
Whistleblower: Wall Street Has Engaged in Widespread Tampering of Mortgage Funds - catacombs
https://www.propublica.org/article/whistleblower-wall-street-has-engaged-in-widespread-manipulation-of-mortgage-funds
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PEJOE
Wait until Propublica learns that lenders are underwriting based on pro-forma
forward Adjusted EBITDA net leverage, not past EBITDA leverage.

The whole idea of Adjusted EBITDA is insane to me. We add back "one-time,"
expenses and other items, but the underlying business ends up seeing similar
"one-time," costs every year.

The result is that companies often borrow at a leverage ratio that looks 30%
smaller than it actually is. This year we are doing "COVID-19," addbacks. What
the fuck? You lost money because of COVID, so add it back to EBITDA so that
you are still meeting your loan covenants? Lenders are in on it too, because
they don't want to see their clients default and deal with bankruptcy or
taking control of the assets.

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css
There is nothing wrong with that if the banks are allowed to fail when the
loans don’t pan out. Underwriting is supposed to be about managing risk, not
completely avoiding it. The problem isn’t the analysis, rather it is not
letting banks absorb the consequences of being wrong.

> The whole idea of Adjusted EBITDA is insane to me.

The straitjacket bank regulators have placed around the ability of banks to go
outside of the government defined process of evaluating credit-worthiness
doesn’t help. The rules (mainly FDIC insurance requirements) make it near
impossible for many companies to get loans. This problem incentivizes
companies to play games to get around the crazy restrictions.

This is also why there is an emerging trend of non-traditional lenders (e.g.
some VCs and PE firms). I’m sure the government will find a way to regulate
them eventually.

> This year we are doing "COVID-19" addbacks.

What’s wrong with that? Ability to repay is based on expected future cash
flows. If COVID losses are believed to be non-recurring (a big if), then that
makes sense.

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PEJOE
> There is nothing wrong with that if the banks are allowed to fail when the
> loans don’t pan out. Underwriting is supposed to be about managing risk, not
> completely avoiding it. The problem isn’t the analysis, rather it is not
> letting banks absorb the consequences of being wrong.

I agree with you, with the caveat that many of these receivables are taken off
balance sheet through a securitization process, and the resulting structure is
almost unable to technically default as long as the AAA tranche interest is
paid. Responsibility for originating good loans, meaning they are creditworthy
in a downturn, goes down if you can securitize them into a credit enhanced
structure or sell them to another investor.

> Generally, I agree. The straitjacket then bank regulators have placed around
> the ability of banks to go outside of the government defined process of
> evaluating credit-worthiness doesn’t help. The rules make it near impossible
> for many companies to get loans. This problem incentivizes companies to play
> games to get around the crazy restrictions.

In my opinion (not worth much) the industry is simultaneously under and over
regulated. Enough bad actors that reducing the regulation is a bad idea, but
the existing regulation makes lending more challenging and constrains growth
on most businesses, who are operated in good faith.

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code4tee
This makes complete sense and there’s no question commercial restate is
turning into a bit of a house of cards.

In some big cities you have many large buildings where their primary tenant
was WeWork, which appears to be imploding, and now adding onto that the whole
covid WFM shift where companies are starting to cancel and downsize future
leases. When you start to dig into the revenue streams behind these buildings
and the owners ability to pay the mortgage back it starts to look really shady
in some cases.

Most buildings need a fairly high percentage of the floors to be leased out
for the building rent to cover the mortgage and moving forward it seems a lot
of buildings will struggle to hit that number. It’s going to be an interesting
time for commercial office real estate.

On the plus side if you’re looking for office space there are going to be some
amazing deals!

~~~
wnmurphy
Commercial real estate is going to be really interesting to watch. For a lot
of mid-size companies, the building lease is 15% of your total operating
expenses.

~~~
jiveturkey
Especially in CA, where it's propped up by umm prop 13!

Every default should trigger a re-assessment when the property changes hands.
CA recently put into place a rule (law?) where a change of control of the
ownership entity also triggers re-assessment, thereby ending the long running
scheme of selling the LLC owner rather than the property itself.

If enough of these bad (metric-wise) loans default, there could be a very far
reaching negative valuation impact, ie well beyond just the defaulted
properties. I expect rents will go up, even as property values go down.

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jl2718
It’s sort of amazing how easy and widely accepted it is to submit, under oath,
completely different corporate financial attestations depending on whether you
are dealing with the IRS, the SEC, or FINRA.

I can imagine 50 years ago, when they all got the ability to check
electronically, and knew that everybody was cheating, but they couldn’t do
anything because it would it would crash the economy, and also these computers
were taking their jobs, so the agencies decided to be willfully ignorant and
inefficient and setting rules according to whatever people were doing already.
So now it’s like, “OMG we never saw this coming!”

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wpietri
My understanding is that after 9/11, a lot of federal law enforcement
resources got retasked away from white collar crime and just never went back.
And I think it's part of a general decline in interest in holding people with
money to account; in the 1970s, the IRS used to audit 2.5% of returns. Now
that's down to 0.45% and falling. This makes a fair bit of sense when you look
at who has influence with legislators and elected politicians: the donors.

But what I think a lot of this misses is that the more a financial system is
prone to cash extraction, the less good it becomes at value generation. As an
example, we can look in software at the era of Microsoft's dominance.
Microsoft was a great cash generator, but its dominance (and misuse of its
market power) discouraged a lot of startups). Then antitrust enforcement and
the rise of the browser unleashed a whole wave of innovation.

~~~
Ididntdothis
"But what I think a lot of this misses is that the more a financial system is
prone to cash extraction, the less good it becomes at value generation. As an
example, we can look in software at the era of Microsoft's dominance.
Microsoft was a great cash generator, but its dominance (and misuse of its
market power) discouraged a lot of startups). Then antitrust enforcement and
the rise of the browser unleashed a whole wave of innovation. "

Pretty much all big companies are good at making cash while killing
innovation. Compared to their size the innovation output of the big tech
companies is pretty low.

Since 2008 it has become clear that the financial sector is viewed as an
industry that needs to be protected no matter what the cost so you should
expect them to keep doing crooked stuff while making boatloads of money. This
comes at the expense of other sectors in the economy.

~~~
wpietri
I agree totally, but want to draw one distinction. I think big companies are
fine in big, competitive markets. They're generally terrible at innovation, of
course (although not always; 3M is a counterexample, as is Apple). But as long
as there is room for upstarts to make a good living, that doesn't worry me.

~~~
Ididntdothis
I still would argue that compare to its size Apple’s innovation is lacking.
They did a lot between 2000 and maybe 2010 but now they are just iterating on
the same things with only a few innovative things sprinkled in. Like all big
companies their main strength is efficient execution and optimization of
systems.

~~~
wpietri
Yeah, they're definitely lacking in innovative products lately. But they're
still spending a fair bit on incremental innovation. The iPhone is still the
phone to beat in terms of camera quality, and they're making other
improvements like whatever their face-radar thing is. This means that the
other phone players have to keep innovating too, and can't just settle down
and hoover up cash, so I'm ok with it.

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cm2187
I find that a bit surprising. I used to structure CMBS transactions before the
financial crisis and even then all income from properties would be ticked back
against the leases and the dataset verified by an independent auditor.

In fact the CMBS market blew massive holes in banks balance sheets in 2008 but
not because of fraud, but because the commercial property market tanked so
much (and will likely not do much better after covid).

So it is always possible that underwriting standards drifted downward, and
there are perhaps different standards in the US than Europe. But I find this
story surprising and unlikely and would like to see more before forming an
opinion.

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alexpetralia
This is in part due to a search for yield (same as we saw with the housing
crisis). There is such a glut of capital that it will invest in anything -
even risky CMBS - without performing adequate due diligence. If you don't
invest, someone else will. Unfettered "quantitative easing" distorts the price
of risk. This is the not-so-surprising consequence.

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cdubzzz
> Flynn has amassed “materials identifying about $150 billion in inflated CMBS
> issued between 2013 and today,” according to the complaint.

[...]

> The SEC has the power to fine companies and their executives if fraud is
> established. If the SEC recovers more than $1 million based on Flynn’s
> claim, he could be entitled to a portion of it.

Hope he got a good lawyer!

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LatteLazy
Why do people keep expecting other people to act against their best interests?
Why are buyers relying on sellers’ valuations? And given these are billion
plus dollar products transacted between professionals, why does Buyer Beware
apply?

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atomi
I love how the SEC's own lease is possibly mired in the scandal. What a mess.
We need another Teddy to clean it all up.

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bitxbit
Every MD running a trading desk comes to work and asks “who’s stealing from me
today?” That’s the Wall Street mentality.

~~~
metalliqaz
sorry, I don't know Wall Street lingo, what is "MD" here?

~~~
cbames89
Managing director I believe

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metalliqaz
thanks

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zentiggr
What if Flynn publishes a list of the companies involved and the timeframes,
we construct a list of the executives, directors, and mangers involved, and
blacklist them?

No business with any company that employs even one of them, ever again.
Starting today.

Damn the chaos, signal that this kind of profiteering and crash-building is
not tolerated.

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hhs
> Investors don’t comb through financial statements, added Riordan, who used
> to manage the CMBS portfolio for retirement fund giant TIAA-CREF. Instead,
> he said, they rely on summaries from investment banks and the credit ratings
> agencies that analyze the securities. To make wise decisions, investors’
> information “out of the gate has to be pretty close to being right,” he
> said. “Otherwise you’re dealing with garbage. Garbage in, garbage out.”

Is there a way to add incentives so investors don’t analyze information from
summaries?

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cm2187
If the summaries were false or misleading, the bank may be liable for any loss
occurred , as for the bankers this may be characterised as securities fraud.
So the incentives are for the summaries to be accurate.

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toomuchtodo
It should be noted that only one person was incarcerated from the fraud that
occurred leading up to the 2008 GFC.

~~~
cm2187
I am aware of lot of losses that went back to the originating bank because of
inaccurate marketing material.

~~~
toomuchtodo
Yeah, no disagreement that putbacks occurred, but those perpetrating the fraud
aren't being held personally responsible. It's a slap on the wrist for the
bank, cost of doing business. Call me when they're doing perp walks and
handing out Maddof length sentences. Those are incentives to not violate
securities law.

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denzil_correa
> The historical profits reported for some buildings were listed as much as
> 30% higher than the profits previously reported for the same buildings and
> same years when the property was part of an earlier CMBS. As a rough
> analogy, imagine a homeowner having stated in a mortgage application that
> his 2017 income was $100,000 only to claim during a later refinancing that
> his 2017 income was $130,000 — without acknowledging or explaining the
> change.

TL;DR

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creativipy
Carl Icahn's short of the CMBX is looking more and more clever.

[https://www.wsj.com/articles/carl-icahn-placing-a-big-bet-
ag...](https://www.wsj.com/articles/carl-icahn-placing-a-big-bet-against-mall-
owners-11574201244)

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lowdose
The difference with the other capitalistic system is that the guys from
Deutsche Bank are going to jail when this kind of shenanigans is going on.
Bankers in the west do not have skin in the game.

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themark
Combine this with the fact that many business no longer exist and the new
normal of the restaurant industry, I would expect to see the commercial market
crash pretty hard.

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blueboo
Rating agencies - S&P, Moodys, Fitch - are in bed with those they rate. It was
a time bomb. It blew up in 2008. It’s a time bomb again.

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ordinaryradical
This reads like 2008 all over again. How bad is this?

~~~
Red_Leaves_Flyy
Somewhere between a nothing burger and covid19 stimulus big.

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JoeAltmaier
This will continue as long as human beings are in the loop. If it were
automated, code-reviewed and made secure we might have a system that could
follow the rules.

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huac
I agree. We need real estate that is only inhabited by data centers or
automated pizza machines, no humans in the loop at all, not even paying rent.

~~~
JoeAltmaier
Huh? I meant of course, the issuing of loans and bonds could be codified and
enforced. Instead of this house-of-cards involving fallible humans.

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bantunes
Am I the only one not surprised at all by this report?

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ganstyles
No one on the comments so far seems surprised. So, no, I don't think you're
the only one not surprised.

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vmception
Instead we just assume this is happening and extend 0% credit to all the
investment banks so that they don't blow up on their fraudulent bets and shady
accounting

Since we'll never prove anybody had the necessary knowledge of breaking the
law and ignorance is an excuse when you write the law specifically that way

