Mortgage Deals and Revolving Doors

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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Goldman and mortgages.

The great inevitability of modern banking is that some bank will always be settling a crisis-era mortgage case with regulators from now until the end of time. This infinite series of settlements sometimes requires a bank to settle with regulators multiple times for the same mortgages, since the banks' crisis-era mortgage misdeeds, though large and widespread, were after all finite. So when I saw that Goldman Sachs had settled mortgage claims with the Justice Department and state authorities for $5.1 billion, my first reaction was a sense of déjà vu: Didn't Goldman just do that in January? And the answer is yes, sort of: The $5.1 billion "agreement in principle" was reached and announced in January, but that deal was only finalized this week. So it's one deal. Goldman won't be paying the $5.1 billion twice.

It won't even be paying the $5.1 billion once: As Nathaniel Popper points out, much of the settlement comes in the form of consumer relief in which Goldman gets more than a dollar of credit for every dollar it spends. For instance, Goldman "is getting $1.50 of credit for each dollar of loan forgiveness within the first six months after the settlement." When this settlement was last announced, in January, I was a bit puzzled by Goldman's consumer relief obligations: It's not a consumer bank, or a mortgage servicer, so it's a little weird to imagine it doing all that much to help homeowners. I confess I remain puzzled even after reading the consumer relief annex to the settlement. It requires some amount of "financing and/or donations to fund affordable rental and for-sale housing," which Goldman can do easily enough by giving out money to organizations, but the main relief is that Goldman has to forgive people's mortgages. How will it find them?

Here's the settlement announcement, and the statement of facts. I have over the years become something of a connoisseur of these things, though I am also biased (disclosure: I used to work at Goldman!), and my reading of the facts is that they weren't that bad? I mean, they were bad, sure. The worst fact is probably Goldman's head of mortgage due diligence, who had just reviewed a bunch of Countrywide deals that Goldman securitized, responding to a bullish equity analyst's report on Countrywide by saying "If they only knew . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ," a quantity of ellipses that suggests not so much "raised eyebrows" or "impish grin" but rather "deep heartsick despair." Goldman should think about modifying its swear-words-and-muppets e-mail filter to block that many ellipses.

But the actual description of mortgage due diligence was ... look, in hindsight, Goldman can't exactly be proud of it, but it strikes me as less egregiously bad than some of its competitors. Goldman took an "adverse sample" of loans in its pools, a due diligence firm graded the sampled mortgages on a good/passable/bad scale, and the bad ones were kicked out. The Justice Department's main criticism was that, when a lot of bad loans were kicked out, Goldman should have gone back and reviewed the un-sampled mortgages to see if they were just as bad. But it seems like Goldman's Mortgage Capital Committee raised the same issue and got answers that satisfied it, though in the context of the Justice Department complaint they don't seem all that satisfying. (When the committee asked "How do we know that we caught everything?," it got answers like "we don't" and "Depends on what you mean by everything?") Still, there is at least the structure of genuine due diligence here; my impression is not of a slapdash assembly line but of a real underwriting effort that was only partially undermined by cynicism and competitive pressures.

Revolving doors.

One thing we sometimes talk about around here is that the regulatory "revolving door," in which regulators and prosecutors often leave government to work for the companies they once regulated and prosecuted, tends to make enforcement tougher. The more onerous the regulation, and the stricter the enforcement, the more need those companies will have for former regulators and prosecutors. This model can help explain a lot of things. For instance, it provides a simple model of why prosecutors are spending so much time punishing foreign banks for violating U.S. laws in foreign countries: The U.S. market for former prosecutors is pretty saturated, but the extraterritorial prosecutions open up whole new markets for ex-prosecutors to get paid by banks. Or, as one former assistant U.S. attorney now working for a U.S. law firm in London put it:

“The pitch was: you can provide something unique in London; or you can be in New York [where] you’re offering the same thing as dozens of other ex-AUSAs,” he recalls.

He means the pitch from the law firm that hired him, not the pitch within the Justice Department to do more extraterritorial enforcement, but the model does fit pretty well. (Now he's representing Navinder Singh Sarao, who faces 380 years in a U.S. prison for trading on a computer in London.) If I were an ambitious young U.S. prosecutor, I'd be focusing on mortgage fraud in the south of France.

Politicians and investing.

As securities-fraud cases go, the Securities and Exchange Commission case involving Texas Attorney General Ken Paxton is, I would say, pretty average? The case is mostly against a company called Servergy Inc. and its founder, William E. Mapp III; Servergy settled for $200,000, while Mapp is still fighting. The SEC's main objection is that Mapp and Servergy were allegedly less than totally honest with investors about the potential of their energy-efficient computer server, telling investors that the server used less power than other servers but neglecting to mention that it "had a less powerful 32-bit processor that was being phased out of the industry." I don't know that much about marketing, but my impression is that you're supposed to play up your product's good points and downplay the bad points. The rules for securities offerings are, of course, the opposite. Anyway this perhaps stretches the bounds of puffery too far:

When Servergy was again low on operating funds in early 2013, Mapp falsely told prospective investors that the company had received an order from Amazon. In reality, an employee of Amazon had merely contacted Servergy because he wanted to test the CTS-1000 in his free time and for his personal use.

The main complaint against Paxton is that, while he was a Texas state representative, he allegedly "received 100,000 shares of Servergy stock for recruiting investors to Servergy," without disclosing that commission to investors. He disagrees:

According to Paxton, he met Mapp at a Dairy Queen restaurant in McKinney, Texas in July or August 2011, intending to invest $100,000 of his own money in Servergy. But, according to Paxton, Mapp refused his investment and stated, "I can't take your money. God doesn't want me to take your money." Consequently, Paxton claims, he later accepted the shares as a gift.

Securities law is full of metaphysical questions like this: Who can say what is a commission, and what is just a gift among friends? ("Servergy recorded the stock issuance to Paxton as payment for 'services,'" says the SEC.)

Elsewhere, Newt Gingrich is going to a private equity fund. Wait, no, he is going to a private equity firm without a fund. "It’s called JAM Capital Partners, and historically has operated as a fundless sponsor (i.e., raises money from high-net-worth individuals on a deal-by-deal basis)." Now it will raise a $100 million fund, and "Gingrich will serve as a strategic advisor focused on helping portfolio companies navigate regulatory waters." And here is a claim about why Ted Cruz didn't get a job at Gibson Dunn despite his Supreme Court clerkship. ("Several of his former classmates who had applied at the prestigious firm made clear it was either them or him.")

Shell companies. 

Owning a European soccer team is a fun vanity project for a lot of foreign billionaires, but it is more fun if your team wins. Most European soccer leagues, though, find it a bit distasteful when a foreign billionaire takes over a second-tier club and spends a lot of money buying players so his club can win. So they have "financial fair play" rules, which more or less say that soccer clubs can't spend too much more money than they make: Rich owners can't just sink money into their teams as money-losing vanity projects, but have to run the teams on vaguely commercial lines. There is an obvious cheat: Instead of just giving money to their teams, the rich owners can buy things from their teams. In particular, soccer teams sell sponsorships; the owner can buy a spot on his team's shirts, and the team can count that as income (good) rather than support from its owner (bad). The leagues have figured this one out, and "losses under FFP rules are not reduced by a club owner paying money to the club, or by doing so via sponsorship, if the amount paid is clearly inflated beyond market value."

But here is a story about Leicester City, which is owned by the billionaire owner of Thai company King Power, and which might be in trouble for financial fair play irregularities back when it was in the second tier of English soccer:

The investigation centres on a deal Leicester say they did in January 2014 with a company called Trestellar Ltd, to market the club in the UK and south-east Asia. That deal immediately produced an apparent £11m increase in Leicester’s sponsorship and commercial income, reducing the club’s loss from £34m the previous year. In the club’s most recent accounts, for 2014-15, Leicester say Trestellar sold the club’s main sponsorships – the name on the players’ shirts and the stadium – to King Power, the club’s owners.

The Thai owners were already sponsoring the shirt and stadium before the Trestellar deal; in 2012-13 Leicester’s sponsorship and other commercial income was £5.2m. After the Trestellar deal, with King Power still holding the same main sponsorships, the income immediately jumped to £16m.

See, if you sell sponsorship rights to yourself, they have to be at fair value. If you sell them to an intermediary, who then sells them back to you, they don't. (Maybe.) "Trestellar, then and still, has no website nor telephone number." Leicester will probably win the English Premier League this year. The best sports stories are always really financial-engineering stories.


By the time I arrived in investment banking, Credit Suisse was just called Credit Suisse, though sometimes older bankers, or younger ones trying on an old-school affect, would still call it "First Boston." I guess this is what happened to the old CSFB name:

The Credit Suisse Fear Barometer, which measures the cost of bearish put options relative to bullish call options, rose to a fresh record of 44.7% on Friday. The gauge, which goes back to 1994, is calculated by selling a 3-month 10% upside call on the S&P 500 and using the proceeds to buy downside protection; the barometer’s level shows how far below the current level of the S&P, in percentage terms, an investor has to go to buy a put that makes the strategy’s total cost zero.

Put simply, an investor has to go really far below the current level of the S&P 500 to buy a put option that is as cheap as the call option 10% above the current level of the index.

Is that the most complicated sentence ever to follow the words "put simply"? Probably not, but it's a good one. Anyway, I ask you: Is that a measure of option skew, or of dividend expectations, or of dealer balance sheet and risk appetite, or of "fear"? I have never quite understood the relationship between short-dated equity implied volatility and "fear." But I can never miss an opportunity to mention Robert Harris's "The Fear Index," a novel about (spoiler!) an algorithmic hedge fund manager whose computer tries to kill him. That is fear.

Elsewhere, I feel like people are too worried about mutual funds? Like, the idea of a mutual fund is, you and I and a bunch of other people put our money into a pot, and some professional invests it for us, and if the investments go up we make money, and if they go down we lose money. The (shared) risk is an inherent part of the product. But with the financial crisis, and all the bond-market-liquidity stuff, regulators seem to have decided that mutual funds are basically bank accounts, and that it's a systemic risk if they lose any money. Or that is more or less how I interpret the SEC's efforts to reduce the use of leverage and derivatives at mutual funds. Here is a story about how that will make some mutual funds riskier, as it gets more difficult for funds that invest in foreign assets to hedge their currency risks.

Hedge funds.

Here's a Federal Reserve discussion paper on the persistence of hedge fund outperformance. It exists! But only sometimes:

We provide novel evidence that hedge fund performance is persistent following weak hedge fund markets, but is not persistent following strong markets. Specifically, we construct two performance measures, DownsideReturns and UpsideReturns, conditioned on the level of overall hedge fund sector returns. After adjusting for risks, funds in the highest DownsideReturns quintile outperform funds in the lowest quintile by about 7% in the subsequent year, whereas funds with better UpsideReturns do not outperform subsequently

My general sense is that hedge funds as a class had a rotten 2015, but on the bright side that might mean that the funds that had a good 2015 really are good.

Meanwhile, Point72 Asset Management is getting the band back together in a big way, hiring six former employees in London, New York and Hong Kong who left in 2013-2014, when it was still SAC Capital. You get the strong sense that everyone at  Point72 is counting the minutes to its return as a full-fledged hedge fund (in 2018). Do you think they'll keep the Point72 name? They've had some time to get used to it by now.

Elsewhere, here is a story about how Third Point's and Greenlight's reinsurance companies haven't been that great for investors, but have paid a lot of fees to their associated hedge funds. And Och-Ziff Capital Management is fighting with the Justice Department over allegations of bribery in Africa.

Energy finance.

There is an assortment of grim tidings from the world of energy lending. Here's a story about how, "in May 2014, with oil trading at $102 a barrel, Wells Fargo & Co. boasted that in just two years it had almost doubled its energy exposure and seized the title of Wall Street’s top oil and gas banker." Oops! Wells Fargo was focused on reserves-based secured loans to "some of the least creditworthy borrowers in the shale patch," which made it particularly dependent on future oil and gas prices to get its money back. "They were not scrutinizing price assumptions and forecasts," says a consultant.

Wells Fargo was not alone; lots of big banks have undrawn credit commitments to oil and gas companies, and those companies are starting to draw on those loans:

“Let’s not sugarcoat it, this is not necessarily a loan a bank wants to make at this point,” said Glenn Schorr, a bank analyst at Evercore ISI.

Despite the unattractiveness of those loans, Chesapeake Energy managed to convince its banks to revise its $4 billion revolver, and postpone its next borrowing-base evaluation until June 2017, by pledging "almost everything it owns." And while volatility is bad for lenders, it's great for traders: "The oil trading industry as a whole enjoyed the best year since 2008-09."


In yesterday's Money Stuff I mused a bit about why some young people don't love banking. I should be clear that those are just reasons why young people generally don't love banking. As several readers pointed out, there are some more specific reasons why young people today especially don't love banking, such as, it doesn't pay as well as it used to, and it is more regulated and boring. But young people not loving banking has always been part of the banking model: Banks need a lot more analysts to sharpen up logos in pitchbooks than they need highly paid managing directors to pitch the business, so they want most of the analysts to leave over time. Elsewhere, here is a claim that the average pitchbook costs $40,000 to produce.

People are worried about unicorns.

"Millennials' favorite animal reveals key insights about their values" is the headline here, and it is not the entitled cat, or the idealistic dog, or the selfie-taking monkey, or the underemployed sloth, or the bad-at-household-formation panda. It is the "majestic unicorn." This section used to be about private tech startups with valuations of $1 billion or more.

People are worried about bond market liquidity.

The best thing about bond market liquidity worrying is that it is unfalsifiable: Everything, or the opposite thing, is evidence of bond market illiquidity. But the second-best thing is that the word "liquidity" itself contains a metaphor, but people forget, and then involve themselves in all sorts of amusing mixed metaphors. Well, mainly one mixed metaphor -- "liquidity landscape" -- but sometimes others too. Here is "Playing With Fire: Illiquidity In The Bond Market," which made me fall out of my chair in delight.

Things happen.

Ben Bernanke on helicopter money. Nomura to quit European equities research. Exchange Operator Bats Global's IPO Said to Be Oversubscribed. Italy Agrees on Fund to Support Battered Lenders. Puerto Rico Aims to Appease Congress With New Debt Proposal. Goldman vs. Brexit. Liquidity v. Solvency: Caesars edition. Uber, but for lawyers. "After your house, asset management will be the most expensive thing you ever buy." Great Leaders Embrace Office Politics. Zillow’s defense: Exec was erasing porn, not evidence. Erik Prince's private air force. Truffle hunting in Iraq. Rage yoga. Superyacht fires. "There is a sentiment among frat guys, lacrosse players and middle class affluent white kids that they are kind of getting persecuted lately." 

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at

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