Tom A's Stock Picks

Redefining "toxic waste"

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As the financial crisis has deepened, the use of the phrase "toxic waste" has come up as a convenient and descriptive term to cover MBS, CDO, CDO^2, RMBS, the whole alphabet soup of Structured Finance. The questionable ingredient in these securities has been residential mortgages, extending from sub-prime through Alt-A all the way to prime and jumbo. Let's remember what the underlying collateral is: it's the American Dream - home ownership.

Many of our ancestors lived as slaves, serfs or tenants on the estates of a privileged few, subject to the arrogant whims of a ruling elite, landless and powerless. Over a period of centuries, and at the expense of the self-sacrifice of many brave men, we have forged a nation that is freer, more equal, and more just than any other. To own one's own home in such a nation is a valuable privilege, beyond the means of most if it were not for the institution of mortgage financing. A home is the one acquisition for which borrowed money is normally a necessity: a mortgage can lay the foundation for a steady increase in personal net worth, enriching homeowners and society as a whole.

So let's not call residential mortgages, as an integral part of the American Dream, toxic waste.

In a previous existence, I was an insurance agent and wrote and serviced homeowners insurance on a good many houses. I inspected them all: went out and took a picture, and either measured them myself or secured a copy of the Assessor's field card, which included the dimensions. Using the dimensions and information provided by the insurance companies, I estimated the replacement cost of all of them and provided insurance in appropriate amounts. I lost a few customers because I would not insure the house itself for more than its replacement cost: remember, the land can't burn. I also lost some customers because I wouldn't under-insure in order to reduce cost. That was OK with me.

Across the hall from my office there was a mortgage broker, who seemed very prosperous. One of my clients, I'll call him Tommy because that was his name, used their services. I asked him why he didn't just go down to the bank and get a loan for himself. Tommy's response was straightforward: "He tells my lies for me." I supposed at the time that this was reasonable given Tommy was self-employed and couldn't document his income. But I used to ask myself whether telling people's lies for them didn't pay better than what I was doing.

It has become distressingly evident that there was a great deal of dishonesty involved by many parties to real estate transactions leading up to the bursting of the bubble. Some home-buyers overstated their incomes or claimed they would owner-occupy houses that were intended for flipping or rental. Some up-raisers submitted inflated appraisals, whether on their own or under encouragement from mortgage issuers. Some mortgage issuers knowingly accepted fraudulent or inflated transactions, secure in the knowledge they could pass the risk on down the line. Those who packaged the resulting transactions at times failed to do due diligence in verifying the quality. The rating agencies at times ignored their own duty of due diligence. Some underwriters at my bond insurers no doubt used a studied carelessness to avoid verifying the quality of the business they wrote. Those who sold the resulting structured finance product at times recommended the investments as safe when they knew otherwise. And so on and so forth, up and down the line.

The toxic waste here is greed and dishonesty.

Plans are being developed to permit the Treasury to buy these transactions. I believe it is necessary, support it, and look forward to the resulting improvement in the economy and the financial sector.

But I hope Treasury does not lose sight of the root cause of this evil. The individual transactions should be examined, bean by bean, and pushed back down the feeding chain to the responsible party. If there has been fraud, misrepresentation, or breach of warranty, let the perpetrators bear the consequences of their own actions. I don't mind contributing as a taxpayer to the support of the privilege of homeownership for as many as possible: what I do mind is paying for losses caused by greed and dishonesty.