Life That POPs

The market has been an interesting place lately. Not too long ago New Century, the second largest sub-prime lender in the land, declared bankruptcy. How did this happen and what does that have to do with Countrywide?

My good friend and co-worker Brian Brady came out of the securities field just as I did (he was a bond trader and I was an options trader). We both are fairly well versed in ‘corporate speak’, which is the business version of military double speak. (For instance, when the military says there was “collateral damage”, what they mean is innocent people were killed.) Corporations use ‘double speak’ to address bad news in the business world. About two weeks before New Century “shuffled off this mortal coil” (Shakespearean ‘double speak’ for died) they came out with an announcement that they had lost track of their underperforming assets. This rather innocuous statement sounds a lot like “I seem to have lost my car keys”. Of course, in the world of lender finance the key focus and the one and only thing you never lose track of is your underperforming assets: loans that are going bad and that you will most likely be buying back. So as a corporation you need to have a very good estimate of that number. When New Century said they “lost track” I took that as ‘corporate speak’ for “we are seeing the beginning of a real problem that we had not accounted for and we are delaying the release of our numbers until we can wrap our heads around what is coming”. Sure enough, after two weeks they “found their car keys” and announced some staggering losses. That, in and of itself, was not the problem. The problem was that they had to restate their earnings and Wall Street is VERY unforgiving when you go back and tell them “hey, remember when we told you we made this much money? Well we were wrong. We only made half as much.” Within 48 hours New Century was bankrupt.

Soon after this New Century debacle, Mr. Mozilo – the CEO of Countrywide – came out and announced that while they had no real sub-prime exposure, they expected to see some losses due to the sub-prime problems. To which Brian and I looked at each other quizzically and said “what?” You have no exposure to the problem, but you will incur losses due to the problem? A short time later Mr. Mozilo announced that while they had absolutely no problems with their current sources of funding, they were in fact looking for new funding. To which Brian and I looked at each other quizzically and said “what?” Your funding source is not a problem but you need a new funding source? Countrywide is the largest lender in the land and over 60% (by my last check) of their portfolio is made up of option arms. The option arm problem is still on the horizon but I have often said I cannot imagine being the V.P. in charge of risk management at Countrywide. How do you hedge the majority of your portfolio against a product that has never existed at this volume and for which the future value is so uncertain?

I think that Countrywide is in the process of misplacing their car keys…