Coyote Blog

It's been a while since I have received a fake "check" whose cashing obligates me to a four year contract, or a deceptive yellow pages solicitation, or even my favorite, the board minutes services that masquerade as an official government form.  So I will highlight Paramount Merchant Funding for this over the top message on the front of their envelope they sent me, again in an apparent bid to masquerade as some sort of official mail that must be opened.

The scam here is clever -- I don't have time to bother looking it up, but my guess is that this message is literally true - for all mail sent through the USPS.  But it is obviously meant to virtually force someone to open it thinking it is official, which I was dumb enough to do.

They seem to have a perfect 1-star review record over at Yelp, a fact I could have called in advance sight unseen.  They have more BBB complaints in the last year (5) than my company has in our whole history (0).

In my younger, more naive days, I would have drawn the following lesson from this story:  "Never create a business plan predicated on subsidy checks from the government.  They may stop at any time."  I still think this is mostly true, as FirstSolar is finding out.  But my sense is that a range of folks from GE to Kleiner Perkins still get their checks.  So one may cynically rewrite the rule: "Never create a business plan predicated on subsidy checks from the government unless you are confident you have the political connections to guarantee and expedite the payments."

It seems like local solar company perfect power tried to feed at the government trough without actually having sufficient clout in the corporate state.  Bad idea

About 100 Arizona homeowners who paid $4,500 up front for solar-power systems fear they may never get their rooftop panels after being left waiting for months by the installation company.

Angry homeowners are demanding their systems or refunds. The company, Perfect Power Solar, is blaming the delays on federal government red tape.

Perfect Power owner Lynn Paige said the company has cash-flow problems because energy grants that were supposed to provide substantial funding of the solar systems aren't being approved quickly enough. She pledged to deliver the systems or refund all customers by the end of the year.

Treasury officials would not comment on the situation. Government e-mails sent to Paige suggest Perfect Power's grant applications were incomplete. In them, officials point to problems with submissions and warn of potential denials.

Industry experts and owners of other solar companies in Arizona said that the grant program is fraught with risks for solar companies and that some built business models based on future payments from the government without the financial reserves to cope with delays. They describe the situation as a high-tech gamble that some companies lost.

Residential solar-power systems cost $15,000 to $40,000. The Section 1603 grant program, part of the American Recovery and Reinvestment Act, offered developers cash to offset 30 percent of the costs. Although the program was not available to homeowners, some companies tapped the grants to sell residential solar systems as leases. A company would install and own the system, then lease it to a homeowner.

Program rules required developers to complete installations before they could apply for reimbursement. But funding was not guaranteed, and even after systems were built, the government delayed approval of some applications and denied others.

If this was one of Kliener Perkins' companies, for example, Ray Lane would just call the White House and get his money released. If your solvency depends on continued flow of taxpayer cash, you better have the clout to keep the money flowing or you are likely to get hosed.  Bureaucracies tend to have default answers of "wait" and "no".  Those are the answers average people without pull are going to get.  The "yes" goes to those who cut through the red tape from the top.  These yeses, like the ones to Solyndra, only make it more likely everyone else get the "no" answer, as the agencies need to show they are being particularly diligent to offset the impression of sloppiness they get from the Solyndra-type cases.

Retroactively, the company's leadership has figured this out, that to survived at the government trough, they have to go political

Paige has asked customers not to file complaints or talk to the media about problems the company is facing.

"It has been very unhelpful ... that a few customers have chosen to write very negative letters to the BBB," she wrote in a May e-mail to customers.

Instead of filing complaints, Paige said, customers should write to Arizona U.S. Sens. John McCain and Jon Kyl to request their help in freeing up the government grant money and to pressure the Treasury Department....

That month, the BBB revoked Perfect Power's accreditation and gave the company an F rating. The company had 16 complaints filed against it the past year. The registrar shows four open complaints against Perfect Power; a fifth complaint was listed as settled or withdrawn.

Forget about the customers.  Let's just focus our attention on our two Senators.

As usual, Michael Lewis is a great and informative read, trying to unravel the whole subprime mortgage / CDS / CDO bundle somewhat for laymen.  The article does not excerpt well, but I would summarize it in saying he identified four mistakes by the financial world.  The first two I would describe as real problems but not really new mistakes -- something similar could have been said about S&L's in the 1980's.  These are:

1. A lot of subprime loans were issued to people with no freaking hope of repaying them, in an incredible general lowering of underwriting standards.  (we all should remember, though, the government and the media was trumpeting this as good news -- increase in home ownership rates, blah blah blah).
2. People who bought these securities grossly underestimated the default risks, particularly in the crappiest tranches  (securitized packages of loans are resold in tiers, with a AAA tranche getting first call on any payouts, and the tail end BBB tier getting high interest rates but who takes the first principal losses if the loans default).

   But Lewis highlights two mistakes that are in some sense brand new.  These mistakes were effectively vast increases in leverage that acted as a multiplier for the subprime problem, while simultaneously spreading the problem into the hands of AAA investors who accepted the higher returns without paying too much attention to how they were obtained

3. Someone started scooping up the BBB tranches from various securities packages, bundled these together, and somehow got a ratings agency to declare that the top 60% tranche of these repackaged dog turds were AAA. 
4. Credit default swaps, originally insurance policies on loan portfolios, turned into a sort of futures market on subprime mortgage packages.  But, unlike futures markets, say in oil, where the futures trading volume are generally well under the total volumes of the underlying commodity flowing around the world, CDS values grew to as much as 100x the underlying commodity volume (in this case subprime mortgage securities).  CDS's went from a risk-management tool to a naked side-bet.

This is interesting stuff, and it was really only reading this piece that I think I started to understand #4 above (though if readers think I am describing this wrong, let me know).  All of this leads me to a few thoughts:

• Nothing about this convinces me any of these firms need to be saved or bailed out.  Let them die.  Maybe the guys who rebuild the industry in their place will be smarter and more careful.  The country is going to face a recession whether Wall Street is bailed out or not -- too much (paper) value disappeared from consumer's net worths (or their perceptions of their net worth) for that not to be the case.  I lived through Texas in the 1980s when the S&L industry went bust almost to the last institution.   Nearly every one of the top 10 banks in the state went into FDIC recievership. 
• I have seen people observe that this is an indictment of capitalism because so many people made such bad mistakes.  Sure.  No one said capitalism is a gaurantee against stupidity, or even fraud.  The difference is that the consequences of said stupidity and fraud have to be less in a free market system than if the same people had the power of cersion via government.  In a free market, these guys will fail and be wiped out and get washed away.  The people who they drag down may consider themselves to be innocent, but they participated of their own free will -- if they did not understand what they were doing, that is their problem.  In a statist system, you still have mistakes like this, but they are infinitely more catastrophic, as the stakes in play are often higher.  And the people who made the mistakes are never punished financially, because they are in charge of the machinery of state  (or friends of those in charge).  They make damn sure the power of the state is used to make everyone else pay for their mistake, kind of like ... this $700 billion bailout.
• Lewis seems to have a hypothesis that the main system change that allowed all this to happen was the shift in ownership structure from partnerships to publicly-held corporations.  And certainly you do get some added agency risks with this, though I find this explanation a bit shallow.  I do think that folks with money are going to approach Wall Street "experts" and rating agencies with a lot more skepticism for a long time, and that can't be a bad thing.
• The opportunity really exists for someone smart to start a brand new rating agency from scratch.  The only reason the current ones won't get wept away is simply that there are not many alternatives right now.  Warren Buffett should partner with someone well-connected with the new administration (Maybe Larry Summers, since there is no way he will survive a confirmation hearing with his men-are-from-large-standard-deviations-women-are-from-narrow-distributions baggage.)
• Lewis is unfair in depicting all the mortgage lenders as predatory.  I am sure some were cheats, but remember that as far as Congress, the Administration, the Federal Government, and the media were concerned, these lenders making subprime loans were doing God's work -- they were expanding home ownership and bringing the dream of owning a home to poor people historically redlined, blah blah blah.  It is only with hindsight that we demonize them for doing the wrong thing -- at the time, absolutely everyone on in the country was pushing them to do exactly what they did.  This is also why Democrats struggle to suggest a resposive regulatory package to this whole mess, as any real reform would have to address minimum underwriting standards, which in turn would have the direct effect of limiting lending to the poor, an outcome with which no Democrat wants to be associated.

Update:  Just to be clear, as I have said before, this is about half of what happened.  There are really two stories, and usually authors focus on one or the other.  Story 1 is the steps taken by the Federal Government  (Fannie, Freddie, Community Reinvestment Act, mortgage interest deduction, low interest rates) that fueled the housing bubble and the expansion of credit to questionable borrowers.  It is described here, among other places.  Story 2 is the one above, how private firms decided not only to purchase these questionable loans made on bubble-inflated assets, but to leverage these assets up to staggering levels.