued they'd be best able to accomplish.
Iowa was a three-way race for the Democratic contenders for months leading up to the caucuses, the first of the presidential nominating contests. Obama's win there gives him crucial momentum heading into New Hampshire, which holds its first-in-the-nation primary on Tuesday.
Obama repeatedly sparred with Clinton during the campaign over who was ready to lead the country. She accused him of being naive and inexperienced; he said her decades of Washington experience would mean more of the same if she were elected. Edwards faulted Obama's health care proposal, saying it would leave millions without coverage.
The Harvard Law School graduate launched his career by organizing black churches on the industrial South Side of Chicago. A turning point in his life came when he was chosen as the keynote speaker at the 2004 Democratic National Convention. He was elected to the U.S. Senate just four months later and became only the third black U.S. senator since Reconstruction.
After just two years in the Senate, Obama announced on the steps of the Old Capitol in Springfield, Ill., that he was running for president.
DES MOINES, Iowa - A victorious Barack Obama portrayed his decisive first-place finish in the Iowa Democratic caucuses as a "defining moment" that he said would lead the way to change in Washington and an end to the war in Iraq.
The first-term senator from Illinois promised "a nation less divided and more united" and told those at a victory rally they could some day "look back and say this is the moment where it all began."
Obama, 46, is bidding to become the first black president. He garnered about 38 percent of the vote, comfortably ahead of former North Carolina Sen. John Edwards and Sen. Hillary Rodham Clinton, the former first lady.
"They said this day would never come. They said our sights were set too high. ... But on this January night, on this defining moment in history, you have done what the cynics said we couldn't do. You did what the state of New Hampshire can do in five days," Obama said.
If elected, Obama vowed, "I'll be a president that ends this war in Iraq and finally brings our troops home, who restores our moral standing, who understands that 9-11 is not a way a way to scare up votes but a challenge that should unite America and the world against the common threats of the 21st Century."
"Hope is the bedrock of this nation, the belief that our destiny will not be written for us but by us, by all those men and women who are not content to settle for the world as it is but who have the courage to remake the world as it should be," he said. "That is what we started here in Iowa and that is the message we can now carry to New Hampshire and beyond."
He appeared at the rally with his wife, Michelle, whom he called "the love of my life," and daughters Malia and Sasha.
As he came to the podium, he repeated "thank you" over and over to a crowd of supporters. Then, he added: "Thank you, Iowa."
An influx of new caucus-goers helped to boost Obama to victory in Iowa.
"We came together as Democrats, as Republicans and independents, to stand up and say we are one nation, we are one people and our time for change has come," Obama said as he launched his victory speech.
The freshman senator from Illinois was able to convince Iowans that he could do the most to shake up Washington, a feat that Clinton and Edwards had argued they'd be best able to accomplish.
Iowa was a three-way race for the Democratic contenders for months leading up to the caucuses, the first of the presidential nominating contests. Obama's win there gives him crucial momentum heading into New Hampshire, which holds its first-in-the-nation primary on Tuesday.
Obama repeatedly sparred with Clinton during the campaign over who was ready to lead the country. She accused him of being naive and inexperienced; he said her decades of Washington experience would mean more of the same if she were elected. Edwards faulted Obama's health care proposal, saying it would leave millions without coverage.
The Harvard Law School graduate launched his career by organizing black churches on the industrial South Side of Chicago. A turning point in his life came when he was chosen as the keynote speaker at the 2004 Democratic National Convention. He was elected to the U.S. Senate just four months later and became only the third black U.S. senator since Reconstruction.
After just two years in the Senate, Obama announced on the steps of the Old Capitol in Springfield, Ill., that he was running for president.
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