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Money Stuff: Goldman Was Just Trying to Help

May 26, 2020
Money Stuff
Bloomberg

Consumer relief

In the years leading up to the 2008 financial crisis, Goldman Sachs Group Inc. did some bad mortgage stuff.[1] It bought risky mortgages from mortgage lenders, packaged them into mortgage-backed securities, understated the risks of those loans and the shoddiness of the underwriting in the offering documents for the securities, and sold them to investors. When the loans went bad, the investors lost money. This was a popular activity among a lot of banks in those years, and they all got in a lot of trouble for it. 

The obvious first-order victims of this behavior were the investors who bought the mortgage-backed securities based on the banks' misrepresentations. The specific thing that Goldman (and other banks) got in trouble for was lying about the quality of the mortgages that it sold to investors, for its "conduct in the packaging, securitization, marketing, sale and issuance of residential mortgage-backed securities." 

But there were second-order victims. The entire global economy was brought down by the failure of the U.S. mortgage machine, for one thing. Also the homeowners who got those risky mortgage loans often ended up losing their homes when they couldn't pay.

So when Goldman (and the other banks) got in trouble for packaging bad mortgage securities, and they had to pay giant piles of money to settle the charges, there was a widespread view that it would not be seemly to hand that money over to hedge funds and insurance companies and German banks and other mortgage investors, while the people with the mortgages kept losing their homes. So a big chunk of each bank's settlement, including Goldman's, was earmarked for "consumer relief." The idea, loosely, was that some of the victims of Goldman's mortgage conduct were regular people who got bad mortgages, and so some of Goldman's penance should be, basically, forgiving their mortgages.

Which sounds fine in a very abstract way, until you realize that Goldman never made mortgages.[2] It just packaged and resold other lenders' mortgages. Nobody owed Goldman a monthly payment and was worried about foreclosure.[3] So Goldman couldn't just call up its hardest-hit borrowers and say "you know what, don't bother paying your mortgage this month, we'll pay it, as part of our court-ordered penance," because it had no hard-hit borrowers.

At the time, in 2016, when the Justice Department announced that Goldman would pay "$1.8 billion in the form of relief to aid consumers harmed by its unlawful conduct," and would "provide loan modifications, including loan forgiveness and forbearance, to distressed and underwater homeowners throughout the country," I wondered—well, which homeowners? "It is unclear exactly how Goldman's consumer relief will be doled out and to whom," reported the New York Times. It was a mysterious settlement.

And then a year later, Liz Hoffman and Serena Ng at the Wall Street Journal found the answer, and it is at the same time obvious and completely wild. The answer is that Goldman would buy mortgages—largely from Fannie Mae and Freddie Mac—to forgive them. Fannie and Freddie are the government-sponsored giants of the mortgage business, and they have lots of delinquent mortgages, mortgages that the homeowner can't pay back. Fannie and Freddie are not in the business of threatening and cajoling delinquent homeowners—it is kind of a bad look—so they auction these mortgages off to buyers who are willing to have a go at squeezing money out of them.

You could imagine Goldman buying the loans at auction and calling up the homeowners and saying "hi, this is Goldman Sachs, we paid off your mortgage for you, have a nice day." It could buy $1.8 billion face amount of mortgages for, say, $900 million, forgive them all, and claim $1.8 billion of consumer relief at a cost of only $900 million.

That is not what happened. Instead, Goldman would buy the loans at a discount and call up the homeowners to try to work out a deal. Ideally the homeowners would agree to pay Goldman (1) something less than the full amount they owed but (2) something more than Goldman had paid Fannie Mae for the delinquent mortgages, meaning that Goldman could make a profit by restructuring the loans. I wrote about it at the time:

The naive way to think about "consumer relief" is like, a bank lends a person $100, and the person runs into difficulty repaying, and the bank says "well okay we'll call it $80," and the person repays $80, and the bank has lost $20. "Consumer relief" is a relief to the consumers, and a cost to the bank. But that's not quite how the cash flows go here. "Goldman has paid between 50 and 90 cents on the dollar for the loans ... with an eye toward restructuring them by reducing interest rates, lengthening the term of the loan, or forgiving some of the debt outright." But if you buy a loan for 50 cents on the dollar, you can afford to forgive 40 percent of it and still make money. The "loan workout process can take one to two years, and buyers can make between five and 15 cents on the dollar above what they originally paid."

Those are just the normal economics of the loan-modification market. But for Goldman the calculation is a bit different: If it buys a $100 loan for $50, writes off $40 of principal, and resells it for $60, it doesn't just make $10 in profit, it also digs itself out from $40 of consumer-relief liability to the government. That's apparently why it buys such a large share of Fannie Mae's delinquent loans: "Because Goldman is getting credit toward fulfilling the terms of its settlement, it can afford to pay more."

The wild result of this is that Goldman's consumer relief could be profitable. For Goldman. Its $1.8 billion penalty could, for instance, consist of buying $4 billion face amount of mortgages for $2 billion and negotiating with the homeowners to get paid back $2.2 billion. In that hypothetical, as far as mortgage-settlement accounting goes, Goldman has paid $1.8 billion of consumer relief; as far as profit-and-loss accounting goes, Goldman has made $200 million of profit.

But it doesn't always work as smoothly as that in practice. Sometimes Goldman and the homeowner can't come to an agreement about how much the homeowner will pay back, or they will come to an agreement and the homeowner still can't pay. Then what happens?

On Friday, Matthew Goldstein at the New York Times wrote the—again obvious, again wild—next chapter of this story:

While Goldman has reworked loans to make it possible for thousands of homeowners to avoid foreclosure, it has also taken back more than 10,000 homes — properties it has started to sell to help offset the cost of the assistance it provides, a review of data shows. ...

Of the 30,000 loans Goldman bought, the monitor's report said, the bank had modified 7,800 mortgages and erased an average of $103,000 in debt owed on them. In some cases, the report said, Goldman has gotten repeat credits for "multiple modifications of the same loan."

But the bank has also foreclosed on more than 10,000 of the delinquent mortgages, and has resold thousands of homes so far, at an average price of $170,000, according to Attom Data.

The basic outline is:

  1. Goldman defrauded some institutional investors in mortgage-backed securities.
  2. As punishment, the government ordered Goldman to go out and help some struggling homeowners.
  3. As a result, Goldman foreclosed on 10,000 of them.

Ten thousand people lost their homes to Goldman Sachs, which would never have happened if the government had not ordered Goldman Sachs to help those people. (To be fair, they would have lost their homes to someone else; "a significant number were almost certain to end in foreclosure," and "nearly a quarter of the mortgages sold by Fannie and Freddie were for vacant and abandoned homes." "Goldman said it had foreclosed on 10 percent fewer mortgages than other investors that had bought mortgages from Fannie and Freddie.")

You could be mad at Goldman about this but I think that misses the point. Goldman is giving people mortgage relief—it is forgiving hundreds of millions of dollars of mortgages—and there's not much it can do with mortgages on abandoned homes other than foreclose. The real point is that the notion of "consumer relief" in the big mortgage settlements was always sort of muddle-headed, and in Goldman's settlement it was always, from the very beginning, completely incomprehensible, and now here are the incomprehensible results. The consumer-relief penalty led to 10,000 foreclosures and also could be profitable for Goldman.

There is a story of the 2008 financial crisis that heavily stresses the complexity of mortgage securitization, the layers of abstract financialization between the people buying the houses and the people who owned their mortgages, the interlocking system that no one person could possibly comprehend or desire. I just want to suggest that you could tell the same story about the response to the crisis, that the punishment here is about as complex and indirect and financialized as the crime.

Boredom Markets Hypothesis

We talked last month about what I guess I will call the Boredom Markets Hypothesis, the idea that an important driving force in modern stock markets is the demand of retail investors for entertainment. The basic theory is that ordinary people will do more trading (1) if trading is entertaining and (2) if other things are less entertaining: The more bored they are, the more they will trade stocks. 

In general, this theory predicts that retail trading would decline over time. As other entertainment options become richer and more accessible and more personalized, everyone can find a really good television show to watch or ax-throwing bar to patronize, so they will spend less time chatting with their broker about stocks. Meanwhile growing efficiency and electronification in the stock market make the brokers less fun to chat with, while the increasing age and size of public companies make stocks more boring. So people who a few decades ago would have actively followed the markets will now be really into fantasy football or Fortnite, and they'll just put their investments in index funds.

If active investing is going to compete with modern entertainment options, it will have to be more entertaining. To be popular, active investments will have to offer wild price swings and the potential for instant wealth, but they'll also have to offer colorful characters, fast-paced narratives, and a sense of moral superiority. The BMH offers an explanation for Bitcoin, or for Tesla Inc.'s stock price. It is not a financial explanation; it is essentially a literary one. Bitcoin and Tesla have good stories, so they are the investments that break through in a saturated entertainment landscape.

Of course we talked about the BMH last month because, right now, the entertainment landscape is the opposite of saturated; people can't leave their houses and have finished Netflix. This makes stock-picking a much more (relatively) attractive hobby than it was a few months ago, and so, as the BMH predicts, there has been an increase in retail stock-picking. I argued that, in the case of a coronavirus pandemic, the BMH is pleasingly countercyclical:

The worse the economy is, the more bored investors will be. If stocks sell off because the coronavirus crisis is longer and worse than expected, there will be even fewer entertainment options and more people will turn, in desperation, to buying stocks on their phones. If someone finds a magic cure for the virus tomorrow, stocks will rally and all the new retail investors will happily sell into the rally at the top and go back to their other, more entertaining, entertainments.

Since then I haven't gone anywhere or done anything and the stock market is up, so I guess it checks out. And at Bloomberg, Sarah Ponczek, Elena Popina and Gregory Calderone have an incredible update to the BMH:

Forget buy-and hold. Stuck at home and dreaming of a killing, bored retail traders are branching out into all manner of Wall Street exotica.

Darting in and out of stock options, dabbling in complicated exchange-traded funds, devouring trading how-to books by the dozen -- all have become tools in the self-directed portfolio playbook. Locked down and socially distant with lots of time and (apparently) money to spare, they're leveraging zero-percent brokerage fees in new and surprising ways. ...

"People are still trying to learn to do this better," said JJ Kinahan, the chief market strategist at TD Ameritrade. "People are just saying, 'OK, retail is going in and being crazy.' Well, I think the fact is retail is trading more because they have more time. People actually have time to do so, and that's why they are more interested."

Yes! Also:

The number of investors at Robinhood currently holding the U.S. Oil Fund, the biggest exchange-traded fund invested in oil, stands at 171,000, 20 times the number of users that held the fund in early March, according to website Robintrack, which uses Robinhood's data to show trends in positioning but isn't affiliated with it. The popularity of the fund only increased after negative oil prices captivated and confused traders.

See? The BMH is countercyclical. Ordinarily one thinks of retail traders as momentum followers who sell stocks when they go down. But when investments go down in an entertaining way—USO plunged in March, and has had troubles ever since, because it owns oil futures that can now go below zero—traders flock to it because, you know, at least they can feel something. "Ooh a stock that can go below zero," they almost say, "that's new, sounds fun, I want that."[4]

Also here's a cab driver, because you can't have a story about retail traders without a cab driver:

"It's a gamble, but a highly intellectual gamble," he said by phone. "It's about knowledge and risk, but especially for guys like me, it's all about sheer luck."

And here's Chris Camillo, a retail trader/YouTube star/chatroom host:

"And, hey, it took a pandemic, but it was already happening before this with Wall Street Bets and cryptocurrency," Camillo said by phone. "Now they're wanting to go one layer deeper. OK I did that, I did crypto, OK now I own Tesla, I get it. But there has to be more to investing than just Tesla."

There has to be more to investing than just Tesla! You need a Netflix algorithm that is like "if you enjoy Tesla, here are some other funny stocks." It is a market opportunity; if you're weird and like rockets and Twitter, you should start a cannabis-and-laser-guns company and sell stock to people who enjoy Tesla but would like to get a little deeper into the genre. "I love how unfiltered Argon Dusk is on Twitter," your fans will say on r/wallstreetbets, "and how many '420' jokes he makes, and how he took a stand against outdated safety regulations when he launched his death-ray space station. I'm gonna buy lots of call options and you should too."

Margin calls

Why did car-rental company Hertz Global Holdings Inc. file for bankruptcy on Friday? Bloomberg and the Wall Street Journal both have good narrative accounts of the business missteps that Hertz made that put it in this position, but the simple immediate answer is that Hertz had basically taken out a margin loan against its cars, the coronavirus crushed the value of those cars, its lenders issued a margin call, and Hertz didn't have enough money to meet it. So the lenders can seize the cars to sell them off, and Hertz filed for bankruptcy to delay that.

I mean Hertz doesn't put it that way. Technically the story is that Hertz finances its cars using asset-backed securities: An entity called Hertz Vehicle Financing LLC buys the cars and leases them to Hertz, and HVF gets the money to buy the cars from an entity called Hertz Vehicle Financing II LP, and HVF II gets the money by selling securities (backed by the cars and the lease payments) to investors. But the lease payment—that Hertz makes to HVF, which passes it to HVF II, which passes it to the ABS investors—is variable, and it goes up when the value of the used cars in Hertz's fleet goes down. From Hertz's 10-Q filed two weeks ago:

Monthly payments under the operating lease are variable and significant and have increased because declining vehicle values resulting from a disrupted used-vehicle market require Hertz to make additional payments to offset such value declines in order to continue using the vehicles. 

The cars in Hertz's fleet are the ABS investors' collateral; Hertz can keep their money because the value of the cars should be enough to cover their debt. Or that is the usual idea. During the pandemic, the value of used rental cars has plummeted: No one is buying used cars, so demand is down, and no one is renting cars, so supply is way up. The ABS investors are undercollateralized—their cars are worth less than they're supposed to be, putting the debt at risk—so they effectively issued a margin call: Hertz has to pay more in operating lease payments to protect the ABS investors from the declining collateral value. Hertz declined to do that, so the ABS investors get to seize the cars:

During April 2020, the Company engaged in discussions with various creditors to obtain relief from its obligations to make full rent payments under its Operating Lease. While such discussions were ongoing, to preserve liquidity, on April 27, 2020, Hertz did not make certain payments in accordance with the Operating Lease.

As a result of the failure to make the full rent payments on April 27th, as of May 5, 2020 an amortization event was in effect for all series of notes issued by HVF II and a liquidation event was in effect with respect to the variable funding notes ("Series 2013-A Notes") issued by HVF II.  As a result of the amortization event, and notwithstanding the forbearance agreement described below, proceeds of the sales of vehicles that collateralize the notes issued by HVF II must be applied to the payment of principal and interest under those notes and will not be available to finance new vehicle acquisitions for Hertz. However, in light of the impact of the COVID-19 global pandemic on the travel industry, Hertz believes it will not need to acquire new vehicles for its fleet through the remainder of 2020.  A liquidation event means that, unless the affected noteholders otherwise agree, the affected noteholders can direct the liquidation of vehicles serving as collateral for their notes.

Hertz's lenders agreed to hold off on seizing and selling the cars until May 22—they don't actually want the cars! what a terrible time to sell thousands of used cars!—but when that agreement expired Hertz filed for bankruptcy.

We have talked occasionally around here about "EBITDAC." This is a semi-joking acronym ("earnings before interest, taxes, depreciation, amortization and coronavirus") for the idea that companies have asked their lenders to ignore the effects of the Covid-19 pandemic on their earnings. Companies borrow money for years at a time, but their loans often have covenants saying, roughly, "if things go really bad in our business we will pay back the money immediately." (This effectively means bankruptcy: If things go really bad, they won't have the money to pay back the loans.) This is a good protection for lenders in normal times, but in a pandemic it just seems sort of mean: Lenders don't want to foreclose on dozens of companies and put them all into bankruptcy; they'd often prefer to ignore the short-term effects of the pandemic on the borrowers' businesses and hope that everything will work out in the long run. So they agree to pretend that their borrowers' income was the same as it was last year, so as not to blow through any covenants and force foreclosure.

Margin loans, and margin calls, are not built that way. Nobody goes to their margin lenders and says "hey let's pretend that the stock we borrowed against is worth the same as it was last year"; the lenders rely on being able to seize and sell the collateral, and if the collateral loses value they want their money back right away. Asset-backed securities with variable operating lease payments that depend on the resale value of the underlying collateral are, apparently, like margin loans in this way; they are not built for pretending. It would be nice for Hertz if its cars were worth as much as they were pre-pandemic, but they're not, so it's bankrupt.

Should you participate in a corporate musical parody?

No, no you should not. I keep saying this whenever I get a chance, and here's this:

As the opioid epidemic raged in 2011, employees of drug distributor AmerisourceBergen Corp., shared an email: a parody of the theme song for "The Beverly Hillbillies," describing how "pillbillies" drove south to obtain drugs at Florida pill mills.

"Come and listen to a story about a man named Jed/ A poor mountaineer, barely kept his habit fed," the song begins, chronicling how Jed goes to Florida, which is described as having a "lax attitude" about pills, or "Hillbilly Heroin."

The email was made public this past week as part of a filing in a mammoth federal case in Cleveland, where thousands of cities, counties, Native American tribes and others have sued companies up and down the opioid supply chain. 

At least it is only a lyrics email; if they'd filmed a video it would presumably be part of a criminal prosecution.

X Æ A-Xii

You know, when Elon Musk tweeted that he and Grimes had named their child "X Æ A-12 Musk," I was 100% sure he was kidding, and then everyone reported—as far as I can tell based on Musk's and Grimes's tweets—that that was the baby's name, and they kept tweeting about it, and now it is just a widely accepted fact that the baby is named X Æ A-12, and … I am still about 80% sure that they're kidding? The kid is named Ethan or something, the X Æ A-12 thing is a elaborate joke, Musk and Grimes are laughing at us. But they are committed to the bit:

Grimes and Elon Musk have changed their baby boy's name, the "Miss Anthropocene" singer said, after it failed to comply with California law. The 32-year-old new mom shared the news on Instagram after a follower asked her what the baby's new name was.

"X Æ A-Xii," she answered in the comments. She later added, "Roman numerals. Looks better tbh," when a separate fan noted she "removed the numbers to conform [sic] to California law."

The songstress also noted that California permits one dash in a name.

It's unclear whether the couple has finally come to an agreement about how to pronounce their son's name.

They pronounce it "Ethan." Absolutely not, none of this is even a tiny bit real, I refuse to believe it. In 22 years I'll get a copy of the Stanford graduation program and if he's listed as X Æ A-Xii or whatever I will accept it but until then, I am sorry, elaborate joke. 

Things happen

Chinese Companies Fleeing New York Will Find Warm Welcome at Home. Now in Default, Argentina Plans Improved Offer for Creditors. Elliott Stokes Credit Fund Furor With Travelport Asset Move. NYSE Trading Floor Reopens as Lockdowns Loosen Further. Oil volatility sparks debate on big commodities bets. BOE Isn't Close to Implementing Negative Rates, Haldane Says. Market 'distress' over virus sparked emergency Wall St measures. Mortgage Credit Tightens, Creating Drag on Any Economic Recovery. Inside Carlyle's 'long-term' Amex bet that coronavirus cut short. Germany, Lufthansa Agree on $9.8 Billion Bailout. Goldman Sachs ramps up cash management plans despite coronavirus. HSBC board rethinks overhaul and seeks even sharper cuts. EU grants banks capital relief to fund €450bn lending boost. Europe's Banks Are Stronger, but Some May Not Weather Crisis, Regulator Says. UK and EU fund managers at odds over Mifid II revamp. Model risk at central counterparties: Is skin-in-the-game a game changer? Have the Fed Swap Lines Reduced Dollar Funding Strains during the COVID-19 Outbreak? Elon Musk's SpaceX Readies First Astronaut Launch by Private Firm. An Oral History of "Friday." Quandary for High Flyers: How to Travel Safely to Your Yacht. Bolivian orchestra stranded at 'haunted' German castle surrounded by wolves.

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[1] Disclosure, I used to work at Goldman, though not doing mortgages.

[2] I mean it has a private bank, and perhaps the private bank did some mortgage lending, but probably not *subprime* mortgage lending to struggling homeowners.

[3] Actually Goldman owned a mortgage servicer for a while, Litton Loan Servicing, but it had sold it years before the settlements requiring consumer relief.

[4] Really USO can't go below zero, only its underlying contracts can, that is the problem. Still what matters in the BMH is the feeling, not the details. "I'd wager that 90 per cent of investors in USO couldn't explain what contango is," an investor told Rana Foroohar. 

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