Goldman Closes the Door on Subprime (BusinessWeek)

When Goldman Sachs (NYSE:GS - News) bought Litton Loan Servicing, a firm that collects mortgage payments from homeowners, in 2007 for an unannounced price, it seemed like a simple way to get an on-the-ground view of the subprime market. The insight would help Goldman Sachs figure out how much to pay for loans, and Litton would work with borrowers to get them back on track. Other sophisticated investors, including billionaire Wilbur L. Ross and private equity firm Centerbridge Capital Partners, bought mortgage servicers with a similar strategy in mind.

It didn't work out as planned. While there were plenty of distressed mortgages and lots of eager buyers, the loan holders had little incentive to mark down prices because that would mean taking a big loss on their books. "The distressed-asset market never got as hot as people were hoping it would," says Dean H. DeMeritte, an executive vice-president at Phoenix Capital, a Denver brokerage for mortgage servicing contracts.

On June 6, Goldman Sachs agreed to sell Litton to another mortgage servicer, Ocwen Financial (NYSE:OCN - News), for $263.7 million. The sale comes two months after Goldman Sachs wrote down the value of the business by about $200 million. "It really makes sense for them to sell it," says David B. Hilder, an analyst at Susquehanna Financial Group. "They bought it at a time when the business was easier, and it looked like there might be some insights to be gained in the mortgage market from having a servicer." Neither Goldman Sachs nor Litton would comment.

Founded in 1988 by Larry B. Litton Sr. in Houston, Litton was one of the first mortgage servicers to specialize in working with troubled loans, sometimes called "scratch and dent" servicing. It developed that skill during the savings and loan crisis, when it was hired by Resolution Trust Corp. to handle mortgages that were orphaned by failed banks.

Larry Litton Jr., who now runs the company, is known in the industry for his Texas drawl, straight talk, and vocal support for working with struggling borrowers before they get too far behind. Bruce A. Gottschall, the founder of Neighborhood Housing Services of Chicago, a nonprofit that worked with Litton a decade ago, says the company "seemed to me a little bit more flexible in terms of modifications early on." Litton Jr. currently is a member of the Federal Reserve's Consumer Advisory Council, where he has been vocal about foreclosure prevention. Ocwen would not comment on whether he will stay with the company after the sale.

Litton's business grew with the subprime market. In 1995 it serviced $1.2 billion in loans, according to Fitch Ratings. By 2007 its portfolio had ballooned to almost $54 billion; it's about $41.2 billion today. As the boom gave way to the bust, Litton was forced to hire more staff to deal with rising defaults. The company became the target of class actions alleging excessive fees and violations of consumer-protection laws as well as investigations by state and federal regulators. It has agreed to settle at least one of the lawsuits while denying liability; others are pending. It says it is cooperating with government investigations. Goldman Sachs will remain liable for fines and penalties that could be imposed by government authorities relating to Litton's foreclosure and servicing practices before the deal closes.

With the Litton sale, Goldman Sachs will no longer deal directly with homeowners. Gottschall says Goldman's unloading the mortgage servicer is part of a bigger trend: "Wall Street is probably trying to distance themselves from the problems they caused."

The bottom line: By selling Litton Loan Servicing, Goldman Sachs is out of the messy business of working with distressed homeowners.

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States Are Rejecting Millionaire Taxes (BusinessWeek)

Millionaires can breathe a bit easier. While President Barack Obama says he wants to let income tax cuts that benefit only the wealthiest Americans expire in 2013, several states are rolling back tax increases for top earners.

New York's highest tax rate on incomes exceeding $500,000 will fall back to 7.85 percent, from 8.97 percent, this year. Maryland's 6.25 percent tax on incomes above $1 million expired at the end of 2010, while California's top tax rate for millionaires has dropped to 10.3 percent from 10.55 percent.

At least seven states instituted temporary so-called millionaire taxes during the recession. Those levies are becoming harder to justify now that state revenues are rebounding. Overall, state tax revenue grew 12 percent in April compared with a year earlier, which may trim $20 billion from estimated state budget shortfalls, according to a recent Goldman Sachs (NYSE:GS - News) report. The soak-the-rich drive "just petered out," says Joseph Henchman, vice-president for legal and state projects at the Tax Foundation in Washington, a group focused on lowering taxes. "All of these states are backing away now."

Business groups have been vocal opponents of the temporary hikes. The Business Council of New York State has opposed efforts to maintain the tax increase on the grounds that such measures are an indirect tax on business income. Most business owners who are paid by partnerships or S corporations report business income on their individual returns. Kenneth J. Pokalsky, the Business Council's senior director of government affairs, says 25 percent of revenue generated from the state's tax on higher earners came from business income. In California, the Silicon Valley Leadership Group, whose members include Bank of America (NYSE:BAC - News), Apple (NasdaqGS:AAPL - News), and Microsoft (NasdaqGS:MSFT - News), along with 12 other business groups, have told lawmakers that tax increases should be extended only if lawmakers agree to "structural reforms" of the budget.

Republicans, who typically oppose tax hikes, now hold a majority of governorships -- 29 -- and many were elected last year after campaigning against tax increases. New Jersey Governor Chris Christie, a Republican, received national attention after vetoing a bill that would have extended a tax on millionaires in the state.

Some Democrats are also fighting the higher taxes. New York Governor Andrew Cuomo sparked a battle with fellow party members in the legislature earlier this year by opposing legislation that would maintain the higher rates on individuals earning more than $1 million. Maryland Governor Martin O'Malley, a Democrat, didn't push to extend his state's millionaire tax last year. "I would like to think it's because these are not very good policies," Henchman says. "If you're a conservative, you don't really like these taxes. If you're a liberal, these (state) services should be so important that everyone should have to pay for them."

The American public is almost evenly divided on the question of whether the wealthy should shoulder a higher tax burden. A Gallup poll released on June 2 found 49 percent of respondents opposed higher taxes on the rich, while 47 percent supported them.

Kim Rueben, director of the state and local program at the Tax Policy Center in Washington, a nonpartisan research organization, says higher tax rates are tough to sustain in states that have progressive tax codes. New York, for instance, has seven tax brackets, with the highest rate kicking in at an annual income of $500,001. "There are certain places that I think can afford to increase the progressivity of their tax system," she says. "In places that have a more progressive system, like California and New York, it becomes harder to keep raising that revenue."

A few states are bucking the national trend. Connecticut has raised its top tax rate from 6.5 percent to 6.7 percent. Oregon voters approved a measure in January establishing two new tax brackets: 10.8 percent for those earning more than $125,000 and 11 percent for those making more than $250,000. District of Columbia Mayor Vincent Gray proposed raising taxes for residents earning more than $200,000, but the District council nixed the plan. Someone making "$200,000 is not a rich person," says Barbara Lang, president of the D.C. Chamber of Commerce. "It's not a lot of money."

The bottom line: New York, Maryland, and California are knocking down tax rates for high earners, while the District of Columbia has nixed an increase.

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