First the Bubble. Then the Short. Now the Long.

An Oakland native-turned New York hedge fund operator, and several Oakland-based foreclosure-to-rental mills bracket the the the boom, bust, and ‘recovery’ of the US housing market

Picture 4Between 2007 and 2011 over 10,000 homes in Oakland, California were foreclosed on. Of home loans originating between 2004 to 2008 within the city, nearly 1 in 10 have gone into foreclosure. Most of these foreclosures threw Black and Latino residents out of their houses, leaving specific neighborhoods in West and East Oakland’s flatlands devastated by vacancy and blight, to say nothing of the hardships facing displaced families. Some streets saw multiple emptied houses deteriorate, often several on the same block. Empty homes quickly became dump sites and health hazards, further depressing surrounding property values and draining community wealth. The process hasn’t stopped. According to RealtyTrac 399 homes went into foreclosure in Oakland in October of 2012.

It didn’t take long for those with capital to take advantage of this crisis. As the Urban Strategies Council has reported, wealthy investors have snapped up 42 percent of completed home foreclosures in Oakland at auction, or from bank sellers, between 2007 and 2011. The goal of these investors is to turn these properties, 93 percent of which are located in Oakland’s low-income flatlands, into rental properties. In the lingo of the Wall Street banks and hedge funds hoping to cash in on this trend, foreclosed homes that can be converted quickly into large portfolios of rental properties are a new “asset class” that promises “higher yields” than almost any other investment out there today.

The result is that ownership of Oakland’s housing stock in Black and Latino neighborhoods, and thousands of homes in parts of the Bay Area, especially the East Bay suburbs, are quickly being transferred from local residents to absentee landlords. It is nothing less than a vast transfer of wealth and power.

For the Bay Area, the origins of the foreclosure crisis are both global and intimately local. In many ways Oakland sits at the center of the foreclosure wave that is itself at the center of the global financial crisis. The unequal impact upon particular communities of the local housing market’s meltdown mirrors national trends. Black and Latino communities have been seriously harmed by predatory lending, the financialization of consumer credit and housing debt, and the resultant crash. Some neighborhoods in Oakland are as devastated as any of the worst hit regions across America — Atlanta, Las Vegas, Phoenix. Now the morphing of the housing bust and foreclosure epidemic into a lucrative multi-billion dollar opportunity for major investors is also uncannily centered upon Oakland and the greater Bay Area, where companies flush with hedge fund cash are buying up homes by the thousands.

The entire sweep of the US housing bubble, financial crisis, and foreclosure wave can therefore be told by looking at persons and companies with intimate links to Oakland and the Bay Area. What follows is one account.

Central to this story is an ex-Goldman Sachs trader, raised in the East Bay’s exclusive Oakland Hills, who helped the mortgage industry create the nationwide housing bubble by underwriting the complex mortgage-backed securities and credit derivatives that eventually exploded, causing a near meltdown of the whole economy. This whiz kid emerged from the crisis as a wealthy hedge fund operator who is now making huge bets on a housing “recovery.”

Alongside Goldman’s ex-golden boy are several hedge funds, some of them based in the Bay Area, and a growing list of corporations, also a few with headquarters here in Oakland, all of them busy buying up foreclosed homes across the region and country, and transforming them into rental portfolios so as to extract value from US families that have been driven from home ownership by the crisis.

Financial operators such as these profited from the housing bubble. Some of them profited doubly from its collapse. All of them are now tacking backward to make billions more on a housing “recovery.”

This recovery, however, won’t involve the salvation of low-income homeowners still struggling to keep their houses, or to obtain new homes on fair terms. Rather, it’s simply about “spreads,” the changes in price differences between different debts and assets traded by powerful banks, hedge funds, and private equity firms. Like the “jobless recover” that appeared in 2010 with corporations and the wealthiest stratum of America posting record profits and incomes, the housing recovery that has commenced is characterized by the absence of middle and working class persons and families keeping their homes, or obtaining mortgage loans for new housing opportunities.

Having run much of its course, a consolidation is occurring at the bottom of the foreclosure crisis, with homes and the wealth of working families being transferred into the portfolios of a few elite investors.

From the Oakland Hills to the Bubble’s Epicenter

In his account of “how Goldman Sachs came to rule the world,” William Cohan says that Josh Birnbaum dreamed from an early age of working on Wall Street.

Head Royce, Oakland's most elite private high school.

Head Royce, Oakland’s most elite private high school.

“His interest in finances was encouraged by an uncle—whom  he greatly admired—and who one day showed his nephew the Wall Street Journal’s options table. His fascination with options and how much money potentially could be made from them grew out of that moment. He was twelve years old.”

In 1990 Birnbaum graduated from Head Royce School, the elite K-12 private institution in the Oakland hills where tuition currently costs $31,000 a year. He had his sights set on becoming a business executive and financier. He left the East Bay for the University of Pennsylvania’s Wharton School of Business, one of the top colleges for aspiring investment bankers.

Before Birnbaum even graduated from Wharton he was already working summers for none other than Goldman Sachs. The bank gave Birnbaum a demanding job that required on-the-fly math skills and on-your-toes negotiating chops. His task was to purchase mortgages from originators, companies like Countrywide and Fremont General, companies that were then beginning to market sub-prime and Alt-A loans on vast new scales thanks to historically low interest rates influenced by federal economic policymakers.

Birnbaum would pool together mortgages into relatively new financial products called collateralized mortgage obligations (CMOs). Goldman and other investment banks were just beginning to ramp up production of these and other hyper-complex debt securities for sale to all types of investors seeking higher yields than government bonds, but less risk than corporate stocks. The biggest buyers were insurance companies, commercial banks, and hedge funds. Credit ratings agencies signed off eagerly on the products.

Oakland’s Birnbaum soon took a full-time job at Goldman Sachs and carried on with the work of securitizing home loans, but he also expanded into trading other products related to mortgage debt, including credit default swaps (CDSs). CDSs are basically insurance agreements against the possibility that a debt obligation (like a CMO) would fail to be repaid. CDSs became a modest-sized market, but so long as the housing bubble continued to expand there wasn’t too much demand for them. Few thought insurance was necessary on mortgage-backed securities. In the world Birnbaum inhabited it was commonly remarked that the last time US home prices declined was the 1930s, the Great Depression, an unthinkable possibility given the supposed sophistication and risk management of the new globalized financial economy.

Birnbaum’s career took off with the housing bubble, but what really made him a star within the bank was his idea for how to make billions off the coming crash that was supposedly unthinkable. Birnbaum and a few other key players orchestrated one of the biggest killings in Wall Street history by betting against the very products they had spent almost two decades creating and selling: mortgage-backed securities.

From the Big Bubble to the Big Short

In 2006 Birnbaum was trading through the ABX.HE Index, a securities index that referenced housing equities in various CMOs, including those that Goldman had structured and sold. ABX.HE was created by Goldman Sachs and a handful of the other Wall Street investment banks that served to make the markets for CMOs, CDSs, and other housing derivative products. Goldman even owned part of the holding company that controlled the administrator of the ABX.HE Index, MarkIt, the London-based data shifter.

Home prices steadily rose for decades, shooting rapidly upward in some regions of the country like California, only to plummet in 2007.

Home prices steadily rose for decades, shooting rapidly upward in some regions of the country like California, only to plummet in 2007.

One of Birnbaum’s clients asking for ABX.HE trades was the Paulson & Co. hedge fund. Paulson & Co. was unlike other clients. In 2006 when few suspected anything was wrong with the US housing market, the Paulson & Co. hedge fund was asking Birnbaum to make bets that were extremely contrary to the prevailing market sentiment.

Paulson & Co. was making a multi-billion dollar bet that US housing prices would decline, that these declines would be large enough to cause millions of home owners to default on their mortgages, and that these defaults would cascade through the financial system, through the CMOs assembled from countless mortgages, thereby triggering credit default swap payouts linked to lower tranches of mortgage bonds. All this would mean enormously big gains for those buying protection through the ABX.HE market. By buying protection through the ABX.HE Index, Paulson & Co. were said to be gaining synthetic exposure to the US mortgage market. The fund wasn’t hedging a bullish bet on one sector of the housing market, or some other investment strategy in corporate stocks or commodities futures with a bearish position on subprime. Rather, they were massively speculating on a crash.

Birnbaum appearing on CNBC in 2012 promoting his views about housing's 'recovery' as an asset class for investors.

Birnbaum appearing on CNBC in 2012 promoting his views about housing’s ‘recovery’ as an asset class for investors.

It was a trade that Birnbaum and a few colleagues soon convinced Goldman’s higher ups to adopt. In little time Goldman Sachs, through Birnbaum’s desk, was also betting massively against the US housing market.

Various accounts of the “big short,” as the strategy has been called, claim that Goldman’s employees were thinking there would be a modest to serious event leading to big market disruptions and a big profit for the bank. Few Goldman employees admit to thinking the entire financial system was speeding toward a cliff. If they did, none of them took action to prevent a crisis by, for example, verbalizing their concerns to federal regulators at the Treasury Department, SEC, White House, Federal Reserve, or elsewhere. In fact, the sell-off of their own mortgage-back assets, their “warehouse” of mortgage bonds awaiting securitization, and their aggressive moves to bet against the market, all amounted to a small, but significant force that actually sped up and worsened the coming crash for everyone but themselves.

Goldman’s traders quietly leveraged their bets for even bigger profits. They were dealing with a universe of equations, numbers, models, far removed from the human toll that would be exacted when their models played out in the real world. Nowhere was the “big short” so devastating as California where more subprime, predatory mortgages had been issued than any other state.

While the most severe consequences of the coming crisis and foreclosure wave would be concentrated in the Central Valley, Inland Empire, and portions of LA, Oakland’s flatlands would endure a serious spate of foreclosures, many of them prompted by declines in home prices. Stockton, and the smaller suburban towns off the I-80 between Sacramento and Oakland have been among the most damaged by foreclosures in the entire country. Goldman Sachs and hedge funds like Paulson & Co. were therefore not just minting money off their sophisticated peer counterparties like Lehman and AIG who were stuck in long positions (betting on US home price appreciation and continuing payments being made on subprime debt), rather, these short sellers were making money off the human crisis of families losing their homes. The more people who found their debts impossible to pay, and were forced out onto the street, the higher would be Goldman Sachs and Paulson & Co.’s profits.

Conflict of Interest

As has been widely reported, Goldman Sachs was making the bet of the Century against the very same products they had earlier structured and sold to investors. This became one of the most scandalous revelations of the financial crisis, something the Senate Permanent Subcommittee on Investigations called a “conflict of interest,” and “abuse,” and for which the Securities and Exchange Commission would fine Goldman $550 million in 2010. Even though it was a record fine, the SEC’s half billion penalty was just a small percentage of the profits the bank made on their bets against mortgage-backed securities, some of which they had assembled and sold.

The deal that led to the half-billion SEC penalty is known as the ABACUS 2007-AC1 collateralized debt obligation. Goldman put the ABACUS CDO together specifically so that the Paulson & Co. hedge fund could short sell hundreds of million in subprime mortgage debt, a strategy designed to siphon billions in profits from counterparties that were willing to be on a continued housing boom.

Goldman duplicitously sold the ABACUS CDO to IKB, a German bank that was too hungry for mortgage income streams, and too far away, or, like many US investors at the time, still too enamored with the fairy tale of never ending economic boom times to realize the mortgage debts being sold their way were some of the most toxic and dangerous on the market.

After buying the ABACUS 2007-AC1 CDO, IKB turned around and sold financial products that depended on the ABACUS CDO’s cash flow to various customers, including non-other than the city of Oakland and the Oakland Redevelopment Agency.

In 2006 Oakland bought $6 million in commercial paper issued by “Rhineland Funding,” an obscure offshore entity controlled by IKB which was financed with the ABACUS CDO. As late as 2007 the Redevelopment Agency had a $25.7 million investment in Rhineland. Oakland government was parking money with Rhineland, as the city and other local governments routinely do, to ensure tax dollars or bond proceeds don’t lose value to inflation.

When the market began to crash in late 2007, Rhineland hemorrhaged value. Luckily for Oakland the city had already been paid back on its $6 million investment, and the Redevelopment Agency got its money back too. Other investors were not so lucky. Paulson & Co. reaped hundreds of millions off bearish swap payments as the ABACUS CDO’s value plummeted. IKB faced massive and growing liabilities and dwindling funds to settle them. It was just one among thousands of major deals struck between some of the world’s largest financial corporations, all based on complicated contracts with values derived ultimately from the ability of US homeowners to pay their mortgages. In a feedback loop process, as mortgages went into default, financial companies began to fail, liquidity dried up, interest rates went haywire, the entire economy slowed and stumbled, reaching back to homeowners in the form of job layoffs, spiking interest rates, and other hardships, causing mortgage defaults, ad infinitum.

Birnbaum, who was at the center of Goldman Sachs’ larger plans to short numerous mortgage securities through the ABX.HE and by other means, escaped unfazed, even emboldened by the big short. He seems to have kept clear of the specific ABACUS CDO deal tailored for Paulson & Co., working instead on Goldman’s own proprietary position against housing prices.

Birnbaum, now a star trader at the world’s most powerful investment bank was, however, reportedly disappointed when Goldman’s partners offered him a paltry $10 million bonus for his services. Soon after Birnbaum left Goldman Sachs to start his own hedge fund, one that would trade you guessed it – mortgage backed securities.

Tilden Park

Tilden Park Capital Management’s web site says only that the hedge fund is a “multi-strategy fixed-income-focused alternative asset manager” that specializes in trading “structured products and mortgages, fixed income relative value and related corporate credit and equity strategies.” Although the fund’s offices are in Midtown Manhattan, the firm takes its name from Tilden Park, the forested regional park in the hills above Berkeley. A picture of Tilden and Lake Anza serves as the fund’s banner image on its web site. Oakland-native Birnbaum presumably chose the name for the hedge fund which he created with Jeremy Primer, another Goldman employee who worked closely with Birnbaum on the big short deal.

Screenshot of Tilden Park Capital Management's web site, Lake Anza appears set amid the rolling hills and oak forests of the East Bay.

Screenshot of Tilden Park Capital Management’s web site, Lake Anza appears set amid the rolling hills and oak forests of the East Bay.

Birnbaum’s official bio on the Tilden web site explains that he’s more or less a mortgage securitization guru. Before founding Tilden he served as the head of Goldman’s Structured Products Group, “which trades all securitized products including RMBS, CMBS, ABS and CDOs. During his career at Goldman Sachs, he served as desk head or lead trader across a wide spectrum of mortgage products including: mortgage credit, mortgage derivatives and mortgage passthroughs.”

No details are known about Tilden Park Capital’s current investment positions. Like other hedge funds, Tilden trades in securities and derivatives that aren’t disclosed in regulatory filings, and the fund has no obligation to disclose any of its trading activities. Birnbaum has been eager to make media appearances over the last year, however, talking about what he sees as the future of the US housing market, and new strategies he has devised to make yet another fortune.

In October of 2012 Bloomberg News reported that Birnbaum’s Tilden Park Capital is posting a return as high as 30% this year, which would amount to roughly $300 million in gains on the fund’s $1.1 billion in capital. Citing Birnbaum himself, the report says that the hedge fund’s largest positions are bets on the value of US subprime mortgage-backed securities.

Birnbaum’s big bet that home prices will recover, that is rise from their current levels, is being made through the same ABX.HE Index he used while at Goldman Sachs to short the US housing market. Goldman Sachs is also currently promoting protection-selling positions through the ABX.HE as the housing market is expected to recover.

This “recovery,” and the opportunities for hedge fund operators like Birnbaum to profit from it, is due primarily to two factors.

First is the federal government’s intervention in the housing market to buy up government-backed mortgage securities. This pushes yields on mortgage bonds down and keeps lending rates lower than they would otherwise be. It is effectively the creation of artificial demand for mortgage bonds, mimicking a healthy housing market with widespread buyer demand.

The second factor helping to push up US home prices is the emergence of a whole new class of investors buying up billions of dollars worth of foreclosed single family homes to turn into rental properties.

Both of these forces have had the effect of bolstering home prices and driving down lending rates, even though there remain millions of homeowners delinquent, or nearing delinquency on their mortgage payments, and there remains a shadow inventory of foreclosed properties that are glutting a market that is already bereft of demand. Neither the federal government, nor the major investor activity should be confused for a program or development that will benefit those who have experienced declines in income and/or spiking interest payments on their debts that has lead to foreclosure.

Hedge Fund Landlords and the New Long Position on US Home Prices

The rise of hedge fund investors taking direct ownership of US housing stock is especially troublesome. Just as home prices are set to stabilize and possibly grow again, partly a result of federal intervention to buy up distressed mortgage debt, wealthy investors are seizing ownership of single family homes to obtain the gains in equity previously promised to many first time home buyers. Oakland is again very much a center of action.

A screenshot of Waypoint Homes' online, map-based rental searching tool. As of December 7, 2012, Waypoint lists eleven homes for rent in East Oakland.

A screenshot of Waypoint Homes’ online, map-based rental searching tool. As of December 7, 2012, Waypoint lists eleven homes for rent in East Oakland.

One company that is credited with innovating the financial and technology platforms to scoop up foreclosures on a bulk level and transform them into rental investments is Waypoint Homes. Waypoint, which is headquartered in Oakland, began buying foreclosed homes in 2008 at the beginning of the foreclosure and financial crisis. The company has focused on single family houses in the East Bay suburbs, especially areas like Antioch. Waypoint now reportedly owns more than 1,800 homes, mostly in California and Arizona. The company is incredibly ambitious, with plans to take their model nationwide, and is already advertising rentals in suburban Atlanta and Chicago.

Propelling Waypoint is the Menlo Park-based GI Partners private equity firm. GI Partners focuses on real estate and manages money for CalPERS, among other big institutional clients. In January of 2012 GI Partners announced a $250 million investment in Waypoint to speed up the company’s acquisitions of homes. GI Partners plans to spend another $750 million to expand Waypoint’s holdings by the end of 2013. On Waypoint’s web site the company lists homes for rent in East Oakland’s flatlands between 55th and 104th Avenue, Black and Latino sections of the city hit especially hard by foreclosures and where Waypoint has been able to obtain properties for half their pre-crisis prices.

Waypoint is reportedly earning large profits. Richard Magnuson, the head of of GI Partners, seems pleased with the results so far, but told a reporter for the Wall Street Journal that he’s wondering, “can you scale it to 5,000 or 10,000 homes, because the supply is there.” That supply of foreclosures is expected to last for several more years due to the stagnant US economy, job losses, and other factors that have caused many low-income, or highly indebted homeowners to default on payments.

Other companies getting in on the foreclosure-to-rental mill model include McKinley Capital Partners, a real estate investment specialist, which has its offices in Oakland’s Kaiser Center high rise. Like Waypoint, McKinley Capital has looked for funding from the world of private equity. New York’s Och Ziff, one of the world’s largest hedge funds, reportedly supplied McKinley with financing to buy up thousands of homes in California (but the hedge fund may be backing off now). As of January, 2012, McKinley reportedly owns $400 million worth of residential housing in the region.

Below this elite level of regionally and nationally focused companies are relatively smaller investors who are also making big plays for foreclosed housing in the Bay Area. In Oakland, as is detailed in the Urban Strategies Council’s report “Who Owns Your Neighborhood,” a small group of real estate speculators have been purchasing a large share of the city’s overall foreclosures. Their business model, and ultimate aims, aren’t as well publicized as Waypoint and McKinley’s, but they stand to profit doubly from displaced homeowners who have been turned into renters in search of housing, and the coming rise in home price values that seems set to occur in the next few years.

  1. Thanks for doing all of this research, as depressing as it may be.

  2. Oakland is being made into a “company town” by these massive landlords reaping the whirlwind. S
    haring this article far and wide.

  3. redwein said:

    Fantastic analysis and depiction of how capital(ism) recovers in times of crisis. This is mega-“disaster capitalism” at its rapacious worst, the only difference being that this disaster was completely man-made from the get go. I’m a “housing is a human rights” fighter in south FL and I’d love to know if there are well-capitalized entities similar to Waypoint making mass buys here, too. A couple of articles in our local np from the past couple of mos. spoke to the issue of investors scooping up properties here, too: …and Thanks!

  4. Eric Ongerth said:

    Good writing and an insightful illumination of these events, thanks.
    Forgive me for an off-topic comment, but I don’t believe that is Lake Anza up there in the Tilden banner image… I’m pretty sure that is a telephoto shot over the ridge and out to San Pablo Reservoir.

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