A big culprit in the housing crisis is punished

After living through the housing crisis and reading and watching news, books and movies, I read with interest that one of the biggest culprits has been punished – the rating agency Moody’s. In my view and the view of others, Moody’s failed in its job to forewarn investors of the true risks of packaged together mortgage loans. They fell into a “pay to play” modus operandi.

What is pay to play? Per an article in Reuters, “Moody’s ratings were ‘directly influenced by the demands of the powerful investment banking clients who issued the securities and paid Moody’s to rate them,’ Connecticut Attorney General George Jepsen said in a statement on Friday.” This would be akin to you paying off the inspector of the house you just built and want to sell. The buyer would not know the inspector was gaming the system against him or her.

So, individual investors, pension funds, 401(k) funds, states, and countries all fell prey to this pay to play ratings approach. Iceland had to declare bankruptcy, e.g. As a result of their actions, Moody’s was fined $864 million which will be distributed to twenty-one states and the federal government, who were part of the lawsuit.

We should not lose sight of an industry who became enamored with riskier investments and did not ask enough questions. Executives did not fully understand the risk they were taking on and it brought them down, along with the housing market, stock market and economy. An excellent movie to watch is called “The Big Short,” based on Michael Lewis’ book, which takes a complex topic and explains it with the dialogue, but also with clever sidebars which use laymen’s terms to define what things mean.

In essence, mortgage loans were given out to anyone who could fog a mirror, then these lesser risks were packaged together to spread risk and sold to investors. The problem is packaging bad risks does not make the risk less, it makes it concentrated bad risk. The law of large numbers to mitigate risk is only effective if good risks are mixed with some bad risks. Moody’s stamped these packaged loan investments with much higher ratings than they deserved. And, investors who trusted Moody’s and the seller bought them in good faith.

We rely on Moody’s and other rating agencies to take their job with seriousness of purpose and ethics. If they cannot shoot straight with us, they will let us down. And, that is precisely what they did. In my view, that fine may not be enough for the damage they helped perpetuate.

“Get your money upfront”

Let me set aside the reason the man who uttered the phrase “get your money upfront,” was being asked his opinion. He was describing dealing as an independent contractor with the various companies under one owner using a common way of saying don’t trust them, get paid before you start. He prefaced his comments with “the word on the street,” to define it is not just him who is having these issues.

If you heard this about anyone, your first reaction, would be to hit the pause button. It could be due to bullying contractors to pay them less or it could be due to companies having cash flow issues. There are two sure-fire ways to see if a company is in trouble. The first red flag is they extend their Accounts Payables from 30 days payment to 45 days or more, e.g. The second bigger one is when they stop paying people altogether, be it contractors or employees. They invent reasons to delay or not pay, begging for a lawsuit, to be forced to pay.

Per a USA Today article on June 1, 2016 (see link below), the owner of these companies has had over 3,500 lawsuits and settled at least 100 of them. Usually, when a settlement occurs, there is no admission of guilt or innocence, but it is my experience companies settle when they have a lesser case. The cases range from stiffing contractors, employees, buyers and co-investors, suing to force the eviction of people from their homes under various local clauses of eminent domain and aggressive or fraudulent misrepresentation.

The sad part is many of the folks who sued this owner went out of business or lost significant portions of their wealth. Another sad part is those who could not afford to sue or would get overwhelmed by the owner’s high-priced lawyers, just went away without getting paid or accepted being defrauded and bullied. It easier for the owner to pay $5,000 in legal fees to make a larger Accounts Payable problem go away.

As we speak, one of those lawsuits is not paying a painter contractor $250,000. The reason is the owner did not like the work. I understand that is a fair claim, but a project that large should have had some milestone payments and checkpoints on quality measures and progress. Again, it gets back to the above statement, “the word on the street is get your money upfront.”  But, these failure to pay claims do not even speak to the fraudulent or legal wording lawsuits where the owner takes advantage of unwitting buyers, which are a subject in their own right.

The man who uttered this statement was giving a two-part reason of why, as a Republican voter, he will not be voting for Donald Trump. It is far more than his first reason that Trump is an abhorrent candidate based on his comments and positions. It is also due to this man’s dealings with Trump’s companies. He is not alone and it continues to this day. And, it will continue after the election.