Worshipping At the Temple of Greed: Fraud, Not Stupidity, Caused Our Economic Mess

In March of this year, we wrote a short piece entitled, "Who are the Brains behind the Housing Crisis?" (March 2, 2008) We questioned how so many of our best and brightest young people on Wall Street, from the very finest universities, working for well-respected companies like Lehman Brothers, Goldman Sachs, and Merrill Lynch could err so badly. Later we found evidence that at least one computer program was in part responsible for what we believed were miscalculations. In the article, "Who's Responsible for the Crash?" (October, 2008) we quoted Alan Greenspan who stated that "bad computer models" led to the current economic crisis.

This early analysis gratuitously assumed one trait of those who had a hand in our economic debacle--good faith. Our assumption was that everyone involved believed that they were doing something positive and were somehow victimized by bad luck or maybe a touch of stupidity. We were deluding ourselves. If you look back and begin to tally the now obvious "mistakes," a pattern of intent begins to emerge that doesn't take "CSI" to uncover. 

Start with the mortgage brokers who hawked no down payment, no proof of solvency loans to low and middle income people who would never, ever be able to repay those mortgages. If we heard one ad for such vultures, we heard thousands, day and night. Did they know that they were putting people into homes with loans that were destined for default? How could they not? They were the ones processing the paper, the applications, and dare we say, they were the ones encouraging the fraudulent statements, at the very least, by failing to demand adequate proof of ability to pay, and at worst, by  creating  information they knew was fraudulent.

Continue with the investment houses that packaged this bogus paper into "equity" interests that were then sold as "collateralized securities" which were bought by funds and included in retirement plans, foundations, endowments, charitable organizations, as well as investor portfolios worldwide. Did financial institutions like Lehman, Bear Stearns, Merrill Lynch, and others, just not question the value of the assets underlying these securities, or did they know they were worthless all along, and thus were part of the scheme?

Finally, look at Bernie Madhoff and those around him. No question there. Out and out theft. Fraud of such massive proportions that we can hardly envision it, except that we can't avoid the stories that fill our newspapers and the television news every night. And does it stop with Madhoff? Who knows? And who knows how much more fake gold exists that people believe is real?

Who or what encouraged this mass misrepresentation? Look in the mirror.  The culture of wealth that rose in this country over the past decade  that made all of this possible was embraced by millions of ordinary Americans.  We reveled in their success as if they were rock stars. It had entertainment value. We wanted it. Millions of dollars in Wall Street "bonuses." Wealth beyond anything that we can remember in our lifetimes. And not just in the United States. Arab sheiks building extravagant cities in the middle of the desert that put anything in Las Vegas to shame. Russian oligarchs, growing rich on the ruins of the old Soviet empire, and petty dictators made large and powerful by oil money produced by their otherwise poor and downtrodden nations. A culture of wealth ruled the world and  cash was the dominant icon since at least 9-11.  

The money god that we worshipped as a country has now proven to be false, but it was not until the temple crashed around us, taking a lot of innocent people with it, that we began to question the religion itself. Did our nation, and our government enable people like Bernie Madhoff and the gurus at Lehman, Goldman, and Merrill to do what they did? Yes we did. Did we hold them in high esteem because they were good upstanding individuals who served as role models for our children? No. It was because they created mountains of paper wealth for themselves, but also for others, and for no other reason.

As a nation we have always admired the entrepreneurs, the industrialists, the inventors who could take a creative idea and build an industry around it, enriching themselves, but also millions of working Americans as well.  But this was different. This was not real wealth. This was an ethereal bubble built on imagination to be sure, but without substance and with lots of hype. If you divide a worthless asset into a thousand pieces, are all of those pieces together worth  more than the single worthless asset? Are they worth anything?  No, of course not. And they won't have value even if a hundred economic gurus swear that they do. It's either valuable or it's not, and if the millions of pieces of worthless paper that contributed to this gigantic economic bubble were fraudulent to begin with, selling them from an ivory tower with the blessings and encouragement of Harvard-trained financial wizards won't make them any less fraudulent. Or less worthless.

And what did all of that bring to us? An illusion of wealth to be sure, but also a  flagrant  violation of the respect, albeit falsely derived, of a nation. And now it has been exposed.  Have we learned anything? Can we recover our direction and self-respect? Can we trust our leaders? As recently as this week, we have seen that the massive government bailouts have  apparently opened new opportunities to reward the financial sector with large bonuses, this time using taxpayer cash, shedding new doubts upon our government's ability or desire to grasp the enormity of this problem or its terrible effect on the national psyche.

Maybe this will all get so bad that government will have no choice but to truly crack down on this shameless looting of the public trust and restrain the wretched excess. Perhaps the new administration, with its promise of a major course correction, will impose some much needed regulation and some new ethics and discipline on the financial sector such that it will begin to apply its considerable economic might to rebuilding our sick economy. Perhaps we will begin to worship a proper god once again. 

We'll see.

Your Homeowners Association is Broke

Who do you Pay When the Cash Runs Out?

         We’re living in troubled times. The American economy hasn’t seen anything like this since 1929 and we won’t likely be out of it for several years. Homeowners associations, like the rest of the country, have entered a period of uncertainty, but more to the point, they have entered a period when the cash pool is drying up. Foreclosures, layoffs, bankrupt developers, and owners conserving cash by not paying assessments—it doesn’t matter which, the end result is fewer assessments being paid and way less cash in the association’s coffers.

            Collection actions don’t do much good when the owner is out of work and can barely feed his or her family. Homeowner assessments are way down the list of priorities and what are the association’s options? Record a lien and foreclose? And then what? The lender has a senior lien and it is very doubtful that there is any equity in the property anyway. Small claims court? Sure, and you’ll get a judgment for the unpaid assessments quickly, but after that you have to execute. On what? The fact is, many owners see no value in continuing to pay a mortgage, much less homeowners association assessments, on a condominium unit that has absolutely no equity whatsoever. And you can’t garnish wages that don’t exist.

            So now what? It’s time to start prioritizing expenses. Who and what does the association pay? What does it pass over? Yes, that may very well be the subject of an upcoming board meeting in many associations, so we might as well deal with reality now. What is the most important obligation of the homeowner’s association? The health and safety of the owners, for sure. What threatens health and safety if it’s not paid? Garbage collection? Yes. The water bill? Of course. The bill for common area electricity? Yes, especially when there are elevators, pathway and corridor lighting. After that, we would put security services and payment of the premium on the liability and fire insurance premium. Management and accounting services come next so that there is someone to pay the bills that have to be paid. Contributions to reserves should continue with any cash left.

            The items at the bottom of our list would be the gas bill for the spa or pool heater; some or all landscaping services; such things as window washing and last of all the cable bill for the clubhouse television! Yes, most of this is obvious, but no board of directors has had to face a situation like this and we want to re-assure them that massive cutbacks in services to accommodate a shrinking budget is not only legal, it would be a breach of their fiduciary duty to sacrifice the health and safety of the owners just to keep the lawns mowed!

            So consider what you will do as a board member when the cash runs out. Think of the personal safety of the owners first and you will usually make the right choices.          

No Right To Refuse Payment

The Court Turns a Right Into a Duty as it Orders a Board to Assess its Members to Pay a Creditor.

A 2005 decision of the California

Second Appellate District Court of Appeal in JamesF. O'Toole Company vs. Los Angeles Kingsbury Court[1] answers the question: can association members be forced to pay, by special assessment, debts incurred by their association? Essentially, O'Toole upholds a lower court order requiring a community association to levy a special assessment to pay a judgment creditor. The importance of O'Toole is not that a community association was required to pay its debts--every person or entity should pay what it owes. The importance of O'Toole is that the court required the board of directors to levy a special assessment upon the members, one that the members had specifically rejected, to pay the obligation. The court also appointed a receiver to enforce collection of the assessment, and pay the creditor.
[1] JAMES F. O'TOOLE COMPANY, INC., v. LOS ANGELES KINGSBURY COURT
OWNERS ASSN., 126 Cal. App. 4th 549; 23 Cal. Rptr. 3d 894 (SECOND
APPELLATE DISTRICT 2005).

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Are They Building Condos Better?

Do New Construction Methods and New Materials make a Better Product?

 Here was the typical multi-family building as constructed 25 years ago: Wood siding, single pane aluminum windows, flat roof, a one or two-ply built-up roof membrane, and galvanized iron water pipes. To make matters worse, the siding often wasn't real wood. Wood substitutes like Masonite, essentially sawdust mixed with glue and pressed in a steam press to resemble wood planks, was used extensively. This was a design formula for disaster. The siding dissolved over time. The flat roof usually didn't stay flat, it deflected causing water to collect because it had nowhere to drain. These “ponds” stayed on the roof until they evaporated. The roofing materials used then could not resist this continued immersion in water and failed prematurely. The plies became separated and the water quickly found its way into the interior of the building. Or, the moisture that the material absorbed heated within the plies and the resulting vapor caused huge blisters to appear on the roof, blisters which eventually cracked and became yet further sources of water leaks. The iron pipe corroded over time, of course, and many buildings had to have all of it removed and replaced with copper.

Many single family houses were built the same way, but since it was up to the owner to deal with all of this, it never gained much attention, because if the owner wanted to maintain the value of her property, she had to repair these problems by re-siding, re-roofing, including adding slope to the roof, and eventually re-piping. But the condominium association saddled with this nightmare had a more difficult problem—it had to find the cash to do the repairs, cash that has always been in short supply. We've written for years about the long-term effect of an association's inability to maintain its buildings—a gradual deterioration of both the physical plant and the value of the individual interests.

But over time, some things have changed...

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The Contractual Community: Why Community Associations are not Governments

Articles in this and other publications devoted to the science of community association operations and management often discuss the concept of "community association" as if it were just another subdivision of local government. It is a common perception because so much discussion about this unique housing type is devoted to questions of governance. We have boards of directors that, in some respects, appear to be like city councils. There are property managers who carry out many of the same functions as city staff. The property so governed has many of the same physical accoutrements as a town or city-streets, utilities, parking and recreation facilities.

There are controls that are seemingly analogous to municipal government, where ordinances such as zoning place restrictions on individual property rights in order to give effect to the paramount needs of the city or county, as determined by the elected policy-makers. But while these two governance systems may appear similar, their respective legal bases are really quite different. Understanding this difference may help to understand why the occasional characterization of community associations as "mini-governments" or "quasi-government agencies" is particularly inapt and can lead to false assumptions about community associations...

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When Condominiums Become Obsolete

What Determines the Lifespan of a Common Interest Development?

"Obsolescence” is the process by which something loses its value and relevancy usually due to being supplanted by a better product or changes in its environment. Several times we have written about our concerns for the impact of that process on common interest developments.

First, let's realize that the obsolescence of common interest developments, as with most man-made structures, is inevitable. It can't be stopped; it’s simply a matter of time. If you doubt that, ask yourself how many residential buildings that you know have lasted, say 100 hundred years or more. Look around and you’ll see only a few types of buildings that have survived the century mark--public monuments, and buildings that have historic or intrinsic value due to their unique location or architectural style. Most others have been replaced with newer structures...

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Who’s Responsible for the Crash?

Today we got our answer... “Alan Greenspan: Bad data hurt Wall Street computer models”

On March 2, 2008, we wrote:

“...We send our best and brightest young people to Wall Street to learn investment banking and figure out new ways to attract investment funds and enrich their firms and themselves. Usually, many are successful and the economy and the country benefit from this economic stimulus that creates capital for investment in new industry, thus creating jobs and purchasing power. So what happened here? Who were the “brains” behind this housing crisis? Which genius or geniuses decided that it was prudent or even smart to lend to people who could not afford to repay their loans and then use those loans as security for other investments? Wasn’t a crash inevitable under those circumstances? 

The lenders and the investment bankers knew in advance that certain borrowers were not credit-worthy; would not have sufficient incentive to repay their loans; did not have the income necessary to meet the projected payments, and yet, in what can only be considered a mass delusion, made these loans anyway. Was it greed? That’s a tempting thought, but even the greediest money managers can sense a disaster in the making and find ways to avoid it--perhaps like not making the loans in the first place? No, that would be too simple. I think it’s more a case of a lot of professional people who were too used to believing in the infallibility of their decisions coupled with the pressure to churn out enormous profits to keep their positions intact. A form of “greed” to be sure, but way more sophisticated, at least on the surface. Here we have a large number of very smart people who perhaps were too insulated from the real world...”

 The New York Times , October 23, 2008:

“...(Alan) Greenspan has long praised computer technology as a tool that can be used to limit risks in financial markets. For instance, in 2005, he credited improved computing power and risk-scoring models with making it possible for lenders to extend credit to subprime mortgage borrowers.

But at a hearing held today by the House Committee on Oversight and Government Reform, Greenspan acknowledged that the data fed into financial systems was often a case of garbage-in, garbage-out.

Business decisions by financial services firms were based on "the best insights of mathematicians and finance experts, supported by major advances in computer and communications technology," Greenspan told the committee. "The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades a period of euphoria."

 A quote from Warren Buffet in his annual letter to investors:

 "As house prices fall, a huge amount of financial folly is being exposed. You only learn who has been swimming naked when the tide goes out--and what we are witnessing at some of our largest financial institutions is an ugly sight."

 Amen.