aThe news of the day is BofA's acquisition of Countrywide (CWF). This is an interesting story. It could be a 1) good money after bad story 2) a bargain because BofA has an incredible ability to offer retail banking products (credit cards) to all those CWF customers 3) a really, really bad disaster if the costs of the litigation losses from the lending practices of CWF prove gigantic rather that large.
This is my perspective: BofA is deadly serious about increasing its retail mortgage profile. One of the core beliefs of BofA's present management is that mortgage loan customers can be cross-sold other banking products such as credit cards and can, consequently, become profit centers.
So what BofA is getting is CWF's servicing portfolio and the database of clients and what they are risking is the potential of some gigantic losses associated with the litigation which will result from potential class action lawsuits regarding CWF's lending practices.
The losers are the folks who created CWF and worked to make it the great company which it was. They made the one mistake of getting heavily into subprime because it was short-term profitable. In a sense the story of CWF is a capsule of the mortgage disaster. The winners are litigation attorneys. Litigation law firms now have BofA to pay the cost of potential litigation rather than suing a bankrupt CWF and counterparties.
The mortgage business is still in a state of chaos. The most important thing is getting credit insurance for Jumbos. It does not appear to me as is anyone is really addressing this issue but rather papering it over.
Let's go bank and examine what insurance is. Insurance is the exchange of a relatively small loss (the principle payment) in place of the possibility of a potential large loss. Looked at over time one can personalize this by regarding it as a payment plan for disasters. In essence whet we get out is equal to what we put in, It's just that we put it in in small amounts and take it out in large amounts.
In short there is no mystery. Credit default insurance must be built into the cost of the loan - either up front or in the cash stream or both. In the subprime disaster the money to cover the credit insurance is not there because the risk was, as Mr. Bush would say, misunderestimated.
The present credit insurers are - how to put this? - uhh, bleeped. The alternatives are 1) have the lenders pump more money into them so that the insurance can be paid 2) have the debt issuers take the loss because the insurers fold 3) let 2 happen and create new credit insurers.
V) Data and Analysis
Last December I was at a meeting with a bioscientist (this is something which I will write about in a future newsletter). One topic we were discussing was how a scientist deals with the large amount of research published in his field. He picked up a journal which had been sitting on his desk and made an insightful comment. He said, essentially, "The thing to do is read these articles and just look at the data and pay no attention to the conclusions drawn by the researchers."
His notion was that anyone reading any such publication was just as capable of drawing his own conclusions from the data than the authors were.
Of course with science there may be cases where profound conclusions are drawn but they are, in fact, rare.
We live in a media-rich era. Economic data is treated like yesterday's sports scores - not really important. The savants and the people who play fantasy baseball want to guess what is going to happen tomorrow or, at bare minimum, draw conclusions from yesterday's data.
A few weeks ago I commented that I found it strange that the NYT defined Christmas Retail Sales gains of +3.6% as "weak." To me, a gain of +3.6% in face of the mortgage crisis was indicative of strength. The NYT points out that sales grew 6.6 percent in 2006 and 8.7 percent in 2005 so, yes, the rate of growth was smaller in 2007 than in the pervious two year but the 3.6% growth in 2007 was compounded on the growth of the previous two years. In short, Retail Christmas Sales are 120.04% of what they were three years ago.
The point here is that the data is the data and while the New York Times and Dick Lepre may have varying opinions about what the data implies you should look at the data and draw your own conclusions. What I mean is that markets may work best if individuals look at the data, draw their own conclusions and make market decisions accordingly.
At the opposite end of the spectrum one has things such as the CIA. These are folks who amass large amounts of data, draw conclusions, and then only share the conclusions with the public not the data. Perhaps it is more accurate to say that they only share that part of the data which supports the conclusions.
I am in no way suggesting that the CIA should share everything of even anything. I am simply stating that the process of presenting the conclusions without presenting data may well be flawed simply because the data is much more important than the conclusions.
My belief here is in keeping with the fact that I value the technical interest rate forecasts. The technicals do not really draw any conclusions except for the thesis that it is that data that drives the data. The stochastic seeks no rationalization of what happened or what is going to happen. It is a notion that markets have cycles and it seeks to quantify those cycles. It does not forecast economic fundamentals.
Markets
Another issue is that markets tend to trade based not on data but on guesses about data. The typical scenario is that a company announces its quarterly and the earnings and sales are great and the stock gets hammered because the data was presumed.
So we have an unfortunate paradox. It is the data that is important to the economy but it is the opinions about what the data will be and the difference between the forecast and the actual data that moves markets.
Dick Lepre
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