Dealing With Collateral Damage

Never has something so ordinary caused so much chaos. It’s why the mortgage is our Mover and Shaker of the Year.
By G.D. Gearino
Anyone with even the barest grasp of chaos theory understands that in 2010 North Carolina was the place — not uniquely but certainly prominently — where its effects played out in dramatic fashion. Chaos theory, of course, holds that small deviations from the original intent or purpose of something can cause wildly varying results. Or to put it more simply, small adjustments or mistakes can produce huge changes, often catastrophic: Rounding off a decimal point when plotting a ship’s course, for instance, can mean missing the port of destination by 100 miles. (If you want to complete that picture to its full chaotic glory, make it an oil tanker — then throw in a tropical storm and a hull-chewing reef for good measure.) Every businessperson sees chaos theory at work first hand, even on a daily basis. Parents, too, considering that child-rearing is one long exercise in chaos theory.

But rare is the instance when a small adjustment in a common, everyday process can wreak profound economic, social and political changes, as happened in North Carolina this year. That common, everyday thing is the mortgage, our Mover and Shaker of the Year. The small adjustment was the bundling of mortgages into securities, the effect of which was compounded by the resulting loosening of lending standards to feed the demand for those securities. Never has so much chaos been wrought by something so ordinary.

We’ll begin with three stipulations. Yes, we know that much of what follows here has a 2008 feel to it. But what we experienced then were the initial shock waves of the mortgage meltdown. What we felt last year are the aftershocks, which have cascaded in unanticipated directions and created significant change as a result. Also, this is the first time Business North Carolina has assigned the Mover and Shaker designation to a nonhuman. But after thinking about it for a while, we realized no living soul had as much impact on the state’s life in 2010 as did this ordinary financial transaction. Finally, we’re not seers: We can’t predict exactly how the aftershocks we describe below will unfold in the long term. Instead, we’re a little like the earthquake survivor who stands amid the rubble of his ruined village and says, “Well, this certainly changes everything.”

Enough with the disclaimers, though. Let’s list the ways North Carolina was, and continues to be, moved and shaken by mortgages, starting with the obvious and descending toward the speculative.

If the housing market were a mental patient (and most real-estate agents likely are nowadays), the term “basket case” would apply.
A recent afternoon spent on Trulia, a real-estate website, revealed that the state’s housing market is almost perfectly bipolar: When three indicators (average list price, median sales price and average price per square foot) for North Carolina’s seven largest cities were compiled, the split was exactly even. Ten were up, 10 were down. and one was unchanged from the previous period. While that seems like robust good health when compared with, say, Las Vegas, the downward pressure on the housing market steadily built throughout 2010. The number of foreclosure filings statewide rose 7.2% from 2009, reaching a record 67,854 last year, according to the N.C. Administrative Office of the Courts.

Needless to say, that’s not a climate in which the housing market stabilizes — much less flourishes. Any big bulge of foreclosures adds to the supply of available homes and simultaneously dampens demand, as potential buyers instinctively hesitate to commit in a market where the price floor seems shaky. Worse yet, some lenders — scrambling to deal with a tsunami of loan defaults — cut corners while preparing foreclosure documents, leading to legal challenges that could stretch out the market’s absorption of the troubled properties even further.

“We’re from the government, and we’re here to protect you from those predators in the financial industry. Uh, sorry about that free-checking thing.”
Once mortgage-backed securities had wreaked their special havoc upon the economy, politicians did what politicians are prone to do: They sought to make things “better” (quote marks included for maximum ironic effect). As part of a passel of new laws passed in 2010 aimed at leashing and taming the financial industry, banks now cannot milk easy profits from overdraft fees and the levies charged to a merchant every time a consumer swipes his debit card. Credit-card fees are likewise more heavily restricted. The pain to every bank’s bottom line was immediately apparent after the law took effect. Charlotte-based Bank of America Corp., for instance, took a $10.4 billion write-down in October in anticipation of a big revenue drop in its credit-card division.

What consumers learned after the new financial regulations were in place was that those overdraft fees and merchant charges subsidized their free checking accounts. Basically, the poor fool who swiped his debit card for a Starbucks double latte when he was down to his last two dollars in the bank — and was subsequently dinged with a big overdraft fee — paid for his neighbor’s checking account. The beauty of that arrangement was that the careful got rewarded and the careless got penalized. Not anymore. Banks everywhere either have eliminated free checking or piled more conditions on its eligibility (such as demanding that consumers not darken the bank’s door and do all routine banking online). The conscientious now pay penance for the sins of a few. In effect, overdraft fees were socialized — we all pay now, regardless of our financial discipline. Perhaps you now understand the ironic quote-marks around “better.”

Bank of America has a chronic infection, and its name is Countrywide.
Two years past the worst of the financial meltdown, BofA continues to sputter like a jalopy on a cold morning. Its stock took a nosedive in late 2008, and by early 2009 the share price was below the cost of that Starbucks double latte. It slowly climbed back up near $20 by April 2010 — then began a slow, inexorable fall that left the stock 40% below its spring peak. One prime cause was the ongoing costs of BofA’s acquisition three years ago of mortgage lender Countrywide Financial Corp. As The Charlotte Observer noted (with an apt metaphor), “Countrywide Financial is turning into a fixer-upper home that keeps needing one more budget-busting repair.” The newspaper reported that BofA’s home-loan division has lost $8.5 billion since the Countrywide purchase closed, the bank has spent $730 million to settle the many legal and regulatory issues that came with the Countrywide deal, and it has set aside $4.4 billion as a hedge against the growing number of demands from investors that BofA buy back the bad loans. Considering that the amount of all such claims against BofA is nearly $13 billion, the set-aside total will almost surely grow. All that, of course, can’t help but cause people to recall the case of Wachovia Corp. and Golden West Financial Corp., another California-based mortgage loan originator purchased by another Charlotte-based bank in another get-rich-quick scheme. We all know how that one turned out: To invoke another metaphor, Wachovia’s balance was overdrawn, and its account was closed — with extreme prejudice.

The line is easy to trace: Mortgages tanked the economy, and the economy tanked political careers.
Woe be unto the politician or party in power when the economy goes sour or, as was the case in 2010, remained sour despite whatever pump-priming resulted from the spending of hundreds of billions of tax dollars. (Not much, as it turned out.) At the national level, that meant Republicans took control of the House of Representatives, gained seats in the Senate and declared their desire to make Barack Obama a one-term president. In North Carolina, the result was that for the first time since 1898, Democrats are now the loyal opposition in the General Assembly. Republicans have majorities in both chambers, a circumstance never seen in any current resident’s lifetime.

Republicans, naturally, want to believe that they’re now the dominant party in North Carolina because voters concluded the GOP was best equipped to lead through the economic downturn. Democrats want to believe they lost the General Assembly because a single rich Republican businessman, Art Pope, threw so much money around that voters eventually fell prey to his propaganda. (Lest anyone fail to make that connection, the progressive-leaning online magazine Facing South put this helpful headline atop its examination of the Raleigh retailer’s election spending: “Art Pope’s Big Day: Republican benefactor fueled GOP capture of NC legislature.”)

As usual, the truth lies somewhere in between. Only the most deluded Republican believes the GOP got a vote of confidence this year rather than benefited from a vote of protest against incumbent Democrats. And for all the wishful Democratic claims that Pope’s money tilted the table to Republicans, to believe that is to ignore the reality of the Democratic wipeout almost everywhere across the country. Pope has spent money on conservative political causes for years. In 2010, he finally caught a lucky wave — which makes him one of the few clear beneficiaries of the chaos wrought by mortgages.

And then there’s climate change — as in “business climate.”
Depending on whom you ask, North Carolina either is one of the the best places for business in the country (Site Selection magazine recently cited it as the top state for business climate, marking the ninth time in 10 years we’ve led the list) or one of the worst. An organization called The Tax Foundation issued its latest State Business Tax Climate Index two months ago and put North Carolina among the 10 most oppressive states — lumping it in with such profit-poaching train wrecks as New Jersey and California.

Those two rankings may feel contradictory, but they’re not. In fact, they nestle together quite easily. The Tax Foundation ranks states based on where their taxes in five categories — corporate income, individual income, unemployment insurance, sales and property — stand in relation to one another. Forty other states scored better than North Carolina when the composite score was compiled. Site Selection magazine’s rankings are a tad spongier and in large part essentially come down to, as its editors explained, which states will take “certain steps ... to help [companies] ride out the broader economic storm.” Or, in short, which states offer tax breaks to businesses as an incentive to relocate. North Carolina tops that list. Its tax burden may be high, but North Carolina politicians regard official tax rates in the same way a Middle Eastern rug merchant regards the retail price of his wares: It’s just the starting point to begin the haggling. Gov. Beverly Perdue confirmed that reality to the magazine, stating that discussions about tax breaks “are a given now” whenever businesses are being wooed to the state.

But incentives are a contentious issue, in part because the companies receiving tax breaks often are those who least need financial assistance — Apple Inc., for instance, and Google Inc., both of which have gotten sweet deals to locate in North Carolina. Curiously, though, sentiment doesn’t divide along partisan lines. “Proponents and opponents of incentives have historically come from both sides of the aisle and both ends of the ideological spectrum,” says Jeanette Doran, who as senior staff attorney for the North Carolina Institute for Constitutional Law has drafted several legal challenges to the state’s giveaways. (And lest you think politics is without nuance, remember that the institute — which seeks to inhibit the flow of state goodies to business — is largely funded by the aforementioned Pope, who also sits on its board of directors.) Instead, Doran says, the pressure on incentives will be economic, not political.

The state is facing a $3.5 billion budget shortfall next year, local governments are getting squeezed, and countless citizens are dealing with their own deficit crises. In times like this, incentives can be a tough sell. Four months ago, Cree Inc., an LED lighting firm, received a $2 million incentive package from Durham County. It had more than $1 billion in cash accumulated in its coffers at the time. That’s what politicians call “bad optics.” At the very least, the optics of incentives are going to be bad for a while, meaning North Carolina’s run atop the business-climate rankings might be nearing an end.

One final thought: Jim Rodgers, a former fund manager to whom the phrase “legendary investor” is frequently attached, says it will be years before the financial industry bounces back from the mortgage trauma. “I know those [bank] balance sheets are full of rotten stuff,” he told CNBC in late October. And he’s particularly gloomy about Bank of America, which he says doesn’t even understand its own condition: “Nobody knows what book value at BofA is, including BofA.” If he’s right, the moving and shaking may go on for years.