It's Payback Time!

One of my all-time favorite books is “The Count of Monte Cristo”.  Not only do I share a similar first name with main character and hero Edmond Dantes (I spell it Edmund), but in a recent movie version they cast a similarly handsome devil in the starring role.

 
Just imagine me with hair and a beard in place of the chrome dome and double chin... Okay, maybe not.

Anyway, the real reason I like this story is the patience and single mindedness with which Dantes exacts his revenge on the men who betrayed him and had him falsely imprisoned.  With a bit of good fortune and ruthless determination, Dantes drove one of his betrayers to suicide, one to insanity, and one to financial ruin and destitution.

Two weeks ago in my article “Are You Prepared to Bail Out JP Morgan – Again?” I explained one reason why it would be best to avoid the Too Big To Fail (TBTF) banks for the foreseeable future.  Today, I want to talk about another reason to avoid them.  It takes the form of a man who could be a modern day Edmond Dantes having laid in wait for 3 years.


Sowing the Seeds

Let’s go back a few years, just after the collapse of Lehman Brothers in September 2008, when Bank of America (BAC) proposed a merger with the failing Merrill Lynch.  With various sub-prime derivatives blowing up in its face, Merrill was losing $2 - $10 billion per quarter.  BAC was willing to accept these losses in order to receive $25 billion in TARP loans (later increased as losses mounted).

For the 4th quarter of 2008, when the merger was expected to be completed, the loss from Merrill was estimated around $5 billion.  At least that was the assumption made by shareholders when they approved the merger on December 5, 2008.

According to the proxy statement, the expectation was that the merger would be dilutive by roughly 3% in 2009, and might be accretive in 2010.  But within days of the vote the numbers were changing rapidly... and for the worse.

The CEO at the time, Ken Lewis, has admitted in recent testimony that the dilution was likely to be considerably more, and that was known to management, but not disclosed, ahead of the vote. 

Enter our hero, Tim Mayopoulos, general counsel to BAC and the expected GC for the new merged companies.

According to testimony given by Mr. Mayopoulos in 2009, he discovered that the expected quarterly loss in question was north of $15 billion.  In Mr. Mayopoulos’ opinion this represented a “material adverse change” in the conditions of the merger and needed to be disclosed to shareholders.  When he discovered this on December 9, 2008, he immediately reached out to BAC’s Chief Financial Officer, Joe Price.  Mayopoulos was told that Price was in a meeting with Ken Lewis for the rest of the day.  No problem, they could meet the next day.

Around noon on December 10, as Mayopoulos was holding a meeting in a conference room with other lawyers at the firm regarding the merger, he was summoned to his own office by the Chief Risk Officer.  Upon reaching his office he was informed that he had been terminated, effective immediately, and would be replaced as general counsel by Brian Moynihan, eventual and current CEO of Bank of America.

Mayopoulos was immediately escorted from the premises, relieved of his Blackberry, and told that they would send his personal things along.  Bye, bye.


A Dish Best Served Cold

This was a man who was recognized as a hardworking, honest, and straight forward guy and whom Ken Lewis had named as GC for the newly merged company.  Clearly, those attributes are not desirable when attempting to perpetrate a fraud.

Fast forward 3 years later and Mayopoulos is named CEO of Fannie Mae (FNMA.OB), effective June 18, 2012.  Mayopoulos has been hiding out with FNMA since April 2009 in the capacity of general counsel.  It’s certainly not unusual to see a revolving door between banks and the government or a government sponsored entity (GSE)... Goldman Sachs, after all, has perfected the process.

An interesting fact about this situation is that, in accepting the promotion from GC to CEO, Mayopoulos is taking a $2.1 million pay cut.  As CEO he will receive $600,000 per year compared to the $2.7 million he received as GC. 

Now remember: The GSE’s -- Fannie Mae and Freddie Mac -- hold something like 90%+ of residential mortgages, including a fair quantity of garbage loans originated by Countrywide Financial, another acquisition of BAC.  The GSE’s have been pursuing all of the banks who originated these garbage loans in an effort to force them to repurchase the loans and recover taxpayer dollars.

A recent estimate of repurchase requests puts the current total around $72 billion.  Of that total, at least $16 billion is attributable to Countrywide.  Mayopoulos was able to recuse himself from dealings with BAC as general counsel, but as CEO he will have no such obligation.  You have to wonder why a man in his prime earning years (he is just 53) would take a massive pay cut to assume a position that puts him in direct opposition to Brian Moynihan, his replacement three and a half years ago.

I have no idea if Mayopoulos is planning an Edmond Dantes style revenge, but he is expected to more vigorously pursue Fannie Mae’s claims.  The size of those claims and the fact that they are mounting ($1 billion of the claims come from mortgages originated in 2011) gives you yet another reason to stay clear of the Too-Big-to-Fail banks.

By the way, if Mayopoulos does pull a Dantes, I’m rooting for him.

Ed Pawelec
Contributing Editor
Price Shock Trader