Financial Crisis

It's been called a market crash, a financial meltdown, fiscal Armageddon and more. It seems the media - and the government officials - can't find strong enough words to describe the financial industry in the western world. A presidential candidate has called it "the worst crisis since the Great Depression." (I wonder how many people alive today are familiar with the Great Depression.) Whatever it is, it is sobering for all of us. It strikes fear in our hearts.

But there are some truths about the current financial markets in the western world (led by the United States). Of course they are not the obvious. Truth is rarely obvious. It gets obscured by the circumstances. But let's be clear ... truth is relevant. That it is often obscure doesn't diminish its relevance. So it would seem that what's true is also what's important. It's sort of like the difference between the urgent and the important. Urgent isn't always true, but it is always demanding. And important isn't always apparent, but it is relevant. So let's take a look at some truths about today's situation.

To begin with, much of what we are seeing in the marketplace is hype. For example, it has been said that as much as $2 trillion worth of wealth has been wiped out in this recent crisis. That is not exactly the truth. Most of us haven't actually lost any real money. If you hold stock in a company, and the market suddenly decides that company isn't as precious today as it was yesterday - you still own the company. You just now own a company that the market doesn't seem to appreciate as much as it used to. But you haven't actually lost any real money. Unless you decided to sell that stock for less than you paid for it, you never actually lose the money. And let's be clear about one more thing: just because the market doesn't think the company is as precious today as it thought it was yesterday doesn't mean that the market is right today - or that the market was right yesterday! You have to look at the fundamentals of the company - it's business, it's market, it's leadership, etc. (And you should have done that before you bought the stock.) Business fundamentals rarely collapse overnight.

Secondly, much of the so-called "market crash" is occurring because people are making decisions in a panic-mode. They are making irrational decisions, and behaving irrationally. Dumping shares and taking losses because you are afraid of the future is irrational! Consider, for example, if your neighbors all told you they were selling at a loss, would that motivate you to suddenly "dump" your house for half its value? Would you suddenly be inspired to agree with the market and take 50% of the appraised value for your house? What if your neighbors brought you a professional looking appraisal, completed by someone perceived to be competent? Would you then dump your house for half its value? Most of us would not. And yet that's exactly what we do when it comes to the stock market.

Finally, let's talk about the mortgage market. It's an interesting subject. Many people are mad about Fannie Mae and Freddie Mac. Many more are angry about the supposed $700 billion bail-out bill that was recently passed. But what is true of this situation? For starters, the government chartered Fannie Mae back in the 1930's to facilitate housing finance. It operated effectively for decades. In the 1970's Fannie Mae was privatized and the government created Freddie Mac to provide competition for Fannie Mae! Again, both functioned effectively and housing finance was available.

In 1977, Solomon Brothers issued the first private mortgage-backed securities. This was the first time any mortgage financing was offered on the national or global markets outside of a government sponsored enterprise (aka "GSE"). It was an important milestone in that it moved us from a housing finance industry to a mortgage banking industry. There is an important distinction between the two. Housing finance facilitates a basic human need (housing). But mortgage banking facilitated basic human greed.

The mortgage banking industry fueled our nation's greed on all levels. The people who made the loans got greedy and pushed mortgages with wild abandon. They were racking up commissions that were unbelievable. For instance, loan officers with Countrywide Mortgage were making as much as $1 million or more - with no college degree, no particular skills, and not facilitating any human need. Wall Street also got greedy. In 2007, Wall Street paid more than $64 billion in commissions to men and women who traded mortgage securities in the global markets. And let's not forget the consumers who took out the mortgages. They financed boats, nose jobs, tummy tucks, cruises, mid-life crises, divorces and many other things besides any basic human need.

In light of this distinction between the housing finance industry and the mortgage banking industry, it would be wise to consider these realities. Perhaps the government intervention can get us back to the basics of housing finance - which functioned effectively for decades - without government bail-outs or subsidies. I'm sorry that shareholders in Fannie Mae or Freddie Mac appear to have been wiped out by the government's intervention (and the jury is still out on whether or not they were). But it if restores a market discipline that makes sense and helps our nation focus on financing fundamental human needs instead of fundamental human greed --- then I'm not so sure this is a bad thing.

There is no question that the chaos in the marketplace is unnerving. But a wise man (or woman) will stop paying so much attention to the urgent - and spend some time looking for and giving strong consideration to the important. After all, important is where the truth usually lives!

Source of Value

Well gosh, you can't hardly look at a newspaper or business magazine these days without being inundated with bad news about the global financial markets. The mortgage sub prime mess, the meltdown in banking, credit crisis and other buzzwords seem to have taken over our vernacular as of late.

Of course, Congress is looking for someone to blame. Inquisitions, hearings, and other initiatives are being undertaken to try and "find the source of this mess." People are asking, "What's the cause?" Others are wondering, "How can we prevent it from ever happening again?" To be sure, legislation is being passed at the federal and state levels to try and deal with both questions.

I've been involved in financial services since 1978. It's long been my primary livelihood. So I've got a view, based on how I understand the global financial services industries to function. And I think I have a pretty clear answer. Unfortunately, it's not an answer that anyone would want to hear. Even worse, it's probably not an answer that could be legislated. That notwithstanding, I'm pretty sure that it's the right answer.

Why are we in this financial mess? It's really simple, you see. Our mortgage industry, which consumes the bulk of the financial services industry in terms of dollars and employment, had a fundamental problem. Back at the end of the World Wars, the U.S. government created securitization - by creating organizations like Fannie Mae, Freddie Mac and Ginnie Mae. There was a shortage of housing in our country and a shortage of capital with which to build houses. Securitization provided it then - and the houses got built.

This mortgage banking industry cruised along for several decades, until America became fully housed. By that I mean that we had adequate housing supply for our population. Unfortunately, we had an industry that had to keep churning out loans. It had been built and structured around creating loans - versus financing houses. I believe there is a difference. And I think that difference makes the difference. Let me explain.

When housing is needed and housing finance facilitates it, a true human need is met. But when housing stock is sufficient and housing is not needed, then the loans we make are funding something else. What else? How about greed? Or folly? Luxuries that we can't afford? And those are the good scenarios! The worse ones are predatory lending, taking advantage of people who are too ignorant to know it.

This is what happened, we constrained our housing finance system so that it could only operate in the U.S. (Fannie Mae and Freddie Mac, for example, are not allowed to fund loans secured by homes in other countries). So when the model matured and the needs had been met, the machine had no where to go and started devouring itself.

There's an old fable about a farmer who wanted his field cut. He brought in a few sheep and noticed that they ate the grass and kept the field cut and looking nice. So he kept adding sheep (capacity), thinking that more would be better. Unfortunately, when he continued to grow beyond the ability of the field to feed the sheep, the sheep turned on each other. The result was not pretty!

If we're going to have a healthy, sustainable housing finance system in this country, it is going to have to limit itself to doing what's really needed ... what really creates value for Americans. To the extent that it is unwilling to do that, then this financial Armageddon is what we'll have.

Angelo Mozilo

It's a name you might not recognize. Whether you recognize him or not, chances are pretty good that he's touched your life in some way. He's Angelo Mozilo, CEO of the world's largest mortgage company, Countrywide (http://about.countrywide.com/StockInformation/StockInformation.aspx).

Here in north Texas, his Countrywide companies collectively are one of the biggest employers we have. Thousands work for Countrywide in Fort Worth, Plano, Richardson and other north Texas cities. The firm's headquarters are in California, and it is an important employer in Simi Valley and Pasadena. Nobody makes more home loans than Countrywide. Nobody services more loans than Countrywide. In all the world.

Mr. Mozilo and his original business partner (David Loeb) were pioneers in the mortgage industry. A scrappy New Yorker who believed strongly in what he was doing, Mozilo set the standard for excellence in the industry. He pushed hard, dreamed bigger and did what many only dream of doing. Countrywide was known for, among other things, a self-sufficient, independent company that got things done. Clearly, Mr. Mozilo poured a lot of blood, sweat and tears into his baby.

I remember many years ago, when Angelo was named Chairman of the Mortgage Bankers Association of America. The event was held at the Anatole Hotel in Dallas. Mozilo was there, with all his family. I remember riding down in an elevator with him. His son, who might have been around 12 or 13 at the time, looked just like him. It was like a little version of Angelo (who isn't a big many anyway). I admired the pride they both exhibited in what they were doing. It seemed that by virtue of pulling him out of school and bringing him to this event, Mozilo was teaching his son about pride in hard work and a job well done.

So why is Angelo Mozilo now in the news, testifying before Congress? Why has he become, almost overnight, the scourge of the industry? Why is his name suddenly synonymous with all that is wrong in housing finance? Well, it's simple really. Greed.

You see, the scandal that unfolded is the fact that Mozilo dumped a lot of his stock in Countrywide --- just before the subprime mortgage bless exploded. He dumped a lot of his stock --- and took a lot of profits --- just before Countrywide's stock nose-dived and its shareholders lost a fortune. Mozilo walked away unscathed, with hundreds of millions of dollars.

Immediately thereafter, Mozilo took some obscene compensation. Between 2002 and 2006, Angelo paid himself $250 million in salary and took $414 million profit from stock sales. During this time, Countrywide was also playing dangerously in the subprime lending market, engaging in predatory (immoral) lending practices. And the company was starting to write off billions in losses from these poor lending practices. And still Mozilo paid himself even more.

Angelo hired three compensation consultants --- and fired the first two who thought his compensation was bloated at the time. He asked the board to pay the income taxes on his wife's personal travel aboard the corporate jet. He asked the board to pay him a retirement income --- but didn't want to retire. In fact, there is a litany of requests and demands ... and even threats, from Mozilo, trying to extract more wealth from his company. It would seem that Angelo Mozilo had become the enemy of his shareholders --- intent of shifting their wealth to himself.

So here's what I think happened. Angelo Mozilo was the scrappy, admirable entrepreneur who did what he believed. He risked a lot and worked his butt off. There was much accomplished and much to be proud of. But at some point he came to the conclusion that money mattered more. Mind you, he already ranked among the wealthiest people in the world. He wanted more though. Hundreds of millions more. And in his quest for massive, obscene wealth, Angelo Mozilo completely destroyed the legacy he had spent his whole life building.

Let this be a lesson for us all.