Monday, January 03, 2011

The End of Wall Street

I'm in the first third of reading the book by Roger Lowenstein. Published in early 2010, it is the extremely well written story of the mortgage / financial crisis of 2007/2008 (after effects continuing through ?). Clips from four interesting references to public communications during the crisis:

1. Speech by Robert Rodriguez, manager of FPA New Income Fund.
Excerpts from Absence of Fear, by Robert L. Rodriguez, CFA; CFA SOCIETY OF CHICAGO SPEECH – June 28, 2007

My talk today, Absence of Fear, is a follow up and expansion of the Special Commentary section that appeared in my March 31, 2007 shareholder reports. It will focus on the concept of RISK since there appears to be little concern about risk in the financial markets currently. My goal is not to scare or sensationalize, but to get investors to consider various risks and ask the basic question, “Am I being sufficiently compensated for these apparent risks?”


We see most investment sectors as providing little in the way of a margin of safety. The potential risks that we see do not appear to be well considered in the valuations within these sectors. Investors/ speculators, in all sectors of the investment universe, appear to be willing to engage in highly risky strategies or investments. There is a sense of virtually unlimited liquidity in the financial markets presently. We believe this liquidity safety net can be withdrawn without any notice. In many cases, the abundance of liquidity is a function of creative debt leveraging. Like all leverage, it feels wonderful on the upside, but watch out how it can come back to bite you on the downside.

2. Citicorp Letter to Shareholders, 2006 Annual Report
Quote from Charles Prince, Chairman and CEO in the 2006 annual report (written and published in March 2007)

As we look to 2007, we believe the credit environment around the world, with some exceptions, is good, but we are very focused on managing our exposure. We expect moderate deterioration in credit in 2007 and are managing our portfolio accordingly.

That was an understatement! And of course there was no follow-up letter from Mr. Prince in the 2007 annual report!

3. Letter to Shareholders, JP Morgan 2006 Annual Report by Jamie Dimon, Chairman and CEO.
Excerpts from the Letter to Shareholders (written/published in early 2007). In a section titled, Managing Critical Risks:

Subprime mortgages: the good, the bad and possibly the ugly


We do not yet know the ultimate impact of recent indus
try excesses and mismanagement in the subprime market. Bad underwriting practices probably extended into many mortgage categories. As government officials investigate the market and losses mount, the industry is tightening underwriting standards by reducing loan-to-value ratios and using more conservative property values. There will be more due diligence on incomes and credit quality.
More rigid standards increase foreclosures and make it more difficult to buy homes. This will lead to a lower number of sales and a reduction in home values.

This seems to be a reasonable disclosure. Contrast this treatment to the Citicorp annual report issued at about the same time!

4. Letter to Shareholders, JP Morgan 2007 Annual Report by Jamie Dimon, Chairman and CEO.
Excerpts from the Letter to Shareholders (written/published in early 2008)

As I write this letter, the turbulence that began in the second half of 2007 continues to wreak havoc on the financial markets today. Given the magnitude and unprecedented nature of events as they continue to unfold, it is a year that will be written about for a long time. We do not know when this cycle will end or the extent of the damage it will cause. But we do know that no financial company operating under these conditions will emerge from them unchanged. ...


The triggering event in 2007 was the bursting of the housing bubble and the related bad mortgage underwriting standards. In the 10 years from 1995-2005, housing prices in the U.S.
rose 135%, far exceeding normal home price increases and out-stripping traditional measures of affordability. While some thought the gains were justifiable, it is clear now that they were not. As of today, housing prices nationally are down on average almost 10% since the end of 2006, and it looks as if they will continue to deteriorate. It is also clear, in hindsight, that increasingly poor underwriting standards (e.g., loan-to-value ratios up to 100%, lax verification of income and inflated appraisals) added fuel to the speculation and froth in the markets. Many of these poor mortgage products were also repackaged and dispersed
widely through various securities, thus distributing the problems more broadly.

As Warren Buffett says, “When the tide goes out, you can see who’s swimming naked.” In this crisis, as the tide went out, we saw subprime concerns first, then mortgage-related collateralized debt obligations (CDOs), structured investment vehicles (SIVs), Alt-A mortgages, mortgage real estate investment trusts (REITs), the impact on monolines and, finally, very unfortunately for us, home equity loans. And the tide is still going out. As this chapter of history continues to be written, we cannot have the full benefit of hindsight. However, there are some lessons we have already learned and others we can draw upon from past crises. In the context of today’s crisis, they are worth revisiting.


Pages 10 through 13 elaborate on issues, insights, and lessons learned. This is a very revealing analysis of the financial crisis with specifics.