The Mortgage Business Is No Fun Anymore

(Bloomberg View) -- Mortgages.

A few years ago I tried to add up all the fines that Bank of America Corp. had paid for doing bad mortgage stuff. There were a lot of them, enough that, as the internet decays, the chart that I put together appears to no longer be readable. The headline number -- $68 billion of fines, settlements, etc. at the time -- was big, but more interesting to me was the repetitiveness of the fines. Countrywide Financial Corp. sold bad mortgages to Fannie Mae and Freddie Mac between 2004 and 2008, and Bank of America bought Countrywide in 2008, and everyone sued, and Bank of America reached settlements with Freddie (in 2011) and Fannie (in 2013) over those mortgages. And then it reached a settlement with the Federal Housing Finance Agency over those mortgages in 2014. And then it lost a trial and was ordered to pay more money to the Justice Department over some of those loans, though that was later overturned. And then later in 2014 it reached a $16.7 billion settlement with the Justice Department and other agencies covering, among other things, those same loans. Bank of America basically spent the first half of this decade revisiting its mortgage misdeeds, over and over again, and paying for them each time.

It must have been pretty tedious for Bank of America! I wrote at the time:

A popular criticism of the modern approach to punishing bank misdeeds -- giant fines imposed on the banks, not much in the way of individual punishments and a preference for settlements rather than trials -- is that it turns the fines into just a "cost of doing business," normalizing misbehavior rather than preventing future wrongdoing.

If a bank does a bad mortgage thing, and you find the person who did the thing (or who signed off on the thing, or who ran the bank when it did the thing, or whatever), and you put him in prison, then that sends a powerful message that the thing was a crime, that it was not business as usual, that it could not be tolerated. If, on the other hand, you hold no individuals responsible, but come back to the bank every year and say "hey remember that mortgage thing? that'll be another $2 billion," then arguably you send the message that the bad mortgage thing was expected in the mortgage business, and that fines for doing it are just a normal part of life.

But you could say that same thing with a different emphasis. If a bank does a bad mortgage thing, and you find the person who did the thing and put him in prison, then the bank could reasonably conclude that the problem was that person, that the bad thing was anomalous, that there is nothing wrong with its mortgage business model as a whole. If, on the other hand, you come back to the bank every year and fine it a few billion dollars for the same mortgage thing, then that will send the bank a message about the costs and benefits of the mortgage business. The message is that the misconduct is not the work of a few bad criminals who are Not Like Us, but that it is endemic to the business model. The bank might reasonably conclude that frequent multibillion-dollar fines are a cost of doing business, and not worth it.

Which approach is correct depends on the facts, of course. If the mortgage business is great, and reliably adds to the long-term prosperity of the nation, but occasionally a mortgage banker murders a customer, then you should probably put the murder bankers in prison and not mess with the business model. But if an aspect of the mortgage business -- say, the originate-to-distribute model that many commentators blame for creating moral hazard, loose underwriting standards and a bubble in house prices -- seems to be pervasively bad and dangerous for the broader economy, and if every bank involved in the mortgage business seems to be getting in trouble for the same sorts of misbehavior, then maybe you do want to add to the costs of doing business. Maybe the way to think about it is not as anomalous crime but as a bad business model that imposes social costs, and to force banks to internalize those costs in the form of huge and frequent fines.

One measure of how much things have changed in the last decade at Bank of America Corp.: The firm has stopped reporting fees from its mortgage business. ...

After billions in fines and payouts to regulators and investors in the years after the financial crisis, Bank of America has moved away from securitizing and servicing residential mortgages. The firm originated $9.4 billion of new mortgages in the first quarter; in 2009, it topped $100 billion in one quarter.  

There is still plenty of mortgage interest from loans held on Bank of America's balance sheet, "but the business of making mortgages to sell them -- the specialty of subprime lender Countrywide Financial Corp. that Bank of America bought in 2008 -- has largely become a relic." Regulators and prosecutors made it incredibly tedious for Bank of America to be in that business, and now Bank of America ... just ... isn't.

Of course this is not purely a story of the fines; the decline of demand for private-label mortgage securitizations matters too. Nor is it a story of the decline of the originate-to-distribute model generally: Nonbank lenders like Quicken Financial have stepped in to replace the big banks in the originate-to-distribute model. (Nor is it even that new: After all, Countrywide was an originate-to-distribute upstart that competed with the big banks, until Bank of America bought it.) Still it is worth commemorating. People spent years arguing that any mortgage fines, no matter how huge and repetitive, didn't matter, that they were less than the profits the banks made from their misconduct, that they were just a "cost of doing business," that they would change nothing. But the fines were enough of a cost of doing business for Bank of America that it's now more or less out of the business.

Elsewhere, here is "Mortgage-Backed Securities and the Financial Crisis of 2008: a Post Mortem" by Juan Ospina and Harald Uhlig:

We examine the payoff performance, up to the end of 2013, of non-agency residential mortgage-backed securities (RMBS), issued up to 2008. ... We establish seven facts. First, the bulk of these securities was rated AAA. Second, AAA securities did ok: on average, their total cumulated losses up to 2013 are 2.3 percent. Third, the subprime AAA-rated segment did particularly well. Fourth, later vintages did worse than earlier vintages, except for subprime AAA securities. Fifth, the bulk of the losses were concentrated on a small share of all securities. Sixth, the misrating for AAA securities was modest. Seventh, controlling for a home price bust, a home price boom was good for the repayment on these securities. Together, these facts provide challenge the conventional narrative, that improper ratings of RMBS were a major factor in the financial crisis of 2008.

The crypto.

The job of a bank's trading desks is to help their clients trade the financial stuff that they want to trade. There's no especially coherent conceptual definition of what counts as "financial stuff." Part of the definition is regulatory -- if regulators say that banks can't own physical commodities or Venezuelan bonds, then banks will have trouble facilitating trading in those things, and they'll essentially fall out of the "financial" system -- but mostly it is loose and conventional. If the sorts of customers who are banks' customers want to trade a thing, then that thing becomes a financial thing, and so the banks had better start helping them trade it.

Exactly what that help comprises also varies: It can mean financing (lending the customers money to buy the thing), or broking (connecting buyers and sellers to broker trades in the thing), or market-making (buying or selling the thing directly from or to customers for the bank's own account), or custody (holding on to the customers' thing for safekeeping and regulatory purposes), or derivatives (taking more complicated bets on the thing from customers), or research (writing reports about the thing). For things that are only on the fringes of "financial stuff" -- art, say -- the banks might do some financing or advising without actually setting up a trading desk or getting into the custody business. But usually it's all of those things: Clients expect banks to provide a certain customary set of services for trading whatever the customary set of financial stuff is, and once there is a critical mass of client expectation that a kind of stuff is financial stuff, then the banks had better start providing those services for it. 

Is cryptocurrency financial stuff? Ugh I don't know come on:

Barclays Plc has been gauging clients’ interest in the British bank starting a cryptocurrency trading desk, potentially joining Goldman Sachs Group Inc. in pioneering a new business on Wall Street, according to people with knowledge of the matter. ...

Demand for such services is plentiful. Hedge funds that deal with Bitcoin and other virtual currencies have been eager to find banks to handle transactions -- much like prime brokers do with securities -- and potentially serve as custodians of digital assets. Some money managers have struggled to expand into crypto, in part because of rules that prevent them from using unregulated exchanges to trade and hold investments.

It is a pain for asset managers to hold Bitcoins, as we sometimes discuss around here. But that's not unique to cryptocurrencies. It's not obvious why it should be easy for a hedge fund to hold, like, aluminum either. Aluminum is ... bulky. If you are running a small hedge fund out of one room, and you buy 100 tons of aluminum, where do you put it? And the answer is that the financial system has mostly domesticated aluminum, so you don't have to actually go to the aluminum store and buy 100 tons of it and put it on a bunch of trucks and store it in your garage. Banks and exchanges have built financial products -- and, also, actual warehouses -- that let you trade aluminum without worrying about dropping it on your toe.

Cryptocurrency is not there yet, but it's getting there. Futures exchanges have Bitcoin contracts that let asset managers get exposure to the price of Bitcoin without having to worry about owning Bitcoins and losing their password. But that's just a start, and if there's enough demand from clients to domesticate cryptocurrency, then it's going to be in the banks' interest to do more.

By the way, the fact that banks, and bank clients, think that a thing is a financial thing doesn't mean anyone else has to like it. Beer-can producers sometimes get pretty unhappy that financial firms trade aluminum. And cryptocurrency true believers, who thought that crypto would usher in the end of the traditional incumbent financial system and the beginning of a new more democratic form of money, may be disappointed if cryptocurrency trading ends up being dominated by the likes of Barclays and Goldman Sachs.

Elsewhere, remember when we talked about that crypto tween, the 11-year-old "chief executive officer" of a "universal cryptocurrency for games" called "Pocketful of Quarters"? Well here's a profile of him (he's 12 now) and his dad, a venture capitalist who "has long been a believer in the potential of cryptocurrencies and blockchain technology." They very strenuously insist that the whole thing is the kid's idea and that he runs the company and they split the economics 50-50. ("Let's do 50/50 because I'm the one that has to build it," said the father during the negotiations over the equity split.) I suppose giving your kid a 50 percent equity interest in an Ethereum-based cryptocurrency venture is a novel way to pay an allowance. Smart contracts via crypto make this super doable.

Direct listing.

Here is a memo from Cleary Gottlieb Steen & Hamilton LLP about the Spotify Technology SA direct listing that makes this intriguing point:

In one respect, Spotify went beyond what IPO companies usually do. On March 26, Spotify issued a press release providing its financial outlook for the first quarter and full year 2018.

Normally, when companies do initial public offerings, they don't publish earnings guidance, because where would they publish it? If they put it in the prospectus that they use to sell stock, and if the guidance turned out to be wrong, everyone who bought stock using the prospectus would sue them. Whereas normal already-public companies publish guidance all the time, but in a non-prospectus setting, and everyone knows that it is just an estimate and not to be relied on. IPO companies don't do that, and resort to workarounds -- like orally providing guidance to their investment banks -- that have their own problems.

But Spotify did something quite weird. Issued guidance, sure, but more than that: It registered its stock and was ready to go public 10 days before it started trading:

Spotify’s registration statement was already effective and it was a reporting company under the Exchange Act, and it furnished the press release to the SEC on Form 6-K. Indeed, the decision to seek effectiveness on March 23 (late on a Friday, 10 days before trading began) may have been related to the desire to issue the outlook on March 26 (early on a Monday)

Normally the way an IPO works is that your registration statement is declared effective right before you price the IPO. Everything happens at once; you register your shares and sell them and list them for public trading all in a single flurry of activity. This is customary and makes sense: You don't want to go public without selling the shares, and no one wants to buy the shares unless they are publicly tradable, so you synchronize everything for one big event. But Spotify just didn't. It went public in one sense (became a reporting company with an effective registration statement for resales of its stock), and then it waited a while, and then it actually did some public reporting, and then it went public in another sense (listed its stock for sale on the stock exchange) 10 days later. By the time its stock traded, it was halfway to being a normal public company already, and so could do normal public-company things like release guidance. 

Happy Tax Day!

I don't really have any independent views on the matter, but I am pretty here for the annual bashing of TurboTax around this time. Here is Dylan Matthews at Vox:

TurboTax is an evil, parasitic product that exists entirely because taxes are confusing and hard to file. Worse than that, Intuit is one of the loudest voices on Capitol Hill arguing against measures that make it easier to pay taxes. 

Disclosure: I use TurboTax to do my taxes, but I do feel guilty about it. It could be worse, though; here is a Wall Street Journal story about people who do their adult children's taxes. "I would rather be improving health care than to be doing something mundane like taxes," says a 31-year-old data scientist who outsources her taxes to her father but who nonetheless has time to sit down for an interview so she can be embarrassed in a national newspaper. "It’s TMI to know exactly what she’s making and what she’s not," says a 78-year-old father about doing his 48-year-old daughter's taxes.  

Elsewhere: "Credit Karma Tax, the tax prep branch of the popular credit score site, said April 13 that fewer than 100 of the 250,000 most recent tax filers through the service have reported cryptocurrency transactions." I wonder what the overlap is between these three stories. I do not recall TurboTax asking me if I had sold any Bitcoins this year. And how many boomer parents doing their millennial children's taxes bother to ask about cryptocurrency trades? That seems like TMI.

People are worried about stock buybacks.

Not worried, I guess; cheerful:

“We are expecting record buyback announcements during this earnings season given further clarity on tax reform, equity multiples are broadly attractive, and companies likely to replenish buyback programmes after the recent sell-off,” noted Dubravko Lakos-Bujas, an analyst at JPMorgan.

I speculated yesterday that "The private markets have taken over the public markets' role in capital raising, but the public markets have retained their role in capital return." If you think of the stock market as just a place where mature high-cash-flow companies return money to investors then you wouldn't expect it to be especially volatile. And a straightforward mechanism for it not to be volatile would be if the companies buy back more stock whenever the stock prices go down.

Things happen.

Goldman Breaks From Wall Street Pack With Bond-Trading Boom. (Earnings release.) What We've Learned From Bank Earnings So Far. Trump Is Planning to Name Pimco's Richard Clarida as Fed Vice Chair. Fed’s Quarles Weighs Letting Banks Comment on ‘Stress Tests.’ Banks Get a Break on Accounting Rule. RIP Lynn Stout. U.S. Libor Replacement, Two Weeks After Debut, Has Some Issues. People are worried about the cross-currency basis turning positive. Incoming chairman to expand Rothschild in the US. Steve Wynn and Ex-Wife Elaine Wynn Settle Long-Running Litigation. Warren Gets Scant Help From Wall Street Watchdogs on #MeToo Push. Harvard, Yale Are Among Colleges Working to Repeal Endowment Tax. Cemetery tours for babies. Anthony Scaramucci's restaurant is hosting a "Sugar Daddy" dating event

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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.

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