NY AG Eric Schneiderman’s suit to bring meaning to the servicing standards of the National Mortgage Enforcement Fraud rises and falls on how the D.C. Circuit interprets two provisions of the Consent Judgment.
In my last post, I explained that one provision–the one sentence section II–seems to require that the banks comply to the letter of the servicing standards in Exhibit A, notwithstanding the elaborate metrics/monitoring process that institutionalizes banks’ right to violate the standards so long as they don’t do it too often. If it doesn’t Schneiderman has no suit.
But even if it does require perfect compliance, the AG has one more argument he has to win. I didn’t explain that properly last post. Here’s the key part:
“3. Enforcement Action. In the event of an action to enforce the obligations of Servicer and to seek remedies for an uncured Potential Violation for which Servicer’s time to cure has expired, the sole relief available in such an action will be:
(a) Equitable Relief….
(b) Civil Penalties….”
NY AG Schneiderman’s right to sue hinges on how the bolded language is read. If “enforce the obligations of Servicer” means the same thing as “seek remedies for an uncured Potential Violation”, then there’s no right to sue until the metrics process really plays out. Bank of America would then be right. (See the end of its letter to A.G. Schneiderman.)
So here is the best case I can make for both sides, written as dialogue:
NY AG: Bank of America, Section II couldn’t be more plain English: you have to comply with the servicing standards according to their terms. You aren’t.
BofA: Look, AG, Section II is not enforceable regardless of what it says. You took a deal–I remember popping champagne when I heard you were going to sign–you took a deal that provides only one way to enforce it: the metrics and related process in E. At best Section II’s a right without a remedy, and you know what those are worth.
NY AG: No no no. You’re reading the enforcement provision wrong. I can sue you to enforce your obligations, and I can sue you to seek remedies for your failures under the metrics/monitoring process.
BofA: You’re being redundant. As the deal is structured, the only way to enforce it is via the metrics/monitoring process. See section IV, which is as plain English as that section II you like so much. Unless we’ve screwed up two straight quarters–hard to do given the generous threshold error rates–you’re out of luck. “[E]nforce the obligations of Servicer” means the same thing as “seek remedies for an uncured Potential Violation.”
NY AG: If it means the same thing we wouldn’t have said it that way. Lawyers are wordy, sure, but the basic idea in reading contracts and statutes are that words are there for a reason, that we’re not just repeating ourselves constantly. If both sides of the “and” were the same thing, we would have put it this way:
”3. Enforcement Action. In the event of an action to enforce the obligations of Servicer, the sole relief available in such an action will be:
We wouldn’t need that bit about uncured ‘Potential’ Violations. The reason we have both is there are two different kinds of remedies available, equitable relief and monetary penalties. Only the monetary penalties are tied to the uncured ‘Potential’ Violations. We can sue for the equitable relief of specific performance of the servicing standards without regard to the metrics process. The right created by Section II has a remedy; just not a monetary penalty one. For that matter, we could sue for equitable relief for uncured Potential Violations too, but why bother with the metrics when we don’t have to?
BofA: You’re superficially convincing, but your problem is the word “enforce”. The Consent Judgment couldn’t be clearer that the only enforcement is via the metrics process, so when it says
“3. Enforcement Action. In the event of an action to enforce the obligations of Servicer,
it can only mean a suit related to failure under the metrics.
AG ES: You think I and the other Democratic AGs who were pushing for a good deal would have signed off on this one if we couldn’t enforce Section II? Our justification for the deal was the servicing standards in Exhibit A. If your read is right, those standards only as good as the metrics, that is, virtually meaningless. That’s not the deal we took. Of course I can sue you for specific performance to the servicing standards in A. Section II requires total compliance, Exhibit E at J.3. gives me the right to sue for it.
BofA: Do you think we and our Bailed Out Banker brethren are idiots? Why would we take a deal that exposed us to suits by 49 AGs, the feds and other regulators for any level of noncompliance with the servicing standards as spelled out in A? Why would we give all of you a way to bypass the metrics? Sure, you can’t get money penalties with your suit, but so what, the money penalties from the metrics process are chump change. The real action is whether we have to thoroughly overhaul our operations to comply with the servicing standards as written in A. We don’t intend to do that overhaul. That’s the point of the Metrics.
AG ES: Section II says you have to overhaul, and the language in J.3 means I can force you to comply.
BofA: Section IV says you can only make me meet the metrics, and the language in J.3 means that too. “Enforce” means “enforce”.
AG ES/BofA: See you in Court!
BofA: (aside, to the audience): glad it’s the D.C. Circuit!
When the National Mortgage Settlement was announced, I called it an enforcement fraud because every major law enforcement entity in the country signed off on letting banks overcharge people, use fake documents and otherwise abuse homeowners with impunity, so long as they didn’t do it too many people for six straight months. Pigs could get fat, hogs would get slaughtered. (The legalese is in the settlement is “threshold error rate.”)
Or not; the maximum penalty for six months of too many violations was $1 million. Hard to see a deterrent effect of any kind in $1 million when the enforcement population is five of our biggest banks. (Sure, if the banks were really really bad in the same way for four total quarters the penalty could then be $5 mil, but c’mon, the settlement itself was more than 1000x that number, and the settlement didn’t drive change, it produced “threshold error rates.”)
And when this deal was done, it had Eric Schneiderman’s signature on it, something he gave for a task force that was obviously staffed to fail, as I noted at the time. But now it seems he’s got buyer’s remorse.
Trying to Get Two Banks to Fix Four things
Now that that A.G. Schneiderman’s learned that Bank of America and Wells Fargo have failed to service 339 New Yorkers according to the standards dictated by the Settlement, he’s served notice he intends to sue. Not for money; for “equitable relief.” That’s what he’s allowed to sue for, pursuant to Exhibit E, at J:
“Equitable Relief. An order directing non-monetary equitable relief, including injunctive relief, directing specific performance under the terms of this Consent Judgment, or other non-monetary corrective action.” (See Exhibit E at J2 and 3 here.)
Though I’ve not seen a filing, I imagine he will seek an injunction to get Wells and BofA to start complying with (specific performance of) the four servicing standards Schneiderman is targeting in his press release:
1. Borrower must receive written acknowledgement of receipt of a loan modification application within 3 business days or receipt.
Note, I didn’t find a metric to measure compliance with this. (Metrics in Table E-1 here.)
2. Servicer must notify borrower of all missing documents or deficiencies in the application within 5 business days of receipt of the borrower’s initial loan modification application.
Metric 6.b.i. measures compliance with this; 5% is the “threshold error rate.” I’ll bet that the 210 Wells violations, and the 129 BofA ones–collected over a year–are many fewer than 5% processed by either bank in a given quarter. So even if AG Schneiderman’s right, these violations alone wouldn’t be enough to trigger the monitor to take action.
3. Servicer must give borrower 30 days to submit missing documentation or correct a deficiency.
Same metric, same “threshold error rate.”
4. Servicer must make a decision on a complete loan modification application within 30 days.
Metric 6.b.ii measures this, and its threshold error rate is 10%.
To be fair to Schneiderman, the metrics are irrelevant from his perspective. He thinks he can enforce the servicing standards as presented in the glittery golden exhibit A. That is why his letter to the monitoring committee focuses on the standards in A, not the metrics in E.
What Is Specific Performance in the Agreement?
I hope he’s right about that; I’m not sure. The Consent Judgment has language for both sides. Section II, top of page 3 says: “Defendant shall comply with the Servicing Standards, attached hereto as Exhibit A, in accordance with their terms and Section A of Exhibit E, attached hereto.” That part of Exhibit E has to do with the timeline for implementation. So far, so good for Schneiderman.
But then “Part IV. Enforcement,” at page 4 says “The Servicing Standards and Consumer Relief Requirements, Attached as Exhibits A and D, are incorporated herein as the judgment of this Court and shall be enforced with the authorities provided in the Enforcement Terms, attached hereto as Exhibit E.” That makes it sound like specific performance of A is defined in E.
Also troubling for Schneiderman is IX.A.2 of Exhibit A, a subsection under “IX. GENERAL PROVISIONS, DEFINITIONS, AND IMPLEMENTATION”:
“2. In the event of a conflict between the requirements of the Agreement and [law or contract] … such that the Servicer cannot [comply with both without risking penalty], Servicer shall document such conflicts and notify the Monitor and the Monitoring Committee that [law or contract trumps the settlement]. Any associated Metric provided for in the Enforcement Terms will be adjusted accordingly.
That is, when Exhibit A talks about implementation of its standards, it references the metrics.
I’d love to hear from experienced litigators what they think “specific performance” means under the settlement–compliance with A or E?
What Schneiderman Can Get By Suing
At first blush it looks good: Schneiderman can go to the D.C. District Court and ask for an injunction ordering BofA/Wells to specifically perform–meaning live up to the letter–of the terms of the Consent Judgment.
For a best case look, let’s assume Schneiderman can enforce Exhibit A without regard to Exhibit E. Let’s assume A.G. Schneiderman goes to D.C., gives a D.C. District Court Judge his documentation of the 339 violations, and promptly gets an injunction ordering specific performance of the four the standards in Exhibit A he’s focused on, without regard to the metrics. What then?
Well, either Wells/BofA suddenly overhaul their operations in a way they failed to do when they were facing down all 50 AGs and the Department of Justice, or they keep on keeping on. I’ll bet on the latter. In that case, presumably AG Schneiderman will find it reasonably straightforward to document more of the same kinds of violations. That is, he will be able to prove that Wells/BofA is in contempt of the injunction. What then?
I guess it depends on things not yet known, such as: will any bank bigwigs be named individually in the injunction, and thus at personal risk of contempt? Who will the judge be?
The law of civil contempt means that if the judge agrees Schneiderman can enforce Exhibit A without regard to E, and if the judge is genuinely interested in coercing compliance, the judge can. See this recitation of the standard in a 2011 U.S. District Court civil contempt order (admittedly Florida, not D.C.; anyone know if it’s dramatically different in D.C.?):
In fashioning a remedy or sanction for civil contempt, a court has broad discretion, “measured solely by the ‘requirements of full remedial relief.’” U.S. v. City of Miami, 195 F.3d 1292, 1298 (11 Cir. th 1999) (quoting Citronelle-Mobile, 943 F.2d at 1304). For example, a court may impose a coercive daily fine, a compensatory fine, attorney’s fees and expenses, and coercive incarceration. See U.S. v. United Mine Workers of Am., 330 U.S. 258, 303-04 (1947); see Smalbein v. City of Daytona Beach, 353 F.3d 901, 907 (11th Cir. 2003). “In establishing the amount to impose, the court must consider several factors, including the character and magnitude of the harm threatened by continued contumacy, the probable effectiveness of any suggested sanction in bringing about compliance, and the amount of the contemnor’s financial resources and consequent seriousness of the burden to him.” Matter of Trinity Indus., Inc., 876 F.2d 1485, 1493-94 (11th Cir. 1989).
If the D.C. Circuit standard is similar, the judge has the power to coerce the banks to comply with whatever the judge deems appropriate–Exhibit A or E. If E, it’s not clear that a violation can be proved on what Schneiderman alleges. But assuming Schneiderman gets an injunction, documents non-compliance, and seeks contempt, would a judge be coercive? Would the judge order a high daily fine, or simply a “compensatory fine” that’s as arbitrary and useless as the checks from Rust Consulting?
Will Schneiderman Be Allowed to Sue?
Before Schneiderman can sue, he has to give the monitoring committee a chance to take over the action. A kind of lawsuit right of first refusal. The Committee, now in receipt of Schneiderman’s notice, has three weeks to decide whether or not to sue. If they say no, he has to (inexplicably) wait another three weeks before suing. So it may be 42 more days before the injunction is requested. (See Exhibit E at J2 here.)
What does it mean if the Committee decides to bring the suit? Is that more or less potent than Schneiderman going alone? People with more political insight would know better; I wouldn’t assume that the Committee taking the suit over is good, but sure, it could be. I’d rather see a bunch of AGs join Schneiderman’s suit and bring their own cases against the other three big banks that he could join. Enforce the 304 servicing standards a handful at a time. (Again, if Exhibit A is the standard; if it’s Exhibit E it’s not worth it.)
The Bottom Line
It’s really hard to see how this effort–even if A.G. Schneiderman triumphs–leads to the kind of systemic change that was possible when all of the liability for the banks’ bad acts was still on the table. You know, pre-settlement, when A.G. Schneiderman and a few other Democratic A.G.s looked like they were going to stand up for America and insist on a meaningful deal.
Consider, the most that can come of this is two of the five banks complying completely with four of the 304 Servicing Standards.
For example, the settlement’s liability release doesn’t cover all these new bad acts. When the SEC finds new acts in violation of prior injunctions, it typically brings new (albeit equally ineffective) enforcement actions. Maybe AG Schneiderman could use the new bad acts to bring a meaningful, new enforcement action. Or maybe there’s a different genre of banker bad action that could lead to more meaningful penalties, drive business model change and put bankers in jail.
I wish I could get excited about this threatened lawsuit. Just like I wish that watching SchoolHouse Rock’s I’m Just A Bill and Preamble didn’t make me cry. And yet I let my preschoolers watch them because I want them to grow up believing in the America that can be, if we Americans bring the transnational corporations and their parasitical executives to heel. It’s been done before, and can be done again. But deals like the National Mortgage Settlement, with all those law enforcers’ signatures, show that this President and this Congress aren’t going to do it.
Monday I did an analysis of a study HousingWire reported as showing that profligate borrowers were the reason many 2009 mortgage modifications failed. I analyzed the reported data to show the 2009 mods left borrowers insolvent, and said it’s not surprising that mods that leave borrowers insolvent fail. In the ‘article’, Showalter rejected the idea that mod terms mattered. Instead he claimed the borrowers’ “lifestyles” explained who defaulted and who didn’t.
But here’s the thing. As I explained Monday, the key “lifestyle” choice was which debt to default on: when insolvent, did the borrower pay Peter (the mortgage servicer) or pay Paul (store/credit card debt)? Indeed, the study was a marketing tool trying to sell the ability of a matrix invented by Veritas to identify which potential mod candidates would pay Peter, and which Paul, so the banks could modify loans only for the people who picked Peter. That focus makes the invocation of the irresponsible borrower myth in the article particularly egregious–both borrowers are trying to be responsible in the face of insolvency.
The Morality Tale
Showalter pushes the ‘it’s not the mod terms, it’s the bad borrower’ idea with far more than the “Living Large” headline. He personifies the data by inventing two couples, pitched as archetypes of good and evil, probably hoping to copy the policy-killing success of Harry and Louise.
Showalter’s heroes are subtype G, the 3% of the sample that redefaulted on their mods “only” 26% of the time. He calls them Lois and Eddie, a small town Midwestern couple who’ve been married 20 years, have kids in the local school, work at the mill, and are deeply “entrenched” in their community. They’re not underwater on average, holding 9% equity in their houses. And they’ll do anything to hold onto their houses, because
“For Lois and Eddie, their lifestyle–and their values–demand that they save their home. They derive their identity and their purpose from their community. Losing their home would mean losing membership in their community, which is a big part of what makes Lois and Eddie the people they are. A foreclosure would cause Lois and Eddie a great loss-of-face among friends, co-workers and family. Their employers might take note as well.”
No wonder they choose to pay Peter over Paul, and default on their credit cards or other debts instead! (Incidentally, surely the mods are objectively inadequate when this archetype of goodness still redefaults a quarter of the time even while they let their revolving debt go delinquent.)
Later in the piece we also learn that Lois and Eddie are:
“low income borrowers who are responsible consumers of debt; they very likely own a modest, below median-priced home, view their mortgage as their primary financial obligation and pay limited interest in other forms of debt, such as credit card and retail card. Property values in their neighborhood have been more stable and not subject to wild speculation and tremendous price increases or decreases.”
So in analysis of mortgage related data we know that someone’s had the same employer for 15 years, has been married for 20, has kids in the school and 9% equity, but we don’t know if their house is below median price? They are responsible consumers of debt because they let their credit and retail cards go delinquent to pay their mortgage? They are responsible borrowers because the bubble didn’t hit their neighborhood?
Without the underlying data it’s hard to be precise about how much Showalter is inventing and what he can footnote, but it’s important to notice that his profile contains factors that aren’t driven by Lois and Eddie, such as the stability of the house prices, and that others, like the responsible nature of defaulting on revolving debt, are a matter of perspective.
Contrast wholesome Lois and Eddie with the can’t-be-helped Vicky and Dave. Vicky and Dave’s first offense is that they are young strivers:
“Vicky and Dave are a 20-something, newly married couple, who bought a home in a rapidly developing metro-suburban community where they live largely anonymously, barely knowing the names of their neighbors. They have no children, few friends locally, and no family nearby. They have been with their respective employers less than five years each and live many miles from work, with no coworkers in the neighborhood.”
Ok. So they’re newly married, no kids, have relatively new employers. So what? They’re young. More; conventionally we want people to get married before they have kids. If they’re college graduates, maybe it’s their first job after graduating. (And maybe they have student loans too.) If they skipped college, child-labor laws would’ve stopped them from having 15 year work histories with the same employers anyway. Living far from their childhood home? Well, they probably went where the jobs are, a brave decision that economists generally want more Americans to make.
Now, why would they live so far from work? Well, as a young couple, they’re surely at the bottom of the house-buying food chain, and homes with convenient commutes cost more. No friends and coworkers in the area? What’s the data is behind those statements? Still, perhaps Vicky and Dave spend all their time working and commuting. So many of us do, after all. So far nothing much separates Vicky and Dave from the strivers we used to idealize except ominous spin.
But Showalter includes another couple sentences about Vicki and Dave, damning sentences at first glance:
“They are more aggressive borrowers with more expensive automobiles bought with borrowed money. They support significantly higher revolving balances and have a penchant to add to their credit portfolio, especially their revolving debt.”
The context to remember is this: regardless of what Vicky and Dave’s accounts are like, Lois and Eddie are insolvent after a mod too. What makes Lois and Eddie special to the bank frame of mind is that they pay the mortgage first and let the other bills slide.
Beyond that, when you commute a long way, it’s important to have a reliable, reasonably comfortable car. What does “more expensive” mean, anyway? A 2008 Ford Taurus or a Lexus? Showalter doesn’t say. Buying a car on borrowed money? Well, that’s how most people do it, and when they do, there’s a lender supposedly assessing their ability to repay the loan.
As to “a penchant to add to their credit portfolio,” I wonder what those credit lines are. How many are store cards like HomeDepot or Lowes, which let you buy 3, 6, 9 or even 12 months same as cash if you’re spending $300 at once? Either is an unsurprising card for young, striving new homeowners. They’re more likely to be DIY types, right? Are the other new lines for stores that sell couches, beds, washing machines or other big-ticket items a young couple in their first house need? Those retailers do time-limited same-as-cash deals too.
In short, I wonder whether the couple is “living large” in the welfare queen way it’s intended, or simply trying to realize the American dream on as affordable terms possible, given the decline in real wages? Showalter doesn’t say.
Later we learn that Vicky and Dave’s cohort:
“is composed of borrowers who in the recent past have been very aggressive borrowers across a broad spectrum of debt, well beyond mortgage. [again, what does that mean, specifically?] However they are beginning to fall behind in their debt servicing and are suffering eroding credit and declining cash to service their debt. [Declining cash? Did someone lose a job?]
And then there’s this:
“[Vicky and Dave's cohort's] Property values [ ] have incurred more depreciation, with many properties now presenting negative equity. This may account for a portion of this borrower’s recent debt servicing distress, since the borrower is no longer able to harvest home equity to support aggressive consumption habits.”
What’s the data point for saying Vicky and Dave were using their equity like a piggy bank? It’s purely a speculative comment–”this MAY account”. I’d like to know what percentage of Vicky and Daves have home equity lines? What percentage of those people were constantly drawing them down before experiencing their current debt servicing problems? How do those numbers compare to the Lois and Eddies? These are not idle questions since negative equity could have a very different impact on Vicky and Dave’s “lifestyle” (i.e. cash allocation decisions).
Perhaps being young and transplants, Vicky and Dave are simply more able to be economically rational, and when forced to choose between the bills, see solving their revolving credit problems as more sensible than paying on a deeply underwater mortgage. That’s particularly true since Vicky and Dave belong to the cohort with the highest negative equity, owing 128% of their home’s value.
But economic rationality in the face of post-mod insolvency is not an acceptable way to understand the situation. Showalter explains:
“Here’s the question: Will Lois and Eddie respond similarly to Vicky and Dave, given a bout of mortgage distress? Hardly. That’s the point. And, the other point: The terms of the loan modification are highly unlikely to uproot the lifestyle and financial priorities of Lois and Eddie or of Vicky and Dave. Lifestyle differences trump loan modification terms and will do so all day long. Loan modification terms cannot cause Vicky and Dave to become Lois and Eddie any more than they can cause Lois and Eddie to behave like Vicky and Dave.”
Really? The loan mod terms don’t matter? What if the terms of the loan modification left Vicky and Dave and Lois and Eddie both solvent? I’ll bet both couples pay all their bills at that point. And as I noted Monday, if the bankers (and their allies in D.C., including President Obama) hadn’t denied homeowners the right to restructure their mortgages in bankruptcy, the borrowers would in fact be solvent post-mod. That’s the whole point of the bankruptcy process.
Friday HousingWire ran a six-and-a-half page big bank/mortgage servicer propaganda piece called “Living Large“, by Tom Showalter. The article, subtitled “A person’s lifestyle plays into whether they will pay their mortgage after a loan modification”, purports to explain why people default on loan modifications. Instead, it spins a bank-exonerating morality play not justified by the data supposedly being interpreted.
I’ll get to the morality play and the “irresponsible borrower” propaganda it represents in my next post to keep this one to readable length. First, to clearly show the wrongness of the bank-serving mythology being sold as its interpretation, I’m going recap the data the ‘article’ presents to answer the questions the underlying study apparently aimed at: why did so many people with mortgage mods made in 2009 default on those mods by 2011? And what needs to be done to make mods more successful going forward?
Note: I can’t assess the data quality because I don’t have access to the underlying tables and sourcing info; I am working off HousingWire’s/Showalter’s analysis of it. I just take his numbers at face value, though as I discuss below, however, something is screwy either in the some of the data or Showalter’s reporting of it.
Regardless, after looking at the data as presented by Showalter, the answer’s clear: People defaulted because the loan mods weren’t steep enough to make them solvent. To get successful mods in the future, payment reduction needs to be enough for borrowers to be solvent again. That’s all. Importantly, a post-mod solvent borrower is what would’ve happened if the loan restructuring were allowed to happen in bankruptcy; we’ve long understood what dealing with debt crises takes.
The Data: Tremendous Financial Stress, Inadequate Modification
So let’s look at the data as described by Showalter. Here’s the setup:
A control group of a random sample of 1 million people with mortgages in 2009, skewed to be a little more than 50% subprime, Alt-A and jumbo prime, was compared to a random sample of 55,000 loans modified in 2009 and tracked through 2011. (Showalter does not say if the modified loan sample is a subset of the control group or not.) The debt loads, bill paying performance and other characteristics of the people in both groups, and of people within the modified group, were compared. In fact, the people in the modified group were broken out into seven different groups, A through G.
So what do we learn about these various groups? The metric most discussed is who was seriously delinquent–60-days or more past due–on credit lines from 2007-2009. This data point is fixated on because, according to the analysis, it is the overwhelmingly strongest predictor of defaulting on a 2009 modification by 2011.
Turns out the baseline borrower–the average borrower in the million person sample of people with mortgages in 2009–was seriously delinquent with 16% (1 in 6) of their “active credit lines” sometime in 2007-09. Think about that: the average borrower with a mortgage in 2009 became seriously delinquent on one or more accounts in 2007-09. That is quite a backdrop of financial stress.
So how do the people who qualified for a mortgage modification compare? Unsurprisingly, mod recipients were even more debt stressed: 30% of their accounts had been seriously delinquent during 2007-09. Mind you, they’re not deadbeats; they were keeping 70% of their accounts current. Still, they were struggling much more than the average mortgage holder.
What about the people who defaulted on their loan mod by 2011? Turns out they were even worse off, having been on average behind on half (51%) of their credit lines during 2007-2009. No surprise there–people with the most debt stress at the start continued to have the most trouble paying their bills. Still, that’s not the whole story.
See, the data show that the tipping point at which “loan modification redefault performance erodes substantially” is serious delinquency on 25% of accounts in 2007-09. But wait–the average for all modified borrowers is 30%! There’s only conclusion possible: the mods were systematically inadequate, unable to address the financial crisis faced by the average person they purported to help.
Redefaulting Data Screwy as Reported
How likely to redefault? Depends on the subtype. At best one in ten redefaulted (11%, subtype F, representing 2% of the sample), and then one in four (26%, subtype G, 3% of the sample). That leaves 95% of the modified borrowers redefaulting at a higher rate, and also signals that the data are screwy, at least as presented by Showalter.
See, he says the average redefault rate was 30%. Group A, which came in at 30% redefault rate, represents 22% of the sample. If 5% of the sample is below the average, and 73% of the sample above, shouldn’t the average be higher? It’s not like the other rates were very close to the average. Subtype C comes in at 34%, D at 37%, and E and B, which combined account for 56% of the loan mods, redefaulted at 41% and 51% respectively. No way that average is 30%; either Showalter or the data are just wrong.
UPDATE: The sentence Showalter writes is “These borrowers…redefaulted at below average rates (average redefault rate <30%).” I read that as meaning the average redefault rate is 30%. Otherwise the 30% is a meaningless, arbitrary number. But considering that a 30% average doesn’t make sense, per the above, and given how incoherent the data presentation was generally, maybe Showalter doesn’t mean the average is 30%. Maybe he picked 30% just because it was the first round number above 26% and 11%, the redefault rates of the groups in question, and the average is in fact higher. Doesn’t really matter.
The Mods Were Inadequate
It’s not just the pre-mod financial stress data that shows mods simply weren’t substantial enough to work. It’s the other data Showalter fixates on, namely what people did with the cash freed up by the mod. Given the “Living Large” headline, I expected to read that redefaulting, ‘bad’ borrowers blew their mod-freed up cash on shopping sprees, decking out their lives with flat screen tv’s, jewelry and vacations. Living Large is about self-indulgent pleasure chasing, isn’t it? But here’s the “lifestyle” choice that Showalter says make some borrowers good, and some bad: whether the borrowers decided to use the cash to pay Peter (the mortgage bill) or Paul (the revolving debt/credit card bill.) Seriously.
“the borrowers in the high redefault group applied their discretionary cash to their distressed revolving debt, significantly reducing the proportion that rolled to a more serious level of delinquency. …The low redefault group behaved much differently. By 2011 they were letting their revolving debt role to more than 60 days overdue at a much higher rate.”
Since when is someone “Living Large” by paying down some bills while falling behind again on their mortgage? Snark aside, here’s the key point: both groups–the high redefaulters and low redefaulters–are still insolvent after mortgage modification. They still can’t pay all their bills even though they are trying to.
Showalter talks about high redefaulters paying down distressed revolving debt. He doesn’t claim the high redefaulters rang up large new debts with the cash, just that they chose to pay existing creditors other than the mortgagee.
Mods Should Make Borrowers Solvent
Let’s remember the context for these mods: our nation faced, and faces, a housing and foreclosure crisis triggered by the collapse of a lender-inflated, fraud filled housing and housing-related securities bubble. The crisis has been exacerbated by the unemployment crisis of the Great Recession. Our government stepped in to help, and responded quickly to save the bankers and Wall Street. The big help for Main Street was supposed to be loan modifications/refinancings.
Seen through the lens of public policy aimed at avoiding foreclosure, the inadequacy of the mods is even more obvious. Why did the government let the banks do mods that left people still insolvent?
But wait, banks might say: it’s not fair to put the homeowner debt reduction burden solely on the mortgage; why should our payment be cut so much that the borrower can service all their debts post-mod? Why not force the other debt lines to take a hit too? A variation on this whine is: but wait, by reducing the mortgage payment so much, you’re hurting pension funds and other investors, folk we don’t want to hurt.
Here are my responses:
If you hadn’t falsely inflated principal balances by suborning appraisal fraud and adding fake demand to the marketplace by abandoning underwriting, thus directly and fraudulently increasing the homebuyer’s debt load;
If you hadn’t engaged in widespread predatory lending including steering people into more expensive mortgages when they qualified for cheaper ones, thus directly and fraudulently increasing the homebuyer’s debt load;
If you hadn’t engaged in predatory servicing, misapplying payments, forcing borrowers to purchase grotesquely priced insurance policies (even when they were maintaining insurance of their own), and charging rolling late and other junk fees, thus directly and fraudulently increasing the homebuyer’s debt load;
If you hadn’t worked so hard to kill mortgage-loan restructuring in bankruptcy, which would have led more people into bankruptcy and thus forced other creditors to take a hit too;
If you hadn’t defrauded homebuyers-as-taxpayers by making false mortgage insurance claims;
If you hadn’t defrauded homebuyers-as-pension-fund-participants by lying about mortgage-backed securities to the investing pension funds;
If you hadn’t criminally manufactured documents to foreclose on people’s homes;
It would have been enough to justify you lowering the mortgage payment to make borrowers solvent that you were bailed out with tax dollars and not held accountable for any of your crisis-causing misdeeds.
Dear Investor Protectors:
The issue isn’t whether the mortgage payment should be modified sufficiently to allow borrowers to become solvent. It’s who should pay for that modification. I agree with you: the banks should pay. There’s nothing about modifying the amount of the payment due you that comes out of the borrower’s pocket that requires investors to take the hit for the difference, except investor passivity and comparatively (to the banks) weak political power.
The Bottom Line
Insolvent people will default on debts owed, making the choice that seems most rational to them about whether to pay Peter or Paul. Public policy aimed at keeping people in their homes based on loan mods is a total failure if the loan mods leave borrowers insolvent. And apparently the 2009 loan mods did just that. And that failure is unconscionable against the backdrop of banker wrongdoing and government solicitousness of bankers.
The Shark Week-worthy feeding frenzy of post-Election analysis has covered a lot of ground (how could the right wing be so delusional? What will Obama do? Especially frequently: What do the results mean for the next election? Rarely: What do the results say about the public policies the electorate cares about?). What follows is my riff on what the election means for the power status quo, through the lens of a Bill O’Reilly comment.
Bill O’Reilly said some remarkable things as he processed President Obama’s re-election. I’m going to focus on one: “The white establishment is now a minority.”
Careless listeners hear “The white establishment is now a minority” and think “black and brown voters outnumber white ones”, which is obviously false. In an embarrassing clip on the Nov. 7 Daily Show, Dick Morris laments that Latino voters rose to 11% of the electorate while black voters rose to 13%. That is, people of color were just about a quarter of the electorate, and not all of them voted for President Obama. (According to Fox News exit polling, Obama was chosen by 93% of black voters and 71% of Latino ones.) Since President Obama won just barely more than half of all the votes casts (51%), more white people voted for Obama than non-whites.
To see how many more, imagine 100 people voted. Using the percentages above, about 19 non-whites chose Obama. Since Obama got 51 votes, that means 32 white people voted for him. See, white people didn’t reject Obama; only the white people Republicans have traditionally catered to–the wealthy elite and the God, guns and gays voters–did.
But O’Reilly didn’t mean that non-whites outnumber whites in the voting booth, or even the popular variation on the theme, that minorities are now politically dominant.
(If minority voters were politically dominant, black unemployment wouldn’t be so much higher, immigration reform including legalization would happen swiftly in a bipartisan way, and various other demonstrations of political muscle would follow.)
O’Reilly said the white “establishment” is now a minority. And he’s right–his white establishment can no longer win a Presidential election by itself.
Here’s Wikipedia’s definition of “the establishment”, bold mine:
The Establishment is a term used to refer to a visible dominant group or elite that holds power or authority in a nation or organization. The term suggests a closed social group which selects its own members (as opposed to selection by inheritance, merit or election). The term can be used to describe specific entrenched elite structures in specific institutions, but is usually informal in application and is more likely used by the media than by scholars.
What O’Reilly meant is that the elite, who were supremely confident they could motivate enough white people to vote for their candidate, suddenly discovered they can’t. The ‘white establishment’ used all its tricks to get one of their own elected: massive spending, Fox ‘News’, and voter suppression (id laws, voter roll purges, curtailed early voting, forcing people to endure long lines). And the white establishment’s tactics failed. Now the wannabe kingmakers are trying to come to grips with the new limits on their power.
Don’t over-estimate the new limits. What happened is that power so vast it mistook itself for omnipotent ran into a limit. That humbling–the humiliation of clay feet–is really upsetting the white establishment in a very public way. But objectively, the white establishment has not yet experienced a material limitation on its power to set policy. It still has the power to encode its policy preferences in statute, regulation or common law almost all the time. And that’s despite the massive, socially devastating externalization of cost and internalization of profit their policies create. Remember, the white establishment is armed essentially unlimited campaign contributions, lobbyists, and post-elected office/staffer/regulator gravy train jobs.
Nonetheless the election results reflect a real limit on the white establishment’s power. How long the limit will remain in place depends on when the Republican Party gets serious (as in fact-facing) about winning national elections. Until then we have a “new” political establishment in the country, one that has the kind of advantages the old establishment used to enjoy when it came to electing presidents.
New Boss Same as the Old Boss (Almost)
But let’s not kid ourselves. President Obama is no FDR. He’s no LBJ. He’s (at best) a modest reformer, not a real threat to the establishment’s power. At most President Obama will modestly curtail the old establishment’s prerogatives.
On no policy has President Obama ever staked out a transformational position, much less fought for one. Don’t tell me health care reform was transformational. Medicare for all would have been transformational. Health Care Reform was just that–reform. Much worse, Obama has been the bankers’ president, not homeowners’ or consumers’.
Wall Street’s rejection of President Obama this cycle is a measure of its arrogance, not President Obama’s threat to its power. Income is more unequal now, and poverty greater, than under President Bush. President Obama’s even more drone-happy than President Bush, and just as 4th Amendment destroying. Rather than lead the charge his base fantasizes about, Obama has repeatedly blown off them off.
Sure, Obama’s establishment is different than Romney’s/the white establishment’s, but not by much.
So many on the left are hoping that President Obama, now freed from the need to run for office again, will finally lead us to the kind of economic and social justice we need. I’m willing to grant the possibility exists. Hey I’ll buy one–just one–MegaMillions or Powerball ticket when the jackpot exceeds $100 million. The possibility of winning exists, and the fantasy is just so nice to enjoy. Just one ticket, though, because the odds of the fantasy coming true are incomprehensibly small. That’s how I see dreaming of a President Obama who not only defeats the white establishment at the ballot box, but also breaks its grip on public policy.
Much higher odds? President Obama helps orchestrate and proudly signs reductions in the basic economic security our country has long believed every American was entitled to in exchange for modest changes in the tax code. Gentle reforms that don’t threaten the feudal power structure embedded in the code.
Let’s see–does the “Grand Bargain” (er, Sellout Deal) involve taxing investment income like wages? Does the Sellout Deal involve eliminating the cap on Social Security and Medicare taxes? Does the Sellout Deal involve closing the loopholes that let enormously profitable corporations dodge paying income tax? How about traditional wartime tax rates on the wealthiest until we’ve paid for Afghanistan and Iraq–you know, 70%+ for the top bracket? I could go on and on, there’s so much wrong with our tax code and the related premise that we must have a ‘Grand Bargain’ that reduces the economic security of the masses to preserve the unspendable wealth of the few.
What kind of terms do you expect President Obama to agree to?
I suppose there’s a possibility, in the Powerball sense, that that the coming Sellout Deal will be a Grand Bargain involving the creation of a fundamentally just tax code. In life there’s always a Powerball chance.
note, I updated the percentage popular vote win for Obama from 50.4% to 51% to reflect the current count, and tweaked the 100 person example accordingly.
We Americans praise the idea of equal opportunity, cling to it as part of our birthright. But we refuse to do what’s necessary to create equal opportunity. Much worse, we refuse to even talk about it. That’s true even though we’ve no problem having the conversation in other contexts; it’s only taboo in public policy.
I’m talking about redistributing wealth.
America is Not the Land of Opportunity Anymore
Our nation’s wealth is grotesquely concentrated, and many Americans’ standard of living has fallen. Everyone understands enough that grouping Americans into the 99% versus the 1% has intuitive resonance. Americans no longer raise their economic status in their lifetimes.
And yet the idea that anyone, no matter how low or distant her birth, can still grow up to be as wealthy as Mitt Romney or Bill Clinton is political dogma that cannot be questioned. We refuse to acknowledge our feudal economic reality like religious zealots who reject physics, astronomy, geology, chemistry, and biology to believe a fallacy their faith demands.
As long as we blindly repeat the mantra that ‘America is the Land of Opportunity, America is the Land of Opportunity, America is the Land of Opportunity’ with the closed-eyed hope of Dorothy clicking her ruby slippers, America will remain the opposite: a place where the rich grow ever richer and the rest of us suffer more.
Sports Fans Know Redistributing Wealth Creates Equal Opportunity
What’s most striking about our inability to talk about redistributing wealth and its connection to equal opportunity, is that most Americans understand the link.
(Note: I’m not talking about equalizing outcomes. I’m not talking about outlawing being rich or preventing poverty. I’m talking purely about opportunity, about giving a kid of the 99% a chance to become one of the 1%, if she works hard and plays by the rules.)
Why do most Americans understand that redistributing wealth creates equal opportunity? Well, most Americans are sports fans. The three big leagues, football, baseball, and basketball, knowing that fans want their hometown teams to have a real shot at winning the big prize, all embraced the same solution: redistributing wealth.
All three leagues “share” revenues and embrace synergistic policies like a “luxury tax” and salary caps. Revenue “sharing” is brilliant branding. “Sharing” doesn’t sound bad, doesn’t make people recoil the way ‘redistributing’ does. And salary caps–what a concept! Can you imagine capping JPM Chase CEO Jamie Dimon’s salary? What seems common sense in one context is unspeakable heresy in another.
See how deep the programming goes?
Are you one of these people that approves of redistribution of wealth in sports, but rejects it in public policy? Why? Would you prefer if our sports leagues stopped redistributing wealth, and the same teams won, year in and year out? No? Then why do you think it’s ok for the same people to ‘win’ at life, year in and year out? Why is social justice–that is, fundamental fairness and equal opportunity–more important in sports than in life? Isn’t life more important?
When candidate Romney came under fire for his 47% comment, he tried to change the subject by accusing candidate Obama of being a wealth redistributer. Here’s the damning Obama quote Romney used to make his charge:
“I actually believe in redistribution, at least at a certain level, to make sure that everybody’s got a shot,”
That sentence could have been said by the NFL, MLB or NBA commissioners, or any team owner, coach or player, and it would’ve been well received by any audience. But in politics it’s the basis for an attack.
So how did candidate Obama respond? Did he defend the idea of redistributing wealth ‘to make sure that everybody’s got a shot’? Heck no. Candidate Obama argued the quote was old and taken out of context. Candidate Obama doesn’t believe in redistributing wealth to make sure everybody’s got a shot. And President Obama’s record backs him up on that point.
Propaganda Explains the Difference
The key reason that redistributing wealth is embraced in sports by people who reject it in policy is propaganda. Two heavily amplified messages drive the policy distortion, one broad and one narrowly on topic. The broad meme is ‘government is the problem,‘ the government is incompetent, the government is broken, etc. The narrow one is the welfare queen, the idea that government takes money from hard working people and gives it to the undeserving poor, specifically, poor black people, especially poor black women with ‘too many’ kids and black women who got rich defrauding the government.
These messages have been relentlessly directed at American voters, particularly white working class suburban and rural men, since President Reagan was a candidate. Combined, these messages mean: you can’t trust government to redistribute wealth and we shouldn’t try.
Besides being slanderous, the idea that wealth redistribution means taking from the middle class to enrich the ‘undeserving’ poor channels righteous rage in the wrong direction. A key the lesson of the mortgage, housing and fraud crisis is that all our biggest banks, and the bankers who run them, got rich defrauding taxpayers. Just consider the settled, pending and never filed False Claims Act housing cases. That theft-from-taxpayers happened on a much, much larger scale than any kind of welfare fraud.
See, the economic parasites aren’t our poor, struggling to survive at the bottom of our economic food chain. America’s economic parasites live on top; feasting on a never-ending banquet of wealth harvested from everyone else.
Tax Avoidance Is Unpatriotic, Immoral and Parasitic
One easy way to spot the economic parasitism of our wealthiest is to look at the way they approach paying taxes.
We’re supposed to put country before self-interest; we ask our servicemen and women to back up that commitment with their lives every day. And if they don’t we call them AWOL (or back in the day, draft-dodger) and we jail them. But when we ask the very wealthy to pay a certain amount in taxes (doesn’t matter how much, it’s never enough to impact their purchasing power), they refuse. Our wealthiest, people who can afford their taxes like most people can afford a cup of coffee, nonetheless engage in elaborate strategies to pay even less.
How dare they? Don’t they remember we financed a decade of war on credit so we could lower the taxes on our richest, even though we traditionally raised their taxes to pay for our wars?
Let’s revisit candidate Romney’s smear of the ’47%’ in light of tax avoidance by the rich. Remember, Romney claimed that those that don’t pay income tax feel like victims, dodge personal responsibility, and expect the government to give them everything. You know who doesn’t pay income tax besides the social security recipients, veterans and others in Romney’s calculus? Wildly profitable companies like GE.
GE’s executives are so lacking in a sense of country, they maintain “the world’s best tax law firm” in-house, just so GE won’t pay a penny for America’s roads, bridges, ports, schools, military, clean air, drinkable water, public order, and any other tax-payer funded public good GE relies on every day. And GE is far from alone; lots of wildly profitable companies don’t pay income tax.
The Bottom Line
Life isn’t fair, and there’s no way to make it so. But the least a just society can do is to give its members a real chance to earn success, by working hard and playing fair. And as our sports leagues have demonstrated, that can only happen by redistributing wealth.
Next time a candidate, elected official, or media personality tries to tell to you that redistributing wealth will hurt you and benefit a lazy good-for-nothing poor person or any variant of that time-honored theme, tell them you know better, the true parasites bleeding taxpayers dry are the tax-dodging financial elite. Point to the game you’re watching, and tell the propagandists that the really criminal redistribution of wealth is the one that results from our current tax code, the code that takes money from everybody so that the few on top can have even more wealth that they cannot hope to spend in a lifetime.
Start talking to your fellow sports fans about redistributing America’s wealth.
The latest example of bankers running our country is the weak mortgage servicing standards proposed by the Consumer Bureau.
Revolving Door Smacks Consumers Around
Hmmm… how come the rules are so bad, given mortgage servicers’ rampant fraud, predatory servicing and gross incompetence, all of which has been well documented by law enforcement (albeit not effectively prosecuted)?
I have no inside scoop. But here’s someone who does: Leonard Chanin. He supervised all of the Consumer Bureau’s rule makings as its “Assistant Director for Regulations.” Guess what? Last month he left the Consumer Bureau to join Morrison & Forrester.
MoFo describes itself on its website as
“one of the leading banking and financial services law firms in the world, advising domestic and foreign banks, insurance companies, credit card companies, mortgage bankers, investment banks, investment management companies and investment advisers, and other financial institutions on regulatory and litigation, as well as transactional, matters.”
Mofo further explains:
“It is fair to say that we have played an important role in shaping the evolution of financial services law in the United States. We have been involved in every federal legislative and regulatory initiative involving or affecting banking over the past 30 years, including proposals addressing bank powers, the regulation of consumer lending, fair lending, mortgage lending reform, privacy and information sharing, electronic fund transfers and other payment systems, capital requirements, and other matters affecting the banking industry.”
Mr. Chanin’s switch from ostensible consumer protector to MoFo partner is not surprising; it’s a homecoming. He went from ‘of counsel’ in MoFo’s lobby shop (the D.C. office) to bank regulator at the Fed to banking industry rule writer at the Consumer Bureau to MoFo partner. According to American Banker, Chanin was an Elizabeth Warren pick. Really? Warren couldn’t find someone with a consumer advocate pedigree to be top rule writer for consumers? Or is American Banker wrong?
I mean, American Banker quotes a banking industry lobbyist saying this about Chanin:
“There was a level of comfort the banking industry had with Leonard, because they dealt with him for many years during his tenure at the Fed… I think this would be a setback for the CFPB because they’re right in the midst of an avalanche of mortgage lending regulations.”
I don’t know that Chanin’s typical. A different top Consumer Bureau lawyer left at almost the same through what sounds like a very different door. Deepak Gupta, “the CFPB’s former senior enforcement counsel [ ] left to start a consumer advocacy law firm” according to the same American Banker report.
Regardless of Chanin’s typicality, I note that a month before its top rule maker departed for partner pay at the banks’ big lobby shop, the Consumer Bureau proposed mortgage servicing standards that are weaker than the enforcement fraud mortgage settlement. Hmmm…
I can’t prove a quid pro quo; I have no inside information. I’m just pointing out the public record.
You decide what it means.
I am back.
Not as frequently as before; I’m aiming for once a week.
A bigger change: I’m going to talk about far more topics.
Yes, I’m still going to write about our housing, foreclosure and fraud crises. I’ll point out how the biggest banks—the biggest bankers– routinely demonstrate their sovereign-level power, codifying their policy preferences in law and regulation, shaping enforcement priorities and influencing enforcers.
But I’m also going to talk about our tax insanity and the related shredding of our social contract, and how we’re destroying our planet in the most wasteful ways possible.
I’m going to discuss how America has become a feudal nation, run by oligarchs-cum-aristocrats and run on the labor of debt slaves. The Land of Opportunity has become Sharecropper Nation.
Most of all I’m going to focus on exposing the propaganda that works to control us all, to keep us in our place, keep us participating in the status quo.
First up will be a key piece of propaganda, the idea that the redistribution of wealth is bad, so much so it’s taboo, to be rejected instinctively without discussion. That’s an amazing feat of social engineering that empowers the greedy and ignores our needy.
But before focusing on the social control propaganda, let’s pay attention to our status quo. Really look at what our nation has become.
Over the past forty years or so American businesses stopped paying living wages so their executives could siphon even more of the company’s earnings for themselves. Even worse, executives fattened their paychecks by raiding worker pensions.
This economic destabilization was softened by the advent of large scale, revolving consumer credit and ever looser lending standards. Because today’s wages just don’t pay the bills, we lease our standard of living. For so long as we can service the debt.
When we get hurt, sick, divorced or laid off, when our income becomes unexpectedly slashed below debt-servicing levels, our Government denies us meaningful relief in bankruptcy. This rejection comes in a nation whose founders understood debt and financial crisis so well they included bankruptcy protection in our Constitution.
Sure, people can get some help by going bankrupt, but those twin, enormous pillars of debt supporting the American Dream—the home mortgage and student loans—cannot be restructured in bankruptcy. Think about that.
Home mortgages and student loans are socially beneficial debts. Homeownership traditionally stabilizes communities, builds wealth, and provides retirement security. A college education is supposed to provide the skills of today and tomorrow’s economy, making our country more prosperous. We, the People, America, want people to take these debts on. It’s good for everybody.
More precisely, home financing is good for everybody only if appraisals are honest, underwriting standards are pre-securitization conservative, loan terms aren’t predatory, the documentation of all kinds is not fraudulent, and the securities aren’t rated deceptively or sold fraudulently. Of course, all those conditions were violated during our last bubble and bust. Similarly using student loans is good for everybody only if the degree delivers good job opportunities, enabling the graduate to work off her debt. Again, that’s not what’s going on.
Our bankruptcy code’s ‘no restructuring for you!’ treatment of debtors with these loans is punitive and wrong. Brutally punitive and breathtakingly wrong, given the size of those debts, the social utility of these loans when done right, and the injustice of enforcing their terms when done wrong.
’Our’ government’s policy choice is even more vividly unjust when you remember corporations in bankruptcy can restructure wage and retirement promises to their workforce, and consumers can restructure mortgages on vacation houses and investment properties, and among other luxurious debts.
Our bankruptcy code is a moral document drafted in our name. Everything about bankruptcy, other than the Constitutionality of the federal bankruptcy system and the Bankruptcy Clause’s power to trump the Contract Clause, is the considered judgment of Congress and the President.
Yes, of course, corporate lobbyists wrote much of the current version of the law, but Congress agreed to it (with President Obama’s help), making the lobbyists’ wishes our law.
Let’s shift from our unjust bankruptcy code to another offensive aspect of our status quo:
A hedge fund guy “earning” a billion bucks in a single year ($1,000,000,000/yr) pays 15% tax (or less) on all his income. This year you and I start losing 25% of our paychecks when we earn our 35,351st dollar.
The billionaire hedge pays our treasury only a nickel and dime of every dollar he wins off his bets but teachers, firefighters, police officers, soldiers, postal workers and other genuine servants of the public interest start kicking in a quarter from every dollar when they finally earn as much as the hedgie did in 19 minutes.
(19 minutes using income of $1 bil/year; at $1 million/year it’s 13 days before the hedgie racks up $35,351.)
The hedgie’s non-cash contribution to society is virtually zero; the public employees’ work makes society function. And yet he’s taxed as if he were the greatest gift our country ever knew. Must be that the hedgie’s lobbyist is the greatest gift Congress ever knew.
The moral corruption of the decision to tax the earns-a-billion-in-a-single-year gambler so little is clearest when you remember this:
When that hedgie earned a billion dollars in a single year, he already had functionally unlimited purchasing power. It’s not just that he doesn’t need the money; it’s worse. He doesn’t benefit (other than ego gratification) by making more.
Our tax code lets people with unlimited purchasing power nickel and dime America. But those of us who know what it is to live paycheck to paycheck, who budget, who defer desires, we all have to kick in a quarter or more long before our income equals economic security, much less unlimited purchasing power. All because we’re foolish enough to work for a living, while the hedgie types ‘invest.’
Feel how wrong that is.
I respect the charity of people like Bill Gates and Warren Buffett. But the tax code, like bankruptcy code, is a moral document, and their charity does not redeem it.
Even so a sane tax code is not possible while our political conversation treats redistributing wealth as a taboo topic.
So next week I’m going to focus in how crazy our politics of wealth redistribution is. Be well until then, and question everything.
The Lying Bankers Scandal should be called the Bailout Theater scandal. I don’t mean the perhaps decades-long part where traders manipulated LIBOR by 0.01% or so, up and down, for personal profit. I mean the part that started in 2007 when the bankers lied by much more so they’d look healthier than they in fact were. That part is bailout theater because Friday’s data dump by the New York Fed proves the Fed and other “regulators” knew what was happening and effectively approved.
Why? Apparently the Fed decided that allowing criminal fraud was necessary to calm markets, even though the fraud did nothing to actually make the banks safer or sounder: Bailout Theater. And for that, the top guy at the NY Fed at the time, our current Treasury Secretary Timothy Geithner, needs to be fired by President Obama and indicted if possible by Eric Holder. Not that I’m holding my breath on either point.
The documents also show that the focus on the LIBOR 1 and 3 month is misplaced. The lying happened at those maturities, sure. But the lying was much worse at 1 year, for example. Why? Well think about it–banks were worried that the entity they were loaning to wouldn’t be around much longer. To take the risk of loaning money a long time in the future, the bankers wanted huge premiums. The victim class of arbitrary winners and losers can be much larger than people have been focused on.
The Federal Reserve Knew LIBOR Was A Lie And Didn’t See Fraud
The document dump’s accompanying press release, er, “explanatory note,” shows the Fed didn’t see criminal fraud when it learned about willful lying about the banks’ borrowing costs for the express purpose of deceiving markets about banks’ health. Barclays, at least, started telling the Fed about the fraud in August 2007, and eventually become most detailed in April, 2008. Here’s how the Fed press release describes learning about what was happening, bold mine:
Among the information gathered through markets monitoring in the fall of 2007 and early 2008, were indications of problems with the accuracy of LIBOR reporting. …Suggestions that some banks could be underreporting their LIBOR in order to avoid appearing weak were present in anecdotal reports and mass-distribution emails, including from Barclays, as well as in a December 2007 phone call with Barclays noting that reported “Libors” appeared unrealistically low.
Let’s look at the indications, courtesy of Barclays
On August 28, 2007 a Barclays reply all email, which includes “Fabiola Ravazzolo” of the NY Fed and Pat Leising of the World Bank, notes:
“Today’s USD libors have come out and they look too low to me. Lloyds for instance has printed 5.48% for 3 months. Probably the lowest rate you coud attract liquidity in threes would be 5.55% and I am not too sure how much you would get at that level. [...]
Draw your own conclusions about why people are going for unrealistically low libors
9/26/07 (“There is liquidity in one to six months but our feeling is that libors are again becoming rather unrealistic and do not reflect the true cost of borrowing.”)
10/3/07 (“USD: 3 month libor rose 1 bp yesterday. It should have risen more. One libor contributor set it 2 bps lower than where they were paying at 11 am!?”) Note, Jason Miu of the NYFed is added to the distribution list
(“…demand for funding and a hoarding of liquidity is still combining to drive Libors higher, another factor we are seeing recently is a more realistic approach in setting Libors by contributing banks, that has been particularly noticeable in USD & EUR this week where the little business that does occur has usually been above where official Libors have set.
With year end coming into today’s 1 month USD & EUR fixings we are looking for EUR to fix @ 4.79 (although the real cash offer is 4.81) and USD @ 5.25 although there is no real offer in the market, one large London broker suggests 5.60 and it would be bid 5.70 through the FX arbitrage out of EUR.”
See that? Even though LIBOR is getting ‘more realistic’, Barclays was still expecting it to settle 0.35-0.45% lower than the real cost of money. I wonder what ‘less realistic’ looked like.
And that December 11 call? Well, Barclays released an ’unofficial transcript’. The key exchange:
“Barclays: You know, LIBORs being set too low anyway, but uh, yeah, that-that is correct.
Fed person: “Yeah.”
(see page 3; the Fed person is a “Peggy” whose last name is not identified.) In context, it’s clear Peggy is acknowledging the NY Fed knew the LIBOR rate is based on lies. And she’s at least the third person to have been directly told.
Barclays also released a March 27, 2008 email, which includes the comment:
“Liquidity conditions in term maturities remains very poor, there is very little cash to support where Libors are being set and the few lenders in the market are increasingly more name sensitive.”
So after eight months and all of the above “indications” that criminal fraud is being committed–again, banks deliberately lying about borrowing costs to deceive the markets and manipulate market perception of the banks’ strength–what does the Fed do? The press release explains:
As market strains intensified in early 2008, to better understand the nature and extent of the potential problems with LIBOR, analysts in the Markets Group gathered additional and more in-depth information. As part of this broad effort, on April 11, an analyst from the Markets Group queried a Barclays employee in detail as to the extent of problems with LIBOR reporting.
Holy Cow! The Fed called Barclays on April 11 and asked a bunch of questions! Now that’s an aggressive response. Which analyst was it? Fabiola Ravazzolo, the very person that was first tipped off about LIBOR manipulation eight months earlier. Here’s how the press release describes the call:
The Barclays employee explained that Barclays was underreporting its rate to avoid the stigma associated with being an outlier with respect to its LIBOR submissions, relative to other participating banks. The Barclays employee also stated that in his opinion other participating banks were also under-reporting their LIBOR submissions.
And then comes what is probably the key sentence:
The Barclays employee did not state that his bank had been involved in manipulating the rate for its own trading advantage.
See, the Fed didn’t see didn’t see the market rigging as wrong, if it was to hide banks’ weakness. But market rigging for trading advantage? Now THAT would’ve been a problem! Since when did motive play a role in criminal fraud, beyond helping prove intent? Given that tiny distortions of LIBOR by traders caused lots of stolen profits, these large distortions of LIBOR gave people much bigger wins and losses that weren’t deserved. Who cares why the bankers lied?
The Fed Knew of Widespread Criminal Fraud on April 11, 2008
Barclays’s unofficial transcript of the April 11 reveals Barclays’s awkward, painstaking efforts to make the NY Fed understand the fraud. Pathetically, the transcript also shows that at least one of the at least three people at the NY Fed that’s been informed of Dollar LIBOR lying by Barclays doesn’t have a clue about Dollar LIBOR, and hasn’t really internalized those earlier notifications.
Note, most of the elipses are to get rid of things like “mm hmm”; none of the omissions are substantive. Starting at page 3, after 2 pages of chit-chat:
FR: But, how reliable is the BBA for instance because you have only sixteen banks? Is it the same framework that the EURIBOR so banks they, they just report the the average rate for what they were lending or is it different?
[Barclays]: You’re supposed to publish, um, the rate at which you could borrow money.
FR: Ah, you borrow, not lending?
[Barclays]: No. So you’re supposed to, and that’s the definition of LIBOR is actually…
FR: You could… Borrow, so not necessary where you are borrowing?
[Barclays]: Yeah, because the-the panel is supposed to be, a, um, a panel of prime banks…And so it’s where those banks, um, decide they, they could actually borrow cash in the interbank market…. Now, um, you know, obviously there has been a lot of speculation about LIBORs and, you know… I’ve read some really interesting articles about them….Um, and uh, w-, you know we, w-we, we strongly feel it’s true to say that…Dollar, Dollar LIBORs do not reflect where the market is trading which is you know the same as a lot of other people have said….Um, wha-, it depends on which part of the curve you’re looking at. … Um, currently, we would say that in the three months, um, if we as a prime bank had to go in the interbank market and borrow cash, it’s probably eight to ten basis points above where LIBOR is fixing….If, if, if we had to go in the market and …Properly borrow money, it would be …About eight to ten above and in the one year…It would probably be about twenty basis points in the market.
Now the analyst asks a good question, albeit one that shows she never paid attention to the earlier “indications”:
FR: And, and why do you think that there is this, this discrepancy? Is it because banks maybe they are not reporting what they should or is it um…
[Barclays]: Well, let’s, let’s put it like this and I’m gonna be really frank and honest with you.
FR: No that’s why I am asking you [laugher] you know, yeah [inaudible] [laughter]
Barclays then tells the analyst as plainly as possible that banks are lying about LIBOR because telling the truth impacts their share price in an untenable way. At this point–at this months late, belated point, the NY Fed cannot claim ignorance of criminal fraud. Sure, normally proving intent is a barrier to criminal prosecution, but in this situation, it’s a gimme. Really.
[Barclays]: You know, you know we, we went through a period where…We were putting in where we really thought we would be able to borrow cash in the interbank market and it was…Above where everyone else was publishing rates….And the next thing we knew, there was um, an article in the Financial Times, charting our LIBOR contributions and comparing it with other banks and inferring that this meant that we had a problem raising cash in the interbank market.
[Barclays]: And um, our share price went down….So it’s never supposed to be the prerogative of a, a money market dealer to affect their company share value….And so we just fit in with the rest of the crowd, if you like….So, we know that we’re not posting um, an honest LIBOR….And yet and yet we are doing it, because, um, if we didn’t do it…It draws, um, unwanted attention on ourselves.
FR: Okay, I got you then.
Barclays tries to alert the Fed that even worse criminal securities fraud than Barclays’s manipulations are occurring:
[Barclays]: And in fact, wha-what we’ve noticed is almost like um, a um, um perverse thing where people that we know that are paying for money actually put in the lowest LIBOR rates.
[Barclays]: So it, it’s almost to um, you know the ones that need cash the most put in the lowest, lowest rates.
I wonder how the (former) shareholders of all those banks feel right now? How about a former Royal Bank of Scotland shareholder? RBS was on the LIBOR US Dollar panel in 2007 and in 2008. RBS failed in October 2008. Want to bet RBS was one of the big liars Barclays is referring to?
All of the above is from the transcript pages 3 to 7. On page 10, Barclays continues telling the Fed like it is:
[Barclays] ...in the Dollar market, people are putting it down below…Where they could actually borrow. Now, you know, it’s the same uh thing, some, uh, people might say, well, you know, sss-, this-this bank and this bank called me or this central bank gave me or things like that, but it’s not interbank…You know? And-and it if-if we kept it to a spirit of interbank…Dealers, cut out money market funds, cut out central banks, cut out cor-corporates…And purely based it on the spirit of it, um, interbank dealers, where the money is available, where I would be able to borrow in the interbank market…Without, w-without question it-it would be higher than the rate that I’m actually putting in
[Barclays]: For, for Dollars.
And again, on page 11, Barclays again explains that what a bank says its LIBOR is is material information:
[Barclays]: Um, it’s like, if I start to say that the LIBOR’s a lot higher and then people…Start to say, well why is he fixing a lot higher than everyone else? Do-do you know, it’s actually going to make it harder for me to borrow that cash?
And then finally the analyst not only demonstrates that she gets it, but that she knows it’s wrong:
FR: Yeah. No, no, it’s clear, it’s clear…you know, I mean, you remember I was in behind [an overnight Euro rate] so I remember when we were looking at rate you always question is correct so you just check, uh, so I’m-I’m c-, I’m very suspicious or I’m very curious or, let’s say, I find bizarre that who is responsible to com-, to collect this, er, you know, data, they’re not questioning banks just to see you know, that the, the level of the rate during the day is very different from…What i-is fixed.
[Barclays]: I mean, we-we-we’ve we’ve all received letters…From the…British Banking Association…To remind people of their…Obligation
FR: Yeah, but this is, mm hmm…
And then you can just see her shaking her head, feeling sympathetic to Barclays:
FR: You have a business and I completely understand the story, ah, but you know uh, if everybody has got a similar approach so one can also overcome this article on the FT or whatsoever…It’s that you are penalized just because you are honest the way somebody else that is dishonest, eh, you know that’s an advantage so that’s why I was thinking in that direction but… I understand. No, no and I completely understand the, the point is that ah you know, you, you, you always try to, to try and help for everybody you know, and this is so bizarre what is going on in the market
[Barclays]: It is bizarre. Yeah…I mean we, it- it’s true words to…Say we feel very…Very uncomfortable with it.
FR: I understand now.
[Barclays]: But, the-the position we find ourselves in, is one where we can’t really fight it.
FR: I know, I know
The call goes on for another dozen plus pages that I won’t excerpt here.
The Fed’s Damage Control Effort
The press release wants us to feel good; once the NY Fed had that April call, the Fed sprang into action! First, it spread the word:
That same day – April 11, 2008 – analysts in the Markets Group reported on the questions surrounding the accuracy of the BBA’s LIBOR fixing rate in their regular weekly briefing note. …this report was circulated to senior officials at the New York Fed, the Federal Reserve Board of Governors, other Federal Reserve Banks, and U.S. Department of Treasury. …
Here’s the key language from the April 11, 2008 memo:
Further, the fact that the TAF stopped out above LIBOR has also triggered a significant amount of questions over the accuracy of the BBA’s LIBOR fixing rate. Over the past few weeks, the 1-month term dollar deposit rate and the 1 -month LIBOR fixing have diverged by as much as 30 basis points. The divergence between the two rates is similar to that observed during prior periods of heightened market stress, most notably in August and early December 2007. Our contacts at LIBOR contributing banks have indicated a tendency to under-report actual borrowing costs when reporting to the BBA in order to limit the potential for speculation about the institutions’ liquidity problems.
Note: the Fed was spotting the problem on its own, using data, without needing to be told by Barclays. The press release continues:
Five days later, the first media report on problems with LIBOR emerged. From this point onwards the notion that banks were underreporting LIBOR in order to avoid signaling weakness was widely discussed in the press and in market commentary.
At this point, why didn’t the SEC leap into action? I realize RBS is listed on the London Stock Exchange, but surely the dollar LIBOR banks that are listed here deserved investigating, right? Citigroup, perhaps? Back to what the press release says the fearless Fed did upon the news of criminal fraud becoming widely known. Basically, they made sure everyone in charge knew:
In late April and into May 2008, New York Fed officials met to determine what steps might be taken to address the problems with LIBOR. The New York Fed also acted to brief other US agencies. On May 1 Tim Geithner, then President of the New York Fed, raised the subject at a meeting of …the heads of the principal regulatory agencies in the US, chaired by Treasury. On May 6 New York Fed staff briefed senior officials from the U.S Treasury in detail.
Which makes me wonder: why don’t all those people see criminal fraud on the facts as they knew them? Securities fraud, wire and mail fraud, bank fraud, fraud fraud fraud: lying for money. And yes, it’s lying for money when you’re propping up your share price by lying. Don’t our top regulators know the way to stop fraud is to prosecute it? Why does it take so many meetings to decide what to do?
The press release:
On May 20 the Markets Group sent a further report on problems with LIBOR to the broad set of senior officials who receive its regular analysis.
Here’s the crucial part of that report:
What evidence exists that banks were misquoting to the LIBOR panel?
Around the time the WSJ article first reported on this matter in mid-April, we heard from several Eurodollars brokers and bank funding desks that many LIBOR banks were bidding for funds up to 25 basis points above their LIBOR quotes in the same maturity on the same day. The BBA also received a number of formal complaints along these lines. Several of these market participants suggested that discrepancies between funding rates and LIBOR quotes had existed since at least last August, but had gotten marginally worse since mid-March.
Additionally, around days on which the BBA’s efforts to address LIBOR have received media attention, there have been fairly dramatic increases in the LIBOR fixings. For example, in the two days surrounding the WSJ’s April 16 article, 3-month LIBOR increased 17 bps, which was the largest two-day increase in the rate since August
9. Earlier this week, as the integrity of LIBOR again received attention, 1-year LIBOR increased 21 bps, and OIS and fed funds-LIBOR basis swaps suggest that a large portion of this rise was not due to a re-pricing of policy expectations.
Amazingly, the Fed still seems to be in well, we don’t really know anything mode: “Beyond the anecdotal evidence and LIBOR re-sets, it is difficult to find convincing evidence of actual misreporting.”
Well, where did you look for such evidence? Given Barclays’ statements, it’s only difficult to find convincing evidence if you ignore what you’ve been told and don’t follow up on it. Subpoenas anyone?
Back to the press release:
On June 1, 2008, Mr. Geithner emailed Mervyn King, the Governor of the Bank of England, a report, entitled “Recommendations for Enhancing the Credibility of LIBOR. Among the recommendations were specific proposals to improve the integrity and transparency of the rate-setting process…As is clear from the work culminating in the report to Mr. King of the Bank of England, the New York Fed helped to identify problems related to LIBOR and press the relevant authorities in the UK to reform this London-based rate.”
That’s how top regulators deal with evidence of criminal fraud quite likely being committed by American banks and which harms American investors? No investigation, no prosecutions, just a set of industry created suggestions for another country to deal with? Who is Tim Geithner getting his cues from anyway? Could it be JPM Chase’s Jamie Dimon, who started serving at the NY Fed in January, 2007 and whose bank was a dollar LIBOR contributor? Did Dimon frame the issues for Geithner, shape the way he understood them?
Meanwhile, Barclays keeps telling the NYFed what’s happening. Check out this excerpt from an October 24, 2008 call:
So, people like Rabo and Chase will be able to get money cheaper than say Barclays, RBS. I mean, West, Deutsche, Landesbank I don’t know where he gets his libor indications from. I can’t imagine anyone would want to lend him any money. There have been, recently you’ve had certain banks who I know have been paying 25 basis points over where they’ve set their libors …
And now, four years later, there’s outrage? Heads had better roll off to jail, not just at the top of a lot of banks, but also from within our government.
We need to restore the rule of law.
As noted in my look at Mortgage Resolution Partners’s pitch to San Bernandino, MRP focuses on condemning the loans of current underwater borrowers. From an investor standpoint, that makes some sense because the borrower’s refinancing should be easy. But from a deal economics and public policy view, it arguably makes much more sense for the Authority to focus on defaulted loans.
Defaulted Loans Are Super Cheap And Valuations Clearer
For starters, the ‘just compensation due’ would be trivial, compared to the price of current loans, meaning the Authority would need to borrow much less money. Second, those amounts would be harder to litigate as there are many more transparent comps. Third, it’s much harder for a bank to prop up the value of its home equity loan/2nd lien when the first is in default, so taking 2nds should involve much less litigation risk too. Fourth, because the defaulted underwater loans are worth so little, the spread between the condemned loans and the refinanced ones should be enormous. The Authority should be much more sanguine that there’d be, enough to repay investors, cover litigation costs, and leave some left over for the Authority.
While taking current underwater loans serves more of a public purpose than the generalized economic development claim of turning homes into property for Pfizer, taking defaulted loans provides even more public benefit. Instead of diverting some properties from foreclosure by refinancing them while they are still current (while also refinancing ones that may never have gone into foreclosure, or at least not soon), every defaulted loan taken is a home saved from foreclosure in the very near term.
Foreclosures depress property values around them; ‘taking’ homes back out of the foreclosure process helps the neighbors, the overall tax base, and the housing market. Moreover, people en route to foreclosure have generally not been able to maintain their homes as well as they’d like. Newly stable homeowners with affordable mortgages are much more likely to put on that new roof or do other repairs, which stimulates the economy.
Taking defaulted loans raises three risks, however, not really posed by taking current ones. First, there’s the chance that the homeowner, credit now destroyed, cannot refinance into even a market value mortgage. Second, there’s political risk. Third, there’s ‘moral hazard’. All can be effectively minimized.
Minimizing Refi Risk on Condemned Mortgages
The risk that a defaulted homeowner who could afford a market value loan could not, nonetheless get one because of the mortgage default history, can be addressed in at least a few ways. First, the Authority could work out an equity sharing deal with the homeowner such that the homeowner only borrows 70-80% of the home’s value, which would greatly increase the chances of a successful refi, while insuring the Authority eventually received most or all of that largess back.
Second, the Authority could hold the note for, say, seven credit-clearing years, while using excess cash from successfully refinanced properties to repay investors for the just compensation lent in the ‘hold the note’ cases. Third, the Authority could condemn the home (it would pay itself the just compensation) and then sell it.
At the national and even state level, the biggest blocker to effective public policy on housing has been the idea that irresponsible borrowers caused the crisis and that helping people in default amounts to the righteous bailing out the unworthy. Regular readers know how little I think of this claim, and how the evidence is overwhelmingly against it. But the idea is nonetheless politically potent; even MRP addresses it on their website by putting up two FAQ:
Is your program a giveaway to the undeserving who borrowed more than they should have to purchase houses they never should have owned?
No. Everyone in California has the opportunity to purchase a home by borrowing from a lender who is willing to take a loss if home prices decline by more than the homeowner’s down payment. The lender willingly takes the risk when making the loan, and the fair market value of the loan reflects that risk. By purchasing the loan at fair value, we give the lender the benefit of its bargain. By doing an economically rational modification or other resolution with homeowners, we afford them the benefit of their bargain without forcing them to default and flood the local housing market with additional foreclosed homes.
Regardless of the legal niceties, is it just wrong and a moral hazard to let these homeowners stay in their homes?
No. We protect our neighbors’ homes, even allowing them to keep the equity in their homes while canceling their debts in bankruptcy, because it is the right thing for them and the right thing for us. In the U.S. we do not put our neighbors into debtor’s prison, or make them homeless unnecessarily. America is facing an economic crisis and the solution requires practical action that keeps people in their homes which benefits the entire community. The real moral hazard is that the system is forcing homeowners to default in order to achieve rational solutions.
While MRP’s answers are tailored to the current homeowner, rather than defaulted one, it doesn’t take much tweaking to apply it to them too. Moreover, when acting at a local level, this kind of pr-scare tactic is counteracted by people actually knowing some of the homeowners involved and seeing the direct benefits of the program working. Partnering with a community organization or two could also help with this issue. Finally, to the extent that the political risk manifests, using an independent authority to do the program, as San Bernadino is, helps deflect it some.
The moral hazard claim is ‘if you take defaulted mortgages, you reward people for defaulting and inspire other people, now current, to default.’
Before taking on the claim, let me preface by saying that I find it incredibly offensive for policy makers to worry about the moral hazard involved in letting homeowners shift some of their losses to creditors by strategically defaulting, when some of those creditors are the bailed-out banks who continue to display the reckless behavior engendered by bailing them out–can you say ‘whale’ Jamie D?
Bailing out the banks without holding them accountable–and our continuing failure to hold them accountable–has created a moral hazard in our financial system that this globally destabilizing. And the policy makers who created that moral hazard are sweating whether the plumber down the street defaults to get his mortgage restructured?
Be that as it may, if our incredibly punitive, anti-debtor policy makers want to prevent current underwater borrowers from defaulting to participate in the eminent domain program, all the local government need do is say they will only take mortgages that were in default as of the day the program is announced.
As to ‘rewarding’ the defaulted homeowner for defaulting? Well, policy makers need to stop being so myopic. First, the homeowner has already been ‘punished’–credit destroyed, emotionally devastated, physically harmed by the stress. Second, the taking and refi isn’t about the helping the homeowner, it’s about helping the community by diverting foreclosures, stabilizing communities and housing prices, protecting the tax base, and stimulating the economy. All those benefits should be ignored because of misplaced outrage that a defaulted homeowner gets to stay in their home while paying the bills they now owe?
The expression ‘cutting off one’s nose to spite his face’ isn’t extreme enough to illustrate how crazy that attitude is.
Bottom line: as San Bernadino moves forward with its plans, I hope it will reject the MRP current loan focus but otherwise adopt the plan for defaulted loans. And I urge other communities to do the same.