My company has purchased loans before. We sent people to the selling bank, parked ourselves in a conference room stocked with coffee and snacks, and did something called “due diligence.” This means we spent a week analyzing the loan files and repayment history. Sound exciting? Guess again. But before we bought a portfolio, we wanted to understand the fundamentals of each loan, and decide which ones we wanted, and which ones we didn’t. 

My understanding is this $700 billion dollar bailout is to purchase distressed assets from financial institutions, to reduce the pressure on their reserve for loss provisions, reduce pressure on credit default swap (CDS) buyers so that they won't need funds to fulfill them, reduce market pressure to sell mutual funds that purchased collateralized debt obligations (CDOs) with these assets as the underlying security, prevent a further deflation of M3, and thereby restore short-term credit market stability. Fine.

But what exactly are we, the taxpayers buying here?

There isn’t a single mention of any due diligence in these bailout proposals. There isn’t even a discussion as to how they came up with $700 billion. Why not? Folks, this due diligence process is what the regulators did in the S&L crisis. This is what JPM Chase may do with the WAMU assets they were forced to buy by the regulators.

First, let’s assume those assets are primarily distressed mortgages. So let’s just play with numbers for a moment to understand what I’m asking and how much it might cost – at least I can provide a concrete example, which is more than I can say for our leadership.

Let’s say there are 2.8 million homes now in the foreclosure process. Let’s start there, then we can go to the ones that are 60-90 days delinquent later. 

In my due diligence trips, I look at 5-10 files per hour. These were commercial mortgages and loans, with more complex cash flows, multiple borrowers, and environmental reports to skim as well as appraisals. I’ve also reviewed consumer mortgage files – they take much less time, once you know where things are in the loan file. Let’s say a typical reviewer can analyze 10 per hour. 80 per day. Let’s assume a 20-day working month; a single person ought to be able to review about 1,600 files per month. To review 2.8 million files in a month, you’d need 1,750 people working at this pace. I bet you can find that many in the financial sector right now who have been laid off this year. So pay them $20 per hour; it would cost $5.6 million bucks.

Want it done in two weeks? Hire about 3,500 people.  Etc.

Where to start?

The easiest place would be the bank(s) with both the highest number of foreclosures and the highest dollar amount of foreclosures. Then the bank(s) with highest dollar amount of foreclosures, then largest number of foreclosures.

So what would we get with this little project? Is it worth more than $3.2 million paid to Alaska to study the mating habits of King crabs? I bet it is.

We should get:

1. The repayment history – vital, because it paints a picture of what the borrower can handle and gives the reviewer an idea of how to work the loan out.
2. Credit report – know how the borrower handled their past credit
3. Collateral value estimate, i.e. an appraisal – likely a high estimate, but this along with www.zillow.com or a tax assessment, you get an idea of what the home would sell for
4. Debt coverage  - this tells you what the lender thought the borrower could afford
5. Source of repayment – was it one income, or two? (hint – if the lender gave two people a mortgage they can barely afford, and one loses a job…)
6. Are there other liens? (if the borrower got a purchase money second mortgage, for example)
7. Liquidity – how much the borrower had to cover bad times (likely zero)
8. type of property – was it a rental property? Vacation home? Primary residence? The disposition of the property could vary depending on the answers here.
9. If it was a rental, was it rented? Is it now? For how much? Are the rent payments on time? How much of a vacancy has it had?

Once you have this data, you’ve got something real to go back to the regulators with. You can see which mortgages may need a deferment, so the borrower can get back on their feet, and which ones truly are due for foreclosure. Put it in a database, and analyze it. Are there concentrations? (We already know there are – California and Florida have the highest number of foreclosures, Arizona, Ohio and Michigan, etc.)

{Here is an aside – many of these mortgages were done from institutions regulated at the state level. So what are these states going to do here? Can’t they foot part of this bill? If South Dakota has the lowest number of foreclosures, why should their taxpayers pay a proportionately higher share of the bill?}

OK, now for the other assets. Like I said about the mortgages, we need to get to the core assets that are a problem. I have no direct experience with what information changes hands when a CDS is sold or a CDO is packaged and sold. Since the initial buyer of these swaps or CDOs can (and frequently) does trade them, we’d need to get to the core of the problem – the original seller. So can any TPM member with experience here comment if a similar due diligence program can cut to the chase with these derivatives? What are we being asked to pay for here?

Why hasn’t the President or the Fed or the regulators issued an order to get this done? I don’t see the problem. If my company can buy hundreds of loans this way, why can’t the Feds do the same thing here while the bailout negotiations are in process. Even if it costs $20 million, that’s a drop in the bucket compared to what they’re asking. This isn’t rocket science. It’s in the trenches analysis. And it would seem that the legislators would have a much better chance at crafting a bill that actually would work if we knew what we’re getting.

So again, what are we buying here?

How about some real information instead of bloviation and doom prognostication?

C’mon. Get cracking.