Help! I need a Bailout!

I was a political science major in college. I considered myself liberal. I was a champion of human rights before it was vogue. I never really bothered myself with economics because money has never been the focus of my life. But I guess you could say I am conservative when it comes to money because I appreciate how money is made.

I grew up in one of Denver's western suburbs--a place built right after the end of World War II. Everyone I knew was lily white and most were Protestants. As I grew older I came to realize that some of the kids I went to school with were "richer" than I was. I figured that out by the size of the houses they lived in and the large new cars that their parents drove.

My parents were almost kids themselves when my sister was born in 1930. I came along 17 years later. My dad had to get whatever work he could find during the Depression to support my mom, my sister and my big brother. Like so many people that endured the Depression, my family came out of it with a fear of ever having to live through anything like it again. So my roots are humble and I have a respect for people who work for a living and who know the value of saving and earning what you get in life.

As an attorney that worked in a couple of Denver banks managing problem loans, I learned that sometimes the rich people that live in big houses and drive big cars are not exactly the nicest people around. Sometimes those people lie and cheat and deceive other people (and bankers) into giving them money they do not deserve and cannot pay back. Oh, they will pay it back if things workout alright for them. But if things go bad, there is always an excuse or a defense.

Back in September when politicians and the media started beating the drums for a bailout of Wall Street, I raised my voice in opposition. I wrote my Congresswoman and my two Senators. A lot of good that did. Congress approved the $700 Billion bailout with no bona fide strings attached. Can you believe they got taken again?

So now DETROIT wants a bailout as well. The apologists are on TV talking up the end of the American way of life if the Detroit automakers have to file bankruptcy. I find myself siding with Republicans like Senator Dick Shelby on this one.

Mitt Romney was all over the morning TV programs today discussing his OP ED piece in today's New York Times. CLICK HERE to read. It's short and to the point. Read it.
I agree. With a Republican. My dad would disown me.

One of Romney's major points is that Detroit can use a Chapter 11 Bankruptcy to get out of many of the costly and burdensome obligations that will continue indefinitely unless they are disgorged by bankruptcy. Romney and others are calling those costs "Legacy" costs. Those costs are primarily health care and retiree benefits. In government speak those costs are referred to an "entitlements" because the demand is always present and everlasting.

Romney also calls for the ouster of the geniuses that have been running Detroit that created the current mess. Again, I agree. In a Chapter 11 Bankruptcy the new companies could use the law to avoid all kinds of burdensome contracts (including the costly executive compensation packages) that have added thousands of dollars in unnecessary costs to autos produced in the United States.

Yesterday afternoon one of the guest commentators on MSNBC blamed Congress for the fact that American automobiles get less miles per gallon than most Japanese cars. Wait a minute, buddy. It was Detroit that lobbied Congress for the lower standards. I am old enough to remember that we went down this same road back in the late 1970s. Detroit was going to build cars that got better mileage. But they didn't.

Lately it has been the Bush White House that objected to the efforts of states like California to enact higher miles per gallon requirements that would limit pollution. The talking heads always seem to blame someone else for the problems that their industry created. This time its just the blame game on wheels.

If Congress gives Detroit a bailout the executives keep their lucrative executive pay and all the trimmings that go with it. That includes deferred compensation plans, bonuses, stock options, etc. Forget that the stock prices are low right now. The executives are probably buying as much of it as they can. Because if the bailout comes, the stock will go back up, and the executives will make out like bandits again.

This is how Romney ends his OP ED: "The American auto industry is vital to our national interest as an employer and as a hub for manufacturing. A managed bankruptcy may be the only path to the fundamental restructuring the industry needs. It would permit the companies to shed excess labor, pension and real estate costs. The federal government should provide guarantees for post-bankruptcy financing and assure car buyers that their warranties are not at risk."

"In a managed bankruptcy, the federal government would propel newly competitive and viable automakers, rather than seal their fate with a bailout check."

Other People's Money

I don't like the idea of a bank bailout one bit. It will reward incompetence and greed. It will not teach anyone anything other than that Big Brother will come to the rescue of those who have power and influence. It will cost taxpayers an unimaginable amount of money and lost opportunities.

The Wall Street mavens created this mess by screwing with private home ownership and turning it into investment vehicles that could be bought, sold and traded at a profit (or a loss). The mavens got rich and earned incredible salaries, bonuses and stock options based on the their production. The mavens got theirs. And now the taxpayer is being told we have to make everything better for the common good. Hooey!

Now the Bush Administration is asking the public to go into tremendous debt so that our large financial institutions do not fail. The Administration is raising the specter of mass financial ruin if we do not act now.

What if several real big banks and a lot of small ones were to fail? What if the remaining investment banks were to fail? I know three things would happen for sure. One: the assets would be marshaled and sold to pay creditors.
Two: the stockholders equity would be wiped out. Three: the unsecured or under-secured might get nothing. But the insiders in the banks who created the mess for the institutions would lose all the equity they had in the companies by virtue of stock ownership.

Let's get up close and personal and look at the mess from Key West. Without naming names let me relate a couple of tales that may cause you to question the rationale of a bailout.

Local bank "A" was an aggressive local lender in the Key West market. It made residential and commercial loans. Since it is not a large bank, it had to participate a portion of some loans to larger upstream lenders. That is a common practice among banks to spread the risk. Bank "A" made no qualification loans based on cash down and appraised value upon build-out of the finished property. The assumption was that the market would continue to grow and that the new structure could be sold at a profit. The bank would fund the cost of acquisition, construction, and provide interim financing until the building was completed and sold. The front end and completed appraisals would be used to justify the loans. That scenario does sometimes work in a perfect world.

Local Bank "B" made aggressive loans including one development loan that was used to convert a group of apartment buildings into condos. I'll call this development "Howard's End". I used to work for a couple of big banks in Denver and did commercial loan workouts. One of the first things I'd do when I got a new credit (problem loan) was to read the Credit File and the Collateral File. The Credit File tells you the story of who the borrower is and the purpose of the loan.

The Collateral File contains the documents (loan commitment sheet, deeds, mortgages, notes, security agreements, assignments of rents, UCC filings, etc.) that secure the lender's position on the property (the "collateral"). Most banks have a loan administration department or loan review department that reviews collateral files to make sure that every required document was properly executed and recorded to insure the bank's position is perfected in the event legal action or foreclosure becomes necessary.

I personally did not like the location of Howard's End, and I thought that the workmanship was marginal. When I saw the project two years ago it was about 70% complete. The entire project flooded during Hurricane Wilma and a lot of the work that had been done needed to be repaired. Local Bank "B" had turned off the money supply to complete the project and used the loan reserves to continue paying interest on the construction loan. By so doing Bank "B" did not have to recognize a potential bank loss by writing down a portion of the loan. In essence the bank was advancing new money to hide the eventual loan loss. (I base this on what the developer told me personally. I have no independent verifiable knowledge.)

The developer somehow deeded one unit a new owner and got a title company to insure title. It is my recollection that Local Bank "B" did not get any money from the sale of that unit but that the developer got the cash.

The deal is more complicated because Local Bank "B" did not properly collateralize its loan. It did not have a first mortgage on all of the buildings or ground that makes up the complex. As a result there were competing parties with conflicting legal priorities on different buildings that make up the project. The result was that even if Bank "B" were to foreclose its mortgage, it would not end up owning all of the buildings and all of the ground. At least two different parties owned individual units or a portion of the underlying ground that prevented access to other parts of the property.

As I recall Local Bank "B" had about a $2 million loan to the developer. A private party had a second mortgage of around $500,000 and then there was that buyer who somehow got to purchase a unit inside the complex before a certificate of occupancy was issued or the condominium documents were recorded. Do you see the problem here dear reader? If you do, would you agree with me that such incompetence should not be rewarded by bailout? Shouldn't the bank fire the moron that created this mess. Shouldn't the shareholders in Bank "B" suffer a dilution of their investment for hiring such incompetent people? Where is the responsibility and accountability for management if managers let bankers hide problem loans and let collateral clerks fail to properly secure a loan? Maybe small banks should not exist if they cannot perform the required functions correctly.

Local Bank "A" doesn't get off any easier. That bank profited by charging huge fees for originating and booking its loans in the Go-Go years before 2005. Local Bank "A" and its officers and its directors made calculated bets that they could grow the bank by making aggressive loans. They bet wrong in several notable instances. Local Bank "A" has had to foreclose on mortgages it held and now must try to sell its foreclosures in a declining market. And it has more foreclosures in the pipeline. Neither management personnel nor style has changed.

I know my rants and raves won't stop anything in Washington. But if you are old enough to remember the Junk Bond fiasco of the 1980's and the S&L collapse in the 1990s you may share my disdain for what is being proposed today. Once again the public is being asked to reward the Wall Street players (and small hometown banks like the two I mentioned in Key West) that took huge risks with other people's money. I could care less if the Wall Street players lose their homes in the Hamptons, Aspen, Boca or anyplace else. They did not earn that wealth. They took it. It's time for payback.