Morgans Hotel: A Zombie Company Defaulting on Debt and Burning Through Cash

I wrote another cheery article on Seeking Alpha, this time about Morgans Hotel Group (ticker:MHGC).

Proof banks are sitting on severely delinquent home loans

The housing market is not going to bounce back because there’s a huge pipeline of severely delinquent and underwater mortgages out there that still haven’t been absorbed by the market.

Courtesy of the NY Fed, here’s concrete proof banks are sitting on huge numbers of bad loans rather than foreclosing and letting them hit the market. (Ignore the data for 2006: there were few foreclosures back then. Focus on the early 2007 to early 2009 trend.)

This first set of graphs shows the probability that once a borrower goes 60 days late, he then fails to make his next payment and goes 90 days late:

Note the percentage of supposedly “near-prime” Alt-A loans where a 60-day-late borrower cures has plunged from 25% to 5%. The percentage of delinquent loans that get repaid in full because of a refinancing (in yellow) has also dropped from low to virtually zero.

So we see once borrowers miss a couple payments they have no ability or no intention to get current.

You’d expect, with this trend, for banks to then be more aggressive about foreclosing on seriously delinquent mortgagers. Yet we see the opposite: The next set shows what banks do for loans than are 90+ days delinquent.

So banks have gone from foreclosing on about 45% of their severely delinquent Alt-A loans each month to 20%.

So if you own a house that’s underwater, in practice you can probably keep living there (or collecting rent payments) for a year or so without making payments to the bank. You have 3 months before the loan is bad enough for the bank to foreclose, around 3 more months before the bank starts the foreclosure process and who knows how much longer before the bank actually moves to take possession of your home.

On that last point, the next graph shows the declining percentage of Alt-A loans in the foreclosure process that resolve out of foreclosure (i.e., short sale or refinance) and the likewise declining percentage of these loans banks are taking possession of:

Finally we see soaring losses on first mortgages:

This would be much worse if you included second mortgages, and worse still if banks weren’t propping up the market by sitting on bad loans. Worse still, banks are sitting on bad loans in the weakest markets the longest.

Bottom line, U.S. banks are still not owning up to their bad mortgage debt. Our government is turning a blind eye hoping the problem will go away. It won’t. This policy was tried and failed in Japan, where the economy never really recovered.

In fact, the Japanese stock market lower now than it was 24 years ago in 1985:

California Unemployment Reaches 11.9%, 2000’s a “lost decade” for the state

Here is a direct link to the statewide unemployment data, with several graphs.

California’s basic dilemma is that the state’s population has grown since Jan 2001, but not the number of jobs.

Specifically, the number of people in the state has increased by about 4.5 million, while the number of employed people is almost exactly the same at around 16.2 million, down from a peak of 17.1 million.

Some of the population growth was children and retirees, though California has a low birth rate and is an expensive destination for retirement.

Therefore most of this population increase consists of adults who do not have jobs, whether they are included in the official U3 rate of 11.9% or the depression-level U6 rate of about 19.9% that includes “discouraged workers” who want a job but have given up looking, and those working part-time but looking for full time work. (The 19.9% rate is an estimate based on adding the Q2 2009 U3/U6 gap of 8 points to the current U3 rate).

Looking at the major counties, Marin has the lowest U3 unemployment at 8.2%, while Riverside and Fresno have the highest, at 14.9 and 15%.

Stanford Ponzi Covered Up by NASD/FINRA’s Arbitrators: Part II

Fox Business has just came out with an interview with Stanford Financial whistleblower Layla Wydler, who was fired from Stanford Financial Group in 2002 when she refused to participate in what seven years later has been finally exposed by federal law enforcement authorities as a “massive Ponzi scheme.”

In 2000, Stanford offered Wydler, a top broker-dealer, a sizeable salary plus a signing bonus. In exchange, Wydler made a five-year commitment to Stanford and brought her valuable book of business with her.

Red Flags

Soon after starting, Wydler became suspicious. First, the Stanford “CDs” were actually administered as a hedge fund and invested in the money market. Consequently, “Stanford was paying about 3% more than everyone else in the world was paying on CDs without explaining how he could earn that return. … [H]ow can you do that, sell a product that you call a CD when it’s really not a CD?” asks Wydler.

Second, Stanford rebuffed requests for portfolio appraisals. “[W]e would never be able to get that from them because they would tell me it’s proprietary information. [There was] a lot of mystery,” says Wydler.

Third, much like Madoff, Stanford’s audits were done by “mom and pop” accountants. “[Standord’s] financials were not audited by a U.S. reputable account[ing] firm. [Instead,] it was done by an unknown firm in Antigua. To me, that was a red flag,” states Wydler.

Fourth, Stanford would claim the CDs were insured by Lloyd’s of London. “[B]ut that’s not what it was,” says Wydler. “It was just to cover the directors and employees in case of a lawsuit, and not the client accounts at all.”

Fifth, the Stanford headquarters building had a plaque stating “Member of SIPC.” This falsely implied the SIPC’s protection covered the CDs. “[I]t’s misleading,” states Wydler. “[Y]ou [would] see the SIPC sign, [and] you would imagine that everything was safe.”

Arbitration

After Wydler refused to sell the CDs, Stanford fired her. “[T]hey wanted me to pay back the promissory note that…was a part of the signing bonus that they gave me when they hired me,” says Wydler. Stanford took Wydler to arbitration before FINRA and sought in excess of $100,000.
Wydler counterclaimed wrongful termination, alleging the firing was punishment for refusing to participate in Stanford’s Ponzi scheme. “[I]n the arbitration, we asked for the documents that would have supported the claim,” i.e., portfolio appraisals and Lloyd’s insurance policies supposedly backing the CDs, says Wydler’s attorney, Mike Falick. “And we were turned down.” Not surprisingly, the arbitrators ruled against Wydler, awarding Stanford over $107,000. (Stanford eventually settled for an undisclosed amount.)

Subsequently, Wydler reported Stanford to the SEC. However, the SEC took no action for five years. “I think there was ineptitude on the part of the regulatory agencies,” states Falick. “NSAD [the predecessor of FINRA and the agency that was responsible for this arbitration] is a self-regulatory body…charged with making [sure] the broker dealers are operating fairly and legally. The SEC is charged with protecting people. I don’t think either one of them, given the opportunities that they had and the information that they had, did what they need to do to make that happen.”

The Hefty Price Tag of Arbitral “Efficiency”

When asked whether he could have subpoenaed the documents to crack the case in court, Falick answered, “If I could’ve gotten this case out of FINRA, the day that we had the discovery issue, when FINRA told me…’we’re not gonna allow you to get those documents,’…that day it would’ve happened.”

Instead of having her day in court, Wydler was forced into a Star Chamber arbitration and panel that denied her the opportunity to support her claims with discovery and to pay the criminal organization she tried to report $107,782. So thanks in part to NASD’s arbitrators, the fraud was allowed to continue for five more years until it finally collapsed under its own weight.

“I asked for the documents that would’ve proven her case and we were stonewalled by Stanford and we were told by FINRA that our document request was irrelevant,” says Falick. “[H]ad we gotten those documents, not only would Leyla have won her case, but maybe 30,000 people wouldn’t have lost their life savings.”

“[W]hen I left, I believe that there was about a billion dollar in the bank,” says Wydler. “[I]t ended at 7.2 billion.”

As an attorney, my advice to my clients is to refuse to participate in any binding arbitration unless they were aware of and understood what arbitration entails at the time they signed the contract containing an arbitration clause. Increasingly courts are recognizing that essentially businesses are using private arbitrators to shield them from the consequences of their lawbreaking, and refusing to enforce arbitration clauses.

Good work by Fox Business! Here’s the full interview and story.
(Note: the video did not play for me with Firefox but played fine with IE)

Here’s my first post on this case.

Keep State Insurance Regulation

Professor Mark Kleiman of the UCLA School of Public Policy and Social Research suggests that it’s “[t]ime for state-level regulation of insurance companies to go the way of the buggy whip.”

I strongly disagree.

I spent the better part of late 2005 and early 2006 prosecuting class actions against multiple large insurance companies. This involved, in part, reviewing multiple boxes full of correspondence and filings between insurance companies and their state regulators.

I was very impressed by the professionalism and concern for the public I saw on the part of state insurance regulators.

Property and auto insurance in particular are heavily regulated by individual states, and this system has long functioned smoothly. These regulations have ensured for a long time these companies are “boring” and stable, with rates regulated to ensure a small but consistent profit margin. Any price changes and new fees must be justified by insurance companies in extensive filings with detailed claims information. Because this system works well, consumers can be assured that of their rates go up it is because the actual cost of insuring them has as well.

AIG’s scam was to collect money for writing credit default swap contracts, spend a large portion of the money it received from the contracts on lavish executive compensation, but never have the ability to pay its obligations to its counterparties under the contracts. The big regulatory failure was on the part of the Bush-era SEC when it allowed companies to pretend AIG’s CDS were as good as money in the bank. Without this regulatory forbearance by the SEC, nobody would have bought what AIG was selling, which only bore the remotest resemblance to insurance as the term is commonly understood.

While I don’t think it is Mark’s intention, in the real world plans to “replace a patchwork of 50 state laws and regulatory agencies with a single federal authority” usually ends up being a back-door deregulations to the detriment of the general public. For example, when the Supreme Court decided that the National Banking Act preempted state usury laws credit card company profits grew substantially and many consumers fell into a spiral of high-interest debt. Replacing state financial regulation with federal regulation also gave rise to highly predatory payday loan industry.

In theory the Fed and federal banking regulators could have capped credit card interest rates at any time, as 50 states once did, and which 47 states still do for non-bank loans. But it’s a lot easier to corrupt one central regulator than 50 state-level ones. And at minimum progressive states like California can protect their citizens from predatory corporations during periods, for instance much of the past decade, when most federal regulatory agencies suffered severely from “regulatory capture.”