Illinois throws its hat in the ring…

Not to be outdone by Louisiana’s "I live in a city below sea level and am ignoring the order to evacuate" Katrina “victims”,

Illinois appears to be desperately trying to lay claim as the state who’s residents are most entitled to being compensated for being stupid.

Today the state declared that they were going to sue Countrywide Financial.

Read Here (Caution 80+ pages)

It’s really a fascinating (if lengthy) read. However, if you’re perusing blogs, you are probably the type that wants a summary. OK, first off, repeat after me—“No bank ever makes a loan hoping to foreclose on it at a later date.”

Feel better?

Me too.

I'll bore you with a little background on what led to the national mortgage “crisis.” If you have a working understanding, you can skip to the line of asterisks below.

Now, in this filing there’s some interesting historical context detailing how the home loan business became a security game (private-label security, not please-don’t-murder-me security.) The gist is that banks used to hold most of the mortgages. In the early 90’s there was a recession and banks got hurt. New rules were made linking the bank’s credit exposure to its value, so because they weren’t increasing value they had to shed risk (technically they couldn’t raise capital so they had to lose assets.)

Enter the Government Sponsored Entities (GSE’s). Since that time, a few major players, namely Fannie Mae and Freddie Mac, gobbled up most home loans made in America because banks don’t want to carry them on their books. The GSE’s mass-buy the loans by posting a set of rules that say “This is the type of loan, this is the type of applicant, etc. that we will buy.” If the loan fits in that “box”, Fannie will buy it at x% interest rate. This is called a “conforming loan” and through the mid-90’s, "non-conforming loans" were pretty rare.

Fannie puts a gazillion conforming loans into a pool and sells that pool to Wall Street. Interestingly enough, if you have a 401(k), an IRA, a pension, a money market account that pays interest, or even a savings account churning out 2% per year, you are Wall Street. The fingers of money are sticky. Your First Bank of Springfield makes you a loan for your house. They sell the loan to Fannie Mae. Your loan and a bunch of its friends get sold as a fund to Wall Street. Your First Bank of Springfield invests in that fund because it generates a safe 4% rate of return. Your bank then pays you 2% on your savings account, pocketing the 2% margin. Congratulations! Through your savings account you’ve just invested in your own mortgage.

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Back on task-- Wall Street has an appetite. It wanted more loans. You know what? There are plenty of people in America who can not qualify for conforming loans. Their assurance that they can repay the loan is not as solid. It usually comes down to credit rating or money-down. How do you quantify this new risk? By charging a higher interest rate and additional fees to offset the risk that a larger percentage will default.

From the Illinois Attorney General’s letter—

“Countrywide sought to place greater numbers of borrowers into loans laden with these premium-enhancing features.”

“The more loans its employees sold, the more money Countrywide paid them.”

EGAD! A company trying to maximize profit! Well dammit, let’s sue ‘em!

There is always a spoon bender (or team) in some office calculating the magnitude of additional risk and how much more you need to charge to offset it and still make money. Investors paid more for higher interest loans with high penalties for borrower non-compliance. Here’s a statistic to chew on: 21% of sub-prime loans are seriously delinquent (>90 days). I doubt you’ll see that number in any investor formula with a smiley face next to it.

Banks, investors, Wall Street—everyone’s getting creamed because they got that number wrong. It was an error. It wasn’t a crime! Countrywide’s stock is down 80% in the last 12 months and Bank of America will be acquiring them in the next week. Fannie Mae has written off billions in bad debt. Bears Stearns is gone.

You think they meant to do this?

Here’s another interesting factoid. In October of 2006 the unemployment rate in Illinois was 4.2%. In May of 2008 the number is 6.4%. That’s 156,800 additional jobless folks in case you’re counting. We didn’t have a mortgage crisis in October of 2006. All lenders combined only foreclosed on 64,310 homes in the state in 2007. Could the cause of the delinquency and foreclosure numbers in Illinois perhaps be linked to the loss of jobs during that time? Could Countrywide counter-sue Illinois for being a terrible steward of its employment market?

Not…bloody…likely.

And here’s the kicker. The argument is that the individual should never have been given the loan. So if I read into that correctly, someone got to live in a house they could not afford for a number of years and now at the end have to move out. With a ding to their credit. But their credit was dinged to begin with which is why they were in the non-conforming loan pool? And now they are entitled to recourse?

Companies made bad business decisions. The Countrywide approved lender villified in the Illinois AG's suit, with 5 felony convictions, should raise an eyebrow or two. None of the lender's charges appear to be related to any financial improprieties, which may or may not count. If the allegations against One Source are as written, and he made those verbal assurances contrary to what was in the contract, you have my permission to hang Mr. Mangold high. However, a business dealing with hundreds of affiliates can't be held to the standard of its lowest commen denominator as is the case here. And I suspect is the case in most under-investigated, over publicized, financial scandals.

But you know what? At the end of the day the contract governs the deal. I read my entire mortgage contract. Pretty boring stuff, and pretty damn empowering to the holder. But I know the rules and live by them. At the bottom of every mortgage sold by every bank to every investment house there is a signature. A person’s signature. That signature seals the contract and at that point the individual agrees to do something and the bank agrees to do something. In this case, only one side of the deal failed to perform.

And in Illinois, failure to do what you say you’re going to do makes you a victim.

Countrywide's gonna lose because people are stupid. They're going to lose because in America, citizens can vote themselves cake from the government pantry. Guess it’s about time to buy that hundred acres and a bunker. I think I’ll pay cash.