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Make builders, lenders fix the housing mess
So this time around we have home builders admitting that employees regularly lied or broke federal lending rules in order to sell houses to unqualified buyers. That, of course, inflated revenues. For example, Beazer Homes (BZH, news, msgs) has admitted that it violated federal housing rules by arranging for nonprofit organizations to lend potential buyers their down payments -- and then repaid the nonprofit by rolling the "down payment" into the buyer's mortgage. On Oct. 11, the company told Wall Street that it expects to pay about $15 million in fines. The stock actually rallied on that news because Wall Street analysts had been projecting the company would face much steeper financial penalties.
Make builders, lenders fix the housing mess
The housing industry showed incredible creativity when it came to qualifying people for mortgages they couldn't afford. Let's make its leaders put their thinking caps on again and fix the problem.
By Jim Jubak
Remember Enron? The company claimed revenues of $111 billion in 2000 only to file for bankruptcy in 2001 when it turned out that revenues, profits and asset holdings were either wildly overinflated or didn't exist at all.
Losses to shareholders were variously estimated at $60 billion to $80 billion. Those are huge numbers. But when you add up all the fines and settlements paid by the parties the courts decided were responsible for at least part of the fraud, it comes to less than $10 billion.
So now we're in the midst of the mortgage and housing mess, and it's reminding me more and more of the Enron scandal every day.
- Inflated revenues? Check.
- Accounting fraud? Check.
- CEO selling stock just before the company's fortunes tank? Maybe. The Securities & Exchange Commission has opened an investigation into stock sales by Angelo Mozilo, CEO of Countrywide Financial (CFC, news, msgs). More on that later.
Before we go down the same unsatisfying road once again, I'd like to propose a different approach to dealing with this latest disaster: Let the punishment fit the crime. Make the companies, the CEOs, the managers and the employees who violated regulations and laws pay off their fines not with cash, but by working out new terms to save the loans they made that are about to go bad.
Hey, who better to fix these mortgages than the companies that made these loans in the first place?
No one left to repair loans
We sure can't leave the industry to fix itself. Because so many mortgage lenders have laid off staff, they don't have enough people to handle all the requests for refinancings and workouts that are flooding their offices. According to Moody's (MCO, news, msgs), lenders have eased terms on just 1% of the subprime-mortgage loans that have reset in January, April and July of this year.
If a subprime borrower can't get someone in the mortgage industry to pay attention, the odds of that borrower going into default go up with every passing month. With more than $350 billion of adjustable-rate mortgages due to reset at higher interest rates in the next 18 months, the problem is only getting bigger.
So this time around we have home builders admitting that employees regularly lied or broke federal lending rules in order to sell houses to unqualified buyers. That, of course, inflated revenues.
For example, Beazer Homes (BZH, news, msgs) has admitted that it violated federal housing rules by arranging for nonprofit organizations to lend potential buyers their down payments -- and then repaid the nonprofit by rolling the "down payment" into the buyer's mortgage. On Oct. 11, the company told Wall Street that it expects to pay about $15 million in fines. The stock actually rallied on that news because Wall Street analysts had been projecting the company would face much steeper financial penalties.
Why did Beazer break the rules? Just as with Enron, the point of all these games was to inflate revenue. And just as with Enron, when the referees put an end to the games, revenue vanished. Beazer, which is fighting to hold off creditors, saw 68% of its prospective home buyers cancel their orders in the quarter that ended on Sept. 30.
Optimistic lending
Beazer and other home builders faced a huge problem as the housing boom began to age and as the supply of traditional buyers began to flag.
To keep sales growing in 2006 and into 2007 at the same rate as in earlier parts of the boom, they had to create a new supply of buyers. To do that, home builders -- who went into the home-mortgage business themselves to an unprecedented degree -- and home-mortgage lenders had to find ways to get potential buyers with less money for a down payment, with less income as a percentage of their carrying costs, and with lower credit scores into houses.
But some of the games went well over the line from imprudent lending to outright fraud. For example, in one case reported by BusinessWeek involving Beazer, a family in suburban Maryland wasn't simply offered a chance to inflate its income on a no-verification loan, but actually received loan documents from Beazer with inflated income figures from nonexistent rental income written in.
No down payment? Don't worry!
And then, of course, there are all the games Beazer played to get houses for potential buyers without the money for a down payment. The federal rules are straightforward -- and not especially onerous. A buyer has to have a 3% down payment, and neither home builders nor mortgage lenders are supposed to lend it to them. Beazer, however, jumped through hoops to lend buyers that down payment, using intermediaries to hide the transaction.
The advantage to the home builder in making the loan is clear -- it creates a new pool of buyers. The downside of selling homes to potential buyers without even a 3% down payment is gradually becoming equally clear. In one Beazer Homes subdivision in Concord, N.C., almost one in five homes are now in foreclosure, according to The Charlotte Observer.
Whether the fines Beazer eventually pays are $15 million or $150 million, however, they won't do anything to help investors recoup the $1.5 billion they've lost in the stock as it plunged to $8.38 on Oct. 17 from $47 a share at the end of 2006. The best those folks can expect from an Enron-style settlement is pennies on the dollar.
And the fines won't do anything to help home buyers who are about to lose their homes to foreclosure. Nationally, the number of foreclosures hit 223,538 in September, a jump of almost 100% from September 2006, according to RealtyTrac.
What we need is to put some people who know the ins and outs of this mess -- because they helped create it -- to work on the problem, and then motivate them, and I mean really motivate them, to fix as many of these problem loans as they can before the loans go bust. The bust would hurt both borrowers and shareholders in the home-building and mortgage-lending companies. Getting more loans worked out before they go into foreclosure would be a good deal for everyone.
And the nominee is . . .
And we may even have the perfect candidate to head up such an effort in Angelo Mozilo, the CEO of Countrywide.
I had this thought when I read that on Oct. 8, Richard Moore, state treasurer of North Carolina, asked the Securities and Exchange Commission to open an investigation into Countrywide stock sales made by Mozilo in the months before the subprime-mortgage meltdown took the price of company shares from $45 to $19. (On Oct. 18, the SEC acknowledged that it had opened an investigation into stock sales by Mozilo and other mortgage company CEOs.)
At the heart of Moore's request for an investigation, now under way, are changes to Mozilo's "automated" selling plans made in December 2006 and February 2007 when shares were selling for $40.50 and $45.03 respectively, that allowed the CEO to accelerate sales of company stock that he had acquired by exercising options.
Mozilo has had an existing 10b5-1 plan designed to automatically sell stock at regular intervals since 2004. Many CEOs use plans like these to avoid any appearance of selling on insider information. After all, if the sales occur every month on a regular schedule set when the plan is put in effect, then what the CEO knew and when the CEO knew it become irrelevant.
Mozilo's problem is that he put a new automatic selling program in place in October 2006 to replace the 2004 plan. Sales under the new plan were at a faster pace than under the old plan.
Then, on Dec. 12, according to the Los Angeles Times, he added a second automatic selling program that increased the number of shares he sold each month to a total of 465,000 from 350,000. And then, on Feb. 2, according to The New York Times, he amended the second plan to increase the number of shares sold each month to 580,000.
At the least, by adding and then amending these selling plans, Mozilo removed exactly the protection that the automatic nature of these plans is supposed to provide a CEO.
We don't know if Mozilo did anything illegal, and we won't until the Securities and Exchange Commission finishes its investigation. But he's certainly going to have to be more forthcoming with the regulators than he was in an interview conducted by CNBC's Maria Bartiromo and published in BusinessWeek on Sept. 10. Bartiromo asked Mozilo point-blank, "Did your planned selling accelerate beginning last fall?" And he said, "Let me see, there were two contracts involved. One, I think -- I don't know when these things originate -- was in October and one in December. And they didn't accelerate. There was just an additional contract put on, I believe, in December."
Put Mozilo to work
If he did break the rules, I don't want to see the SEC simply slap on a fine. I'd like to see it put Mozilo to work. The man who built Countrywide into a power in the home-mortgage industry is just the kind of person who could lead a national effort to work out as many of these troubled loans as possible in the coming months. And if the SEC found him guilty of violating securities regulations, it would certainly have the leverage to motivate him.
And if Mozilo hasn't violated any of the rules? Then bravo for him, and he's a very hard-charging but honest CEO. And maybe he'll volunteer to put his talents, and those of his company, to work helping as many subprime borrowers as possible work out their loans.
But I'm not pinning all my hopes on Mozilo. While he is the first mortgage-industry CEO suggested to the SEC for potential investigation, I doubt he'll be the last. I'd bet that before this mortgage mess is over, the agency will have more than enough candidates to let it be creative in fitting the punishment to the crime.
Developments on past columns
Shares of dry-bulk shippers are hot. How hot? So hot that my shares of Quintana Maritime (QMAR, news, msgs) climbed 13% between Oct. 11, when I wrote my column "5 bubble-proof foreign stocks," and Oct. 16, when it was posted. But freight rates for commodities such as coal and iron ore continue to move higher -- and look like they'll continue to climb in 2008. Analysts at Dahlman Rose raised their estimates on 2008 freight rates again on Oct. 17 and upped earnings estimates for dry-bulk shippers by 10% to 13%.
As I wrote when I added Quintana Maritime to Jubak's Picks on Oct. 16: "When dry-bulk shipping rates are at highs, it doesn't hurt to have ships coming off charter, because that gives a company a chance to sign them to new contracts at higher prices. Quintana Maritime has five ships coming off below-current-market-rate charters in the first two quarters of 2008. That's one reason I think earnings growth will beat Wall Street estimates of 54% growth in 2008 -- even after the company is on target to turn in 81% growth in 2007. And there may also be a silver lining for Quintana in the weak U.S. dollar.
"Thanks to rising U.S. exports, trade volumes in and out of U.S. ports seem to be equalizing. One indicator is the container market, where a year ago only 32% of containers shipped from the port of Los Angeles were loaded. This August, the percentage loaded with cargo came to 41%."
As of Oct. 19, I'm raising my target price on this stock to $32 a share by March 2008 from my prior target price of $28 a share.
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