To Our Clients, Colleagues and Friends:

Remember New Century? The Court appointed bankruptcy examiner has already turned over 17 million pages of documents. Oh, and 1,000 gigabytes of files from shared network drives.

Did anyone notice that Indymac’s retail Loan Group closed $345 million in November, up from only $9.0 million a year ago? IMB is doing a good job of adjusting to a new environment. Oh, and their Financial Freedom group closed $367 million in reverse mortgages in November. We also saw that 93.5% of their servicing portfolio consists of first lien mortgages.

This will be controversial, but we think there’s a very slim 2-3% chance that Countrywide’s bank could fail before the BofA acquisition takes place. From what we understand, the BofA will not support their capital or liquidity during this period, and when we look at the rates CFC is paying for deposits, we just get very nervous.

There’s still a reg on the books that a “troubled bank” can’t pay deposit rates more than 50 bps over the prevailing rates in their markets. But is Countrywide a “troubled bank”? We don’t know that, but after their next Safety & Soundness Exam, and after what we believe will be big write-offs in the 4th quarter, we just don’t see them getting a healthy CAMEL rating from the OTS. They’re obviously not getting a CAMEL-One or CAMEL-Two, and even CAMEL-Three would seem unlikely. We believe that a CAMEL-Four or Five automatically gets you labeled a “troubled bank, and if this happens, we think they’d be unable to offer such high rate deposits and could have serious liquidity problems. If we’re wrong, and we hope we are, we would still expect a substantial re-pricing of the deal. Let’s remember that, even if Countrywide’s bank ran into trouble, their mortgage company would still go forward.

When there’s a mania or bubble that everyone gets caught up in, can you blame any one individual or group of individuals? With the mortgage situation, who wasn’t involved? Participants were securitizers, mortgage brokers, mortgage bankers, rating agencies, commercial banks, bond insurers, investors and just about everyone else. Quite frankly, we don’t remember anyone of note warning that this would end badly, and we never heard of any Board members loudly objecting. So if everyone participated, then we really can’t point fingers. This kind of supports our questioning the firing of the CEO at Merrill Lynch, Citigroup, Bear, Stearns et al. It’s just not possible to really blame their company’s woes on their decisions. There was a collective bubble or mania going on, and no one was immune.

We’ve been thinking a lot about the mortgage mess of 2007 and trying to look at it in the context of the S&L crisis of the late 80’s and early 90’s. Back then, there was economic activity with massive overbuilding. But when it was all over, the nation had a lot of new office buildings, apartment complexes and malls. Ultimately, they all got leased up and became part of the infrastructure of our economy. And back then, the S&L crisis didn’t seem to have created global problems.

With the current crisis, banks throughout the world have been impacted. And what was the end result? A lot of mortgage brokers made a fortune, but they’re now unloading their Mercedes and are looking for work. The Wall Street players are taking massive layoffs and diluting shareholders by raising new capital, much of it from foreign governments. And a lot of people bought homes they couldn’t afford and are now losing them to foreclosures. So in the end, this one seems to have added nothing to the economy – and may actually have been a net negative. We know it sounds simplistic, but it’s just a thought on a Saturday morning.

When banks take massive write-offs, does that really impact the economy? It does. Big losses mean less capital, and less capital means less lending. Citigroup has shrunk something like $170 billion from a year ago. And if you assume that loans make up something like 50-90% of the assets of most banks, that’s potentially $85-$153 billion fewer loans at Citi alone. Fewer loans mean less economic growth. So yes, mortgage related write-offs do have a serious impact on the economy, here and around the globe.

In response to all the interest in grammar last week, we looked up Dave Barry’s Book of Modern Grammar and offer the following. “It is with great verisimilitude that we present another installation of “Ask Mr. Language Person.” Q. Like millions of Americans, I cannot grasp the eternally subtle difference between the word “your” and “you’re”.

A. Top grammar scientists are often confused by these two words, which are technically known as “bivalves”, or words that appear to be identical and have hinged shells. The best way to tell them apart is to remember “you’re” is a contraction, which is a type of word used during childbirth, as in “Hang on, honey, here comes you’re baby.” Whereas “your” is, grammatically, a prosthetic infarction, which means a word that is used to score a debating point in an internet chat room, as in “Your a looser, you moron.”

What about our comment above on Countrywide? Before you get too excited about the scenario we posed, read it again. We called it a very slim chance, maybe a 2-3% likelihood of occurring. So, no, we obviously don’t think it will happen. We just think it’s a possibility.

If you’re reading this, there’s a good chance your company has survived and, while not thriving, is at least making a small profit. At your next Senior Managers meeting, it might be worth discussing the lessons learned these past few years and what risk management processes you can institute to make certain it doesn’t happen again. Okay? Just because you’re only originating FNMA-eligible loans doesn’t mean you can’t have buy backs or other problems. This is no time for complacency and a good time to think about safeguards to prevent future near death experiences.

Joe Garrett and Corky Watts – Garrett, Watts & Co. -
http://garettwats.com/