Thursday, October 23rd, 2008
under the green tree

In their new book, Billion Dollar Lessons,Billion Dollar Lessons | The subtitle summarizes the book as a compendium of “what you can learn from the most inexcusable business failures of the last 25 years.” Paul B. Carroll and Chunka Mui delve into one such lesson that’s near and dear to my heart, the fall of Green Tree Financial.

The company was founded in 1975 as a subsidiary of Midwest Federal Savings & Loan Association, whose corporate symbol was a leafy green tree, thus the name of its progeny.  That logo and the bank’s advertisingMidwest was the major sponsor of the Minnesota Twins broadcasts during the team’s early years.  As a small lad I was thrilled to be selected as a winner of a contest sponsored by Midwest that invited fans to send in motivational sayings about money.  I submitted one that came from a thrifty small-town lawyer that was a friend of our family:  “The first dollar you save is the one that works the longest for you.”  It was a different time. built a brand centered on strength and thrift.  Mismanagement trumped the image, and Midwest perished during the S&L crisis.

By then, Green Tree was on its own and well on its way to becoming the biggest lender to purchasers of mobile homes.  The recitation of its story is particularly timely, but disheartening, since so many aspects of today’s banking crisis are amped-up versions of the events of ten years ago.

At the center of each drama was the ability to create profits through the magic of the securitization of assumptions.  Green Tree used gain-on-sale accounting, allowing it to claim fanciful profits today based on estimates of its choosing regarding the performance of the underlying mortgages in the future and, therefore, the securities that were derived from them.  Similarly, the “take” on the CDOs created by Wall Street was reliant on self-serving models.

In each instance, the ability to manufacture more profit by creating more product kicked the volume machine into high gear, with predictable consequences for the credit quality of the mortgages being written to feed the monster.  Wall Street loved Green Tree — it made fancy fees each time the firm packaged more securities for buyers who were doing more salivating than analyzing.  It repeated the love affair with a motley crew of originators during this decade, and did some squaring and cubing of its own on top of that.

In each case, however, the business model was “both elegant and preposterous,” a wonderful description that Carroll and Mui use to characterize Green Tree’s construct, a “well-oiled moneymaking machine” that leveraged utopia until reality intervened.

In the meantime, the players got filthy rich.  The now-vilified CEOs on the Street were pikers, though, compared to Lawrence Coss, the head of Green Tree.  He took advantage of a passive board to take a nice cut of the reported profits, giving the leader of a tiny firm a series of paydays that dwarfed those of any executive anywhere.  He took advantage of poor corporate governance, profits created out of thin air, and incentives to take lots of risk — does this sound familiar?  It’s too bad there is always collateral damage:  Coss managed to peddle Green Tree to Conseco just as things were falling apart, but the pieces could never be put back together again, and Conseco ultimately had to file for bankruptcy.  Today’s unwinding differs only in its massive scope.

One final and important thing the two situations had in common:  The first signs of trouble in the underlying collateral started a degradation in the prices of the fixed income securities that had been so eagerly purchased.  Sell-side equity analysts covering Green Tree, perhaps influenced by those fees their firms were earning from doing its deals, ignored the evidence and stayed positive.  The price of the stock stayed high while the fundamentals worsened, providing great opportunities that could be exploited.And this, dear reader of footnotes, is why the episode is “near and dear to my heart.”  Those way-out-of-the-money Green Tree puts became way-in-the-money puts. The same thing happened during the first part of the credit crisis that began in 2007.

There are many lessons to be learned by looking at history.  Specifically, I am continually amazed that sophisticated investment firms often don’t share information across asset classes in a way that could minimize the damage, especially for investments in firms that rely on debt financing.  More broadly, when we are lounging under a green tree, someone needs to be there to remind us that things are seasonal and winter will come one day.