Reality Check

Perhaps you’ve heard the line about not wasting a crisis. It means seize the opportunity to make big changes.

Well, the banks are doing just that: they are using their self-created foreclosure crisis to build pressure to dismantle judicial foreclosures. The bankers want it to be much cheaper and easier to take collateral with fraudulent documents. Which it is, in non-judicial foreclosure states.

Before I dissect an example from today’s news, I want to explain why I think the banker campaign to end judicial foreclosures is about easing fraudulent foreclosure, rather than, say, liquidating collateral quickly. It’s simply really– the banks aren’t swiftly liquidating the collateral they’ve already taken title to. The banks are letting the properties rot.

More than that: the banks are slowing foreclosures all on their own. Florida attorney Matt Weidner saw banks voluntarily dismiss some 50 foreclosure cases he defended in 2010. A year later, not a single one has been refiled, even though his clients remain in default. Or consider this anecdote from Michael Olenick of Seeing Through Data:

The last time I went to [Florida] foreclosure court with a reporter there was a borrower who thought the bank lawyer was his own lawyer because, he said, “she really goes all out, even when the judge gets cranky, to keep me in my house.” The judge was cranky the bank attorney wasn’t advancing her case and kept arguing for sale delays (cranky’s an understatement; red in the face yelling at her) but she kept her ground.

I tried to explain to the defendant that she works for the bank and is supposed to be trying to take his house but he wasn’t having any of it. After a few minutes of that the bank lawyer came out of court and he said “hey – I have to go – I have to ask my lawyer what to do now.”

Let’s be clear: the banks aren’t bitching about the Due Process accorded homeowners in court because the banks need to speed up foreclosures. No, the bankers want what they always want: to cut costs and reduce potential liability. And that’s easiest if they can manufacture fraudulent docs, as needed, and foreclose using them without hassle.

Spotting the Bankers ‘End Due Process’ Campaign

So here’s an example of what I’m talking about, a Mortgage News Daily article from today, May 16, titled: “Judicial States Continue to Skew Foreclosure Statistics”. Take a look at the article’s opening sentence:

There were substantial improvements in delinquency rates during the first quarter of 2012 according to the National Delinquency Survey for the period released this morning by the Mortgage Bankers Association.

and then this one later in the article:

“The problem continues to be the slow-moving judicial foreclosure systems in some of the largest states,” [Mike Fratantoni MBA's Vice President of Research and Economics] said.

Here’s the funny thing; the bold is in the original, and it’s the only bold in the original, other than the headline. The bold aren’t links, nor is it subheds; in both cases it’s just emphasizing part of a sentence. The bold’s only purpose is highlighting banker/government talking points.

The Foreclosure Crisis Is Nowhere Near Over Yet

The first talking point, the decreased delinquencies, is a misleading fact. Sure, it’s true, but what does it mean? Does it mean that the foreclosure crisis is ending or winding down? No, it doesn’t, because the crisis isn’t. But when your brain picks up on the bolded language, that’s the implicit message: delinquencies are down, so the foreclosure crisis is easing.

Beyond all the foreclosures in limbo, and all the excess inventory, socially destructive foreclosures are still rising; the National Mortgage Daily article itself says:

Nationally the percentage of loans in foreclosure rose slightly but …the top-line figure covers up a couple of trends. “First, the percentage of loans in foreclosure is up for prime and FHA loans. The percentage of subprime loans in foreclosure continues to fall as the subprime loans age and the problems [sic] loans are resolved one way or the other. However, the percentage of loans in foreclosure for both FHA loans and prime fixed-rate loans are climbing and are just below all -time records.”

To see how the “substantial improvements in delinquency rates” feeds the banks’ the courts-are-the-problem meme, read it in conjunction with: “The problem continues to be the slow-moving judicial foreclosure systems in some of the largest states,” Franantoni said.”

Implied conclusion: things are getting better and would be much better if it weren’t for those dang courts!

Targeting the Courts

The key sentence couldn’t be clearer: “The problem continues to be [the courts]…”, but the whole push on the point needs deconstructing:

“The problem continues to be the slow-moving judicial foreclosure systems in some of the largest states,” Franantoni said. While the rate of foreclosure starts is essentially the same in judicial and non-judicial foreclosure states, the percent of loans in the foreclosure process has reached another all-time high in the judicial states, 6.9 percent. In contrast that rate has fallen to 2.8 percent in non-judicial state, the lowest since early 2009.”

Ok, note: foreclosures are starting at the same speed in both places, so the problem of delinquent loans that the banks want to seize the collateral on is evenly distributed. But once started, the foreclosures can’t get done quickly in judicial states. Hmmm… let’s see what we can learn about why that is from the article:

The difference in the rates is even more disturbing in certain states. In Florida the percent of loans in foreclosure is now 14.31 percent.

Ok, Florida. I opened by mentioning that banks are driving lots of the delays in that state. How is that the court system’s fault? One reason for the chaos in Florida is the banks’ heavy use of foreclosure mills like David Stern. When Stern spectacularly flamed out, he created chaos by just dumping files. Again, how is that the court’s fault? No one told the bankers (or Fannie/Freddie) to use Stern or any other mill. The Florida delays are caused by the banks’ fraudulent documents and their attempts to foreclose on the cheap through the mill model.

Back to the article:

New Jersey and Illinois are trailing Florida substantially but still have rates of 8.37 percent and 7.46 percent and, Brinkmann said, their rates are increasing.

New Jersey and Illinois. Hmmm… I know New Jersey has been taking a close look at the banks’ fraudulent documents. I haven’t followed Illinois, but banks have  been walking away from homes in the foreclosure crisis. New Jersey courts are only “the problem” if rejecting fabricated “evidence” is a problem, and the Illinois issue may not even be court related.

More from the article:

Ten judicial states have rates above the national average of 4.39 percent. On the other hand, among the 29 states using a non-judicial process, only Nevada has a higher rate of loans in foreclosure (6.47 percent) than the national average.

What’s up with Nevada? Oh right: the Attorney General indicted “robosigners” and the legislature further criminalized the banks’ document fraud. The Nevada foreclosure rate has spiked for the same reason the judicial states’ has: banker document fraud. Still, the article pushes the idea that the problem is the courts:

Five state [sic] now account for over 52.4 percent of all foreclosures in the country while accounting for only 32.1 percent of the loans services They are Florida, California, Illinois, New York, and New Jersey.

New York is easy to explain: the Court system required bank attorneys to swear their documents were true. The lawyers refuse to do this, so the cases languish. California is nonjudicial, and lacks a Nevada style law, so I imagine its high rate is a combination of CA’s size and its bubble size, and banker unwillingness to complete the process (as is visible in Florida).

The article then goes on to say FHA loans are starting to experience the same pattern of delays in states where courts and legislatures care about the rule of law (well, the article puts it a little differently) and then says:

“You have to ask yourself, …who is going to bear the costs of this differential foreclosure rate? They are being passed on to all FHA borrowers in the form of higher across-the-board increases in insurance premiums, and ultimately to the taxpayers if the FHA insurance fund develops a shortage.”

Those darn courts, wrecking the housing market by slowing foreclosures and costing all of us more money.

Due Process is the Solution, Not the Problem

See where all this is going? Enough messaging like this and some states may change foreclosure laws more to the bankers’ liking. Short of that, people will target the courts as the problem instead of the bankers.

Whenever you read banker talking points embedded in news like this, remember: our Constitution guarantees Due Process for a reason. Due Process is essential to the rule of law and a fundamental check against the abuse of power. Don’t let the bankers sell you or your representatives into taking it away.

Here’s the narrative Jamie Dimon is trying to sell about JPM Chase’s $2 billion loss:

“JPM Chase’s Chief Investment Officer made egregious mistakes executing and monitoring a hedge, and that’s why Jamie Dimon’s bank lost $2 billion, a full third of its quarter’s profits. The losing bet was a legitimate hedge allowed under the Vlocker rule, just a really bad idea.”

Here’s what really happened:

JPM Chase placed a huge bet that went bad, a bet that cannot be described as a “hedge” in any policy relevant way. JPM Chase was simply gambling for profit.

Defining “Hedge”

What’s a hedge? Well, here’s a couple definitions from Financial-dictionary.thefreedictionary.com, one a noun and one a verb, bold in both mine:

A transaction that reduces the risk of an investment.

To reduce the risk of an investment by making an offsetting investment. …This means that one will profit (or at least avoid a loss) no matter which direction the security’ s price takes. Hedging may reduce risk, but it is important to note that it also reduces profit potential.

Hedging has three key features: reducing risk, in a particular investment, and reducing profit potential. All three are key to a hedge, though most people focus on the first. Focusing only on the “reducing risk” part is very dangerous, however. Reducing the risk of what? An investment or a $360 billion portfolio of investments?

That’s the big fight about the Volcker rule–can banks trade to hedge an investment, or an entire portfolio? If a banker’s reducing risk in a single investment, the mechanics of risk management, and thus the legitimacy of the hedge, are transparent. The risks involved in the initial investment and the hedge are the same risks. What’s different between the investment and hedge is what happens to the money when the risk plays out.

If you’re hedging a portfolio, it’s not obvious what the “right” hedges are. Remember, we’re talking highly complex securities, totally opaque transactions, and an unusually unstable and volatile world.

The Truth About Portfolio Hedging from Occupy the SEC

Occupy the SEC warned about “portfolio hedging” in its Volcker Rule comment letter, making it possible for those of us not in the thick of finance (as the anonymous SEC Occupiers are or have been) to understand the two things portfolio hedging is really all about.

First, traders throughout the banks gamble on the bank’s behalf. Management sees all these trades in the aggregate, and places “broad-line hedges against lumpy trading-desk exposures.” Those are hedges, but are only necessary since the bank is doing so much gambling on their own behalf. Since the Volcker rule bars banks from gambling for profit (“proprietary trading”), then managers shouldn’t have much to aggregate and hedge, as Occupy the SEC’s letter notes. As a result, there’s no justification for a “portfolio hedge” exemption to Volcker.

And that leads to the other, totally illegitimate (under Volcker and common sense) reason for “portfolio hedging”–to let senior management make really big bets while calling it “portfolio hedging.”

As the Occupy the SEC letter explains:

Management will often make use of a “back book” or “management book” [to take] proprietary positions that fall outside of the mandate or risk-limits of an individual trader. …We are troubled by the potential for such “back books” to become havens of prohibited proprietary activity after the implementation of this Rule.

So that’s what “portfolio hedging” is really about: managing the aggregate risk the banks’ legion of gamblers-for-profit (traders trying to profit for the bank through bets) pose, AND empowering senior management to place really big bets. Both are doozies, but the last especially.

Back to the definition of a hedge, the part that’s the dead giveaway Chase’s whale wasn’t hedging.

Hedging Reduces Profit Potential

The third hallmark of a real hedge is it costs money. Safety isn’t free. More risk means more potential profit (a “risk premium”) because there’s correspondingly more potential loss. Hedging reduces the risk of loss, but in paying for that safety–in placing the hedge–the trader reduces potential profits.

When a trader’s looking to increase potential profits, she makes an investment/take a position/place a bet, etc. Then she hedges to reduce losses.

Why Whale Wasn’t Hedging

Since we still don’t know precisely what JPM did wrong, it’s hard to do a thorough dissection. But what has come out indicates the loss came from gambling, not hedging.

1. The bet could not be wound down easily. As the NYT said: “It is hard to justify a position as a hedge if the trades cannot be sold quickly without destroying their value.” That’s common sense: being trapped in a position increases risk. And in fact, Wall Street is apparently feasting on the risks JPM created with this bet.

2. The bet’s enormous size signals its speculative purpose.

Reportedly the position involved more than a quarter of the CIO’s investment budget–$100+ billion. Surely all the small gamblers, er, traders, at JPM didn’t have positions so similar that a single “broad-line hedge” against them took such a huge share of the CIO’s cash.

FT Alphaville explains that the size of the bet destroyed the hedging potential (if any was really intended) because it made the play unmanageable:

A flattener trade [what JPM probably did] is just fine in reasonable doses, i.e. if there’s enough liquidity in the market to support it.

Unfortunately,…you have to rebalance them reasonably actively…Get this wrong and your position will start to look even more risky and volatile…

That large size meant that rebalancing in order to keep the trade on in its true form would ultimately become impossible.

How big was it? Well, the London Whale’s trades cornered so much of the market he drove prices.

3. The losses grew and grew.

Hedges work counter to a different investment. A perfect hedge would produce no loss and no gain. If “the trading strategy started losing a lot of money when the market turned against corporate bonds toward the end of March”, as the New York Times said, then the investment it was hedging should have started making even more money when the market turned against corporate bonds toward the end of March. To put it another way, a hedge is supposed to limit downside risk, not create a bottomless pit.

Don’t be fooled by JPM’s claim that other gains make the $2 billion a net loss of $800 million. Those gains don’t make the whale fail a poorly executed hedge unless all the offsetting gains resulted from the market turning against corporate bonds. And JPM’s not claiming that.

4. The CIO became a profit center, not a hedge center.

This point is context for understanding the $2 billion bet rather than relating to the details of the bet.

In recent years the division that made the bad bet sharply increased its speculation for profit. According to Bloomberg:

Dimon, 56, had transformed the unit in recent years to make bigger and riskier speculative trades with the bank’s money, five former employees said.

Very specifically, Dimon oversaw a shift from hedging into profit oriented bets on corporate debt. That’s relevant because the London Whale’s play related to corporate debt:

The chief investment office’s push into risk-taking was led by Achilles Macris, 50, according to three former employees, …[he] led an expansion into corporate and mortgage-debt investments with a mandate to generate profits for the New York-based bank, they said. Dimon closely supervised the transition from its previous focus on protecting JPMorgan from risks inherent in its banking business, such as interest-rate and currency movements, they said. [Bold mine, quote is from the same Bloomberg article]

The NYT has reported similarly.

Pundits and Wall Street reforming politicians are crowing: Wowie! Jamie D has fought for weak regulations, especially a weak Volcker rule, but now Wall Street’s goose is cooked! We’re going to get a strong Volcker rule!

But that gleeful analysis amounts to: We lost the war but hey, we might still win a battle!

Former Fed Chair Paul Volcker fought incredibly hard for something much more powerful than even a strong version of the so-called Volcker rule. Volcker pushed for a return of Glass-Steagall, a law that until 1999 prevented the public financing of Wall Street gambling. Glass-Steagall/Volcker-for-real stands for the idea that when a company’s cash (deposits) is guaranteed by the government and the company has access to incredibly cheap government money, under no circumstances can the company be allowed to gamble with it.

Let’s be clear: Glass-Steagall wouldn’t prevent gambling addicts like Jamie Dimon from losing big bets. Crucially, however, Glass-Steagall would make the cost of placing those bets market rate, and make the gambler’s shareholders take the loss.

It’s a tremendously sad testament to the power of the banks that first they killed the return of Glass Steagall in favor of a ban on gambling for their own profit (a strong Volcker rule) and then used their lobbying prowess to eviscerate the rule.

FDIC Vice-Chairman Renews Glass-Steagall Push

Well, common sense is rising again. Shahien Nasiripour of the Financial Times interviewed Thomas Hoenig, Vice Chair/second in command at the FDIC recently, and Hoenig said

“that broker-dealer activities [that is, trading in the markets] should be cleaved off from banks, particularly large, systemic financial institutions.”

That is, Hoenig called for a return of Glass-Steagall. Why? Because

“’In a crisis, who will absorb the loss?’”

In case you’re not sure, the answer is you, me, and hundreds of millions of others. Not that we share in bankers’ profits, of course, just the losses.

Hoenig then pointed out the obvious, foreshadowing Jamie Dimon’s mea culpa:

“‘If management cannot adequately monitor and control their risk, it is unreasonable to expect supervisors to do so in their place,’”

Glass-Steagall is the key to preventing future bailouts because it makes the implicit government guaranty the big banks now have less credible. See, right now, between the FDIC and the discount window, there’s a mechanism in place to honor the implicit guaranty. Spin off the trading operations, and we’re back in overt bailout territory, a political minefield many won’t walk through again. As Hoenig explained  the guaranty that is the only reason the bailed out banks’ trading operations haven’t yet bankrupted the banks:

“without government support, Mr Hoenig argued…investors and counterparties would then appropriately price for the risk that these institutions could fail, eventually leading to more disciplined trading and less risky activities.

“I’m not impressed by the markets’ smarts, but I’m very impressed by its harshness,” Mr Hoenig said.”

Perhaps worse than the standing risk of stealth bailouts driven by bailout-empowered greed, every day the present arrangement continues the banks get to leech off America quite extravagantly, as Sheila Bair detailed in the Washington Post:

For several years now, the Fed has been making money available to the financial sector at near-zero interest rates. Big banks and hedge funds, among others, have taken this cheap money and invested it in securities with high yields. This type of profit-making, called the “carry trade,” has been enormously profitable for them.

Shifting Gambling Risks to You and Me

Last fall Bank of America backed up its bets with the money you and I have deposited with it, and which the FDIC has guaranteed to pay back (up to a point) if BofA blows it. Here’s what happened: people on the other side of BofA’s bets said, we’re not sure you’re good for the money, if it’s your gambling company on the hook for the losses (Merrill Lynch). So move the bets to your FDIC-insured company. Then we know the cash will be on hand to pay us off.

In this 10-18-11 Bloomberg article on how BofA’s move was supported by the Fed and opposed by the FDIC noted

“Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with how to protect FDIC- insured bank accounts from risks generated by investment-banking operations.”

That is, “Three years after taxpayers rescued some of the biggest U.S. lenders, regulators are grappling with” how to re-invent the Glass-Steagall wheel. Why should they have to re-invent that wheel anyway? Oh, right, the banking lobby.

Big Dumb Rules Needed

As Felix Salmon pointed out, and highlighted by David Dayen, society needs big dumb rules as the foundation of modern finance. With the right boundaries set, a complex financial system can flourish. Glass-Steagall is a great example of a big dumb rule.

Big dumb rules are cruel at the margins. In law, that’s why judges will sometimes eschew “bright line rules” for the more discretionary “balancing tests”, which create less uniformity but can be used to minimize socially unjust outcomes. In finance that marginal unfairness is hated because it’s expensive. As Salmon says, “traders hate dumb rules, because they cap the amount of money they can make.”

To be clear, Salmon’s not advocating Glass-Steagall in his piece; here are the big dumb rules he’s talking about:

simple limits on how big any one position can get, on how much exposure you can have to any one counterparty, or in general on any trade which is based on the hypothesis that your desk is smarter than anybody else on Wall Street.

Very sensible stuff. Salmonesque rules would compliment Glass-Steagall nicely, because his rules are aimed at the trades themselves, reining them in directly.

Besides cruelty at the margins, another hallmark of big dumb rules is that they’re easy to enforce uniformly. Wrongdoing is obvious. What a change restoring big dumb rules would make! We still don’t know for sure what cost Jamie Dimon so much money. That’s shocking, as our whole financial system cratered on opaque risks, as FT Alphaville pointed out.

Take Back the Power

Because Jamie Dimon has been the public face of the Wall Street effort to keep the cash spigot wide and the accountability for its use narrow, it’s worth revisiting the definitive history The House of Morgan, published in 1990 by Ron Chernow. Here are excerpts from the New York Times review of the book, bold mine. Try reading just the bold first, and remember this was written in 1990, 22 years ago:

A second refrain is the seesaw of power between Wall Street and Washington. In the early 1900′s the moneymen overwhelmingly controlled the national economy. Later they were reined in …But is Wall Street once again beyond control? After all, Congress has been groaning about stock market volatility, and it is horrified by the wave of debt-creating leveraged buyouts. Yet the lawmakers seem helpless to do much about these issues….

And when considering this next bit, you could insert “Goldman” for Morgan in the first sentence for variety’s sake:

Certainly, Mr. Chernow believes that the Morgan firms have become like their competitors - predatory bankers with little concern for anything but the bottom line – only much better at the game. He concludes that they have squandered their former reputation of being unswervingly loyal financiers to the world’s most respected companies. But he seems ambivalent about whether this could have been avoided in the modern era, dominated as it is by deregulated markets and ferocious competition.

Let it sink in: 22 years ago a serious look at financiers in America worried that their potentially devastating destructive power had become dangerously un-leashed. In those 22 years, the pendulum has only continued to swing toward the bankers. The pendulum got so far, in fact, that after blowing up the global financial system, the banking lobby prevented the restoration of a crucial big dumb rule and neutered its lobbying compromise.

Rather than stay caught in the briar patch debating “the Volcker rule” with the likes of Brer Jamie Rabbit Dimon, let’s climb out and look at the whole forest of modern finance again. Let’s put big dumb rules back in place, starting with Glass-Steagal and Salmon’s suggestions. Let’s save ourselves from the greed of the financial services industry, and save the industry in the process.

P.S.

Many want to dismiss the idea of restoring Glass-Steagall as pie in the sky naivety, ignorant of the way the world now works and implying that the world must continue to work that way. I’m sure many said similar things about breaking up Standard Oil, or US Steel, or Ma Bell… Heck, those were only monopolies, relatively inefficient extracters of unjustified profit compared to the Fed subsidized gambling addicts of today…We shouldn’t worry about these banks’ failing before we confront them. If we could undo monopolies on economic grounds, surely we can undo today’s monstrosities.

Much of the media coverage of the protests at the Bank of America shareholder meeting yesterday was traditional and solid in the who what where when way. But some “reporting” was really a powers-that-be pushback, trying to undermine the protesters. A great example was CNBC’s interview with Occupy Wall Street’s Max Berger.

The opening minute or so fine, with Berger giving lucid, focused answers in response to open ended questions like “What’s your beef with Bank of America?” Shorter Berger: BofA is a bankrupt company that is a danger to the American taxpayer. “So what do want to see as a solution? What do you want to see happen? What are you trying to accomplish today?”  Shorter Berger: we want to break up BofA.

But then, at 1:49 Maria Bartiromo switches into propaganda mode:

“What kind of intelligence, what sort of credibility might you have, or the Occupy groups have, in terms of really knowing and understanding what’s involved in the break up of a bank? Why would what you say matter more, for example, than what the Board says and what management says in terms of understanding the complexities of this company?”

Slanted Versus Challenging Questions

Note, I like challenging questions. Challenging questions are an important part of separating bias from truth. But the credibility question as posed is slanted, not challenging. A straight version of the question would have been:

“The Government has the power to break up BofA if BofA threatens the financial system; the Government got that power in Dodd-Frank. Since the Government’s not liquidating BofA, obviously the Government doesn’t think BofA is a threat. So why should anyone take protesters’ calls to break up BofA seriously?”

There’s two key differences between my version and Bartiromo’s. Mine sets up an objective basis for challenging the protesters’ demand; hers does not. Also, mine doesn’t assume that someone has to know the intricacies of how to break up a bank before having a legitimate opinion about whether the break up should happen; Bartiromo’s does.

On the first point, Bartiromo’s citing BofA’s Board of Directors and management as a more credible source of analysis than the protesters is not the same kind of contrast that I make when I cite the government’s failure to liquidate BofA. BofA managers’ jobs and obscene compensation depend on believing BofA should not be liquidated. Indeed, the Dodd-Frank liquidation authority allows more than firing BofA management; the government can also go after money management has already paid itself. BofA’s pronouncements on the feasibility of breaking up BofA cannot be taken at face value. The government has its own credibility problems regarding the big banks, but at least its job is protecting taxpayers and the public interest; BofA’s management is expected to act in a self-interested way.

The second big difference between my question and Bartiromo’s is that she suggests the protesters need an action plan for liquidating BofA before they can call for its break up. Specifically she asks ‘why should we think you credible in “terms of really knowing and understanding what’s involved in the break up of a bank?”‘ More on that later.

Attacking the Occupy Movement

Berger keeps his cool in the face of Bartiromo’s condescension. He responds first that Occupy has financial industry participants that “know where the bodies are buried, so to speak”, so the protesters do, in fact, know what they’re talking about with some sophistication, but then Berger pivots to the key point:

“But more importantly, we’re all taxpayers, we’re all citizens, we all have a stake in the outcome of what happens with this company and the fact that we still have these too big to fail banks. We can’t continue to let them exist and need to break them up. I think Bank of America is the worst offender in that regard because they are so weak and still depend on so much government support to continue to exist.”

The next credibility attack disguised as a question comes from Bartolomo’s co-anchor Bill Griffeth at 2:45:

“Max, I’m glad you’re here because working here on Wall Street, especially here on the New York Stock Exchange, we see the Occupy folks outside all the time with their various placards and the various protests that they have and whenever I discuss this issue with people [What issue is that? BofA's annual meeting? Breaking up BofA?] the question they always have, and I’m going to pose it to you, is what exactly are you protesting? It seems to be an unfocused anger. For example you have income inequality issues, environmental issues, racial discrimination, foreclosure practices and on and on as it pertains to the banking industry. Do you lack credibility simply because you lack focus with your protest movement?

The credibility attack widens; now it’s not just ‘why should we believe you because you don’t run the bank.’ It’s why should we believe you about breaking up BofA or anything else because you protesters don’t know what you want and can’t be understood.

A straight version of this question could have had the same set up, right up to the start of the credibility question, though even then Berger would be within his rights to point out that media has been pushing the “Occupy demands everything and nothing, they’re just mad” line for a long time now, and to the extent CNBC doesn’t understand Occupy, it’s because CNBC’s not listening, not the movement’s failure to be clear. But Berger didn’t take the bait, and it’s the last sentence that’s the real problem.

A straight question would have logically followed from the premise that people, particularly Wall Street, doesn’t understand the Occupy movement because makes lots of demands and lacks a focused message. For example, Griffeith could have stopped with the first question he asked, instead of just continuing his set up “What exactly are you protesting?” Or he could have asked “Can you be effective if people on Wall Street don’t understand what you want? Instead he said “Do you lack credibility simply because you lack focus with your protest movement?”

Credibility relates to truth telling, not to how many truths are being told. It’s a quality of message issue, not a quantity one. If talking about multiple topics accurately undermines credibility, how should elementary school students believe their teachers?

Berger’s really sharp in response, totally unfazed:

So I think there’s two answers here. First, this is an incredibly focused protest here today. We’re saying break up Bank of America because it’s insolvent and bad for America. So that’s number 1. In terms of Occupy generally I think it’s a very simple answer. We’re here to support equality. And fairness. And that’s something that’s true across all of those issues.

I think what you’ve seen over the past couple years is tremendous anger at essentially two systems. One for folks who have and one for folks who have not. And so what we’re here to say today is we want the same system for everyone. The bankers who broke the law should be treated the same as the rest of us.

Berger could have noted, but didn’t, that the African-American civil rights movement could have been critiqued the same way. Imagine: ‘It seems to be an unfocused anger. For example you have restaurant issues, public transportation issues, voting issues, and on and on as it pertains to race. Do you lack credibility simply because you lack focus with your protest movement?’

The false incoherence line is just as clear this time around. But for the government enabled overwhelming power wielded by one segment of society–the 1%, particularly but not only financial industry leaders–all the social injustices the Occupy movement has identified would not exist. Occupy is about equality and fairness, just like all major protest movements in this nation’s history have been.

More Fake Credibility Attacks

On the heels of Griffeth’s “Occupy has no credibility” push, Bartolomo circles back to her ‘you don’t know enough about BofA to demand it be broken up’ line.

Max, let me ask you this. How would you like to see the bank broken up? Go through the various divisions. How should the bank be broken up?

Really? For Berger to be credible in his demand he has to give Maria Bartiromo an action plan for BofA’s liquidation? The federal government asked BofA and the rest for “living wills” to facilitate their liquidation if needed, precisely because no one on the outside can detail the best action plan without BofA’s sharing the information.

Amazingly, Berger remains professional:

That’s not something that I’m able to talk about in great detail. I think there’s a number of different ways.

Bartiromo cuts him off saying:

“Do you know do you know do you know the divisions of Bank of America? I mean, do you know this company in terms of how it makes its money, commercial banking versus the other divisions? Can you tell us the divisions of the bank? [yes, she said Do you know three times, it was her way of shouting Berger down]

Berger again keeps his cool: I feel a little unprepared to speak about those issues in great detail…

and Bartiromo again jumps in “No problem.” They say thank yous, and it’s a wrap.

Bartiromo’s claim that no one should take protesters’ demands that BofA be broken up seriously unless Max Berger can detail its divisions and a plan to sell them off is obnoxious. To understand just how obnoxious it is, think about a different context in which the details of the issue are complicated and much hidden from view but the basic power and social justice principles are not. Imagine Bartiromo telling Israelis and Palestinians that they can’t have a serious or informed opinion about a two (or one) state solution to their crisis unless they can offer treaty text that both sides will agree to.

And then there’s this. In the little text blurb that accompanies the CNBC clip:

“Occupy Wall Street Organizer on Protesting BofA

WED 09 MAY 12 | 03:47 PM ET

Bank of America is in the news today as an estimated 500 protesters stand outside its shareholders’ meeting. “We’re here to support equality and fairness,” says Occupy Wall Street organizer Max Berger.”

See how CNBC mixed and matched question and answer to try to damage protester credibility? The headline and the first sentence are about the BofA protest. But when they quote Berger, they don’t quote him saying “break up BofA”. They use his quote from the credibility attack on the Occupy movement. As a result, it reads like a nonsequitur and makes Berger sound ineffective. You’re protesting BofA’s shareholder meeting to support equality and fairness? How does that work? Only if someone actually listens to the interview do they understand the protest.

CNBC’s interview, unlike much of the other coverage of yesterday’s protest, had a deliberate disinformation agenda that supports the incredibly unjust status quo. Shame on CNBC, Bartiromo and Griffeths.

Yesterday Bank of America held its annual shareholder meeting in the midst of peaceful protest against its foreclosure, coal and payday lending financing, and worker policies. They call for the break up of the bank. The protests included rallies and three marches, as well as shareholders speaking at the meeting. A few protesters were arrested trying to enter the meeting. Coverage was not clear if those people were shareholders or not; some shareholders were turned away on the grounds that the meeting was full.

Nothing Extraordinary 

Leading up to BofA’s annual meeting, the City Manager of Charlotte used the unlimited discretion the City Council gave him, and declared that this ordinary corporate business was an “Extraordinary Event” warranting draconian, and surely unconstitutional, restrictions on personal liberty. According to the coverage, however, the police didn’t use their new powers, and confined their security measures. Specifically, the arrests were for trespassing, and the police did not use the power to search people allegedly conferred by the Extraordinary Event status.

That’s great, because the search power is breathtakingly broad and trivially easy to abuse. But in a way it’s unfortunate, as the rules escaped challenge. Will the Extraordinary Event of a Charlotte Memorial Day weekend celebration trigger enforcement problems? What about at July 4th? Will anyone sue to enjoin the rules ahead of the upcoming Democratic National Convention, held at “Bank of America” stadium.

Police simply cannot be given a blank check to stop, question, frisk, search and arrest people for the crime of carrying a permanent marker near the convention. Never mind that the person always has a fine point Sharpie in her purse, and didn’t think about it as she headed to the convention; under the new rules she’s a criminal subject to arrest if caught.

Americans cannot be burdened with trying to communicate to cops that they have only peaceful intentions for using innocuous items they carry, like the Snapple (or other glass bottle) they carry in a cooler, or bike helmet in their hands.

As the cops demonstrated in Charlotte and in San Francisco earlier, society need not abandon control of its police, empowering them with limitless discretion, to handle political protest. Charlotte must repeal its Extraordinary Event rules, or someone needs to sue to enjoin their enforcement. The fact that the police did not use, much less abuse, their alleged Extraordinary powers this time is not a guaranty for next time. These incredibly invasive, anti-liberty, anti-American rules need to be repudiated by our nation.

For FireDogLake 

To protect Bank of America from inconvenience, Charlotte, North Carolina has directed its police officers to harass and arrest protesters. Unconstitutionally, in my opinion.

Charlotte Sides With Bank of America Over People

Charlotte has imposed special rules on a 2 block by 2 block square for 12 hours on Wednesday (May 9) to protect the Bank of America annual shareholder meeting from disruption by protesters. The rules apply to any “Extraordinary Event”, and were adopted nominally for the coming Democratic National Convention and city celebrations such as July 4.  While the rules are poorly drafted and I believe facially unconstitutional regardless, imposing them for the BofA meeting seems overwhelmingly so. Extra restrictions for the July 4th celebration in the name of public safety is one thing; it’s an outdoor, public event hosted by the city for the benefit of its citizenry. The Democratic Convention is similarly easy to rationalize, given that the President and other national security targets will be there. But Bank of America’s shareholder meeting?

This annual corporate event is private, indoors, and part of ordinary corporate business. Worse, law enforcement’s targets aren’t potential Presidential assassins or hooligans with a stash of illegal fireworks; they’re peaceful political protesters. Heck, the protesters will include dissident shareholders and their proxies who have every right to be at the meeting. Besides, BofA will have home field advantage: the meeting’s at its corporate headquarters.

The recent experience of shareholder protests at Wells Fargo shows Bank of America executives, employees and shareholders are not in danger of anything except inconvenience. Nor did San Francisco police need special powers to handle the situation outside, while Wells handily managed the situation indoors–CEO John Stumpf’s pay package was approved in record time. Why is Charlotte helping BofA?

Unfettered Police Discretion to Target “Undesirables”

The establishment has always tried to silence dissent and enforce the social order by policing protesters as “disorderly” undesirables. During African-Americans’ civil rights struggles, Southern cops would arrest protesters using statutes that essentially let them pick their targets at will. The Supreme Court responded by saying unfettered police discretion is unconstitutional.

Unfortunately, in the ensuing decades, the Supreme Court’s doctrine around political speech has degraded into a blunt weapon for enforcing the social justice status-quo, empowering the establishment to marginalize dissenting voices and magnify corporate speech. For example, protesters get penned into irrelevant, out of the way “Free Speech Zones” and corporations get unlimited freedom to spend money to elect their favorite “representatives.” (One of the banks’ more effective purchases has been Congressman Spencer Bauchus (R-AL), who chairs the House Financial Services Committee and who has publicly said that Washington exists to serve the banks.) In a way, the city’s imposition of the new rules for BofA’s benefit is just a step further down the line toward corporations directly deploying state power against citizens. After all, it is an act of deploying state power against citizens for corporate benefit.

How? Well, the rules render anyone near the Bank of America shareholder meeting criminally suspect for normal, harmless activities. As a result the new rules appear to give the police unlimited discretion to stop, frisk, arrest and search people–harass people–for nothing more than officers’ preconceived biases. Profiling. Normally “profiling” means “racial profiling”, which is unconstitutionally stopping, frisking and/or searching someone because he’s black, since being black is inherently suspicious to many cops. Since race isn’t a proxy for protester status, what the new rules do is encourage “First Amendment Profiling”–targeting people for looking like protesters.

Rule Specifics

(As I detail what’s wrong with the rules, you can read along. The rules are codified in the City’s code at Chapter 15, Article XIV, Section 15-310 and seq. This link is easier to use, however.)

For example, a person can be arrested for walking his dog near in the prohibited zone. Although this Charlotte blog claims residents needn’t worry, here’s the rule:

“During the period of time and within the boundaries of an extraordinary event, it shall be unlawful for any person, other than governmental employees in the performance of their duties, to willfully or intentionally possess, carry, control or have immediate access to any of the following:

…(17) An animal unless specifically allowed under the terms of a [parade permit] or is a service animal used to assist a person with a disability.”

Maybe the blog is confident the police will “know” who they’re supposed to target, and that residents will be able to walk around unmolested. But that’s the kind of unlimited police discretion that’s unconstitutional.

Dog walking isn’t the only innocent activity rendered suspect.

People also can’t possess or have accessible “(5) A backpack, duffle bag, satchel, cooler or other item…” if they have “the intent to conceal weapons or other prohibited items”. Well, unless one’s bag is transparent and nearly empty, a person using it plausibly has the intent to “conceal” whatever is inside. So how well that intent requirement limits police discretion to arrest you for having a bag hinges on what’s prohibited. Too bad the prohibited items include permanent markers (list of banned items at (4).)

Permanent markers are so ordinary (see this Google shopping list) and so small that a cop might reasonably believe that anyone with a purse, briefcase or backpack is carrying a concealed permanent marker. That means anyone carrying any kind of bag or container is suspect. Where is the limit on police discretion?

Specifically, what guides the cop in deciding whether to ask a purse-carrying woman for permission to search her purse? If she says no, what stops him from arresting her? When the wrongdoing is possessing a Sharpie, what facts could rise to enough suspicion that he doesn’t need to ask to search? Is it enough that she’s dressed like an office worker?

Also banned are Snapple bottles possessed with bad intent. Specifically, “(6) A glass or breakable container capable of being filled with a flammable or dangerous substance carried with the intent to inflict serious injury to a person or damage to property.” Will a cop think “sure, he’s just drinking the Snapple now, but he’s a protester, young, dressed in black with a pierced nose; looks angry. Maybe he’ll use the empty to make a Molotov cocktail. Better arrest him”?

Bike helmets are prohibited too, if “(10)…carried or worn with the intent to delay, obstruct or resist the lawful orders of a law enforcement officer”. What does carrying a bike helmet with “the intent to delay…the lawful orders of a law enforcement officer” mean? (“Delay” must be different from “obstruct” or “resist” since all three are prohibited.) Perhaps it targets a woman who inexplicably plans on shoving a bike helmet onto a cop’s face, catcher’s mask style, as soon as he starts to speak. Maybe it means she intends to keep dropping it and picking it up as to try and slow walk the arrest process. How do you use a bike helmet to delay (but not obstruct or resist) the lawful orders of a law enforcement officer?

How should a bicyclist carry a bike helmet so she can convey only lawful intent? By studiously avoiding looking at the cop? By clutching it extra tightly? Couldn’t both of those be suspicious too?

To fully explore the rules’ absurdity, read them at the links above. The bottom line is this: for twelve hours, within a two block buffer zone around BofA headquarters, the City of Charlotte, North Carolina has told its police that any person carrying a purse, backpack, cooler, briefcase, bike helmet, Sharpie, and much else is suspect. If the suspects look like protesters, then Charlotte wants the cops to stop, question, perhaps frisk, perhaps search, and perhaps arrest them.

These Rules Can’t Be Constitutional

I’m not reading between the lines; the city’s explicit about targeting protesters. Speaking with station WCNC, the city reassured residents that while they might be stopped and questioned, only protesters would be targeted for punishment:

CMPD Deputy Chief Harold Medlock said the main benefit to the designation is that it allows police officers to “interact” more with people.

For example, if a person or group of people walks down the street with [prohibited items], an officer can’t normally do much about it, Medlock said.

But with the extraordinary events designation, “It gives us the ability to come up and say, ‘Hey, where are you going with this?’” Medlock said. “If they tell us they’re going to the protest, we’ll tell them ‘No, you’re not.’” (bold mine)

Note: I took out the word “crowbars” and put “[prohibited items]” in, because “crowbars” is misleading. The power exists, and can be used, for far more innocuous items. Deputy Chief Medlock uses “crowbars” to reassure people that the police are limited in sensible ways, when they’re not. For more on how the rules are aimed at protesters, see this Charlotte Observer article. Even the “residents can walk their dogs without fear” blog was clear on the point.

While I think the new rules are unconstitutionally vague on their face, how could they be constitutional as applied to defend BofA against protesters? Perhaps in the July 4th context Charlotte can claim the rules regulate conduct, not speech, but the fact that on Wednesday cops will targeting protesters as protesters makes it seem the rules are aimed at speech. Worse; they’re aimed at certain speakers.

If the rules are read as speech regulations, they seem even more clearly unconstitutional. The protesters are all anti-BofA, so isn’t enforcement content-based? Since disorderly conduct, trespass and other statutes could enable arrests for truly problematic protester conduct, how are the new rules “narrowly-tailored”? And what’s the compelling state interest being furthered? We haven’t yet reached the level of corporatism where preventing inconvenience to BofA can be called a compelling state interest.

We haven’t yet.

My latest for FireDogLake

Regardless of the recent bullish stories on the housing market (examples here, here, here and here), housing market fundamentals are lousy. Demand in the last decade was wildly distorted by banker abandonment of underwriting and appraisals. Now bankers are worsening the crash they created. As a result, prices will just keep falling, and foreclosures cannot lead to clearing the market (regardless of what some say). Foreclosures can only make the problems worse.

Market Distortion From Excess Demand in Bubble Years

As a first step to seeing the problems, let’s get real about how profoundly market-distorting that lender-inflated bubble was. People who could not afford to buy homes, period, were nonetheless given loans, artificially expanding the number of people expressing demand. In addition, people who could have afforded a house, if not the house they purchased, expressed their natural demand in the ‘wrong’ segment of the market. Both distortions combined to spike prices far higher than natural demand would have driven them.

To see the price spike, consider the median and average home prices, nationally, in 1976, 1986, 1996, and 2006, using August values in each year, in constant 2006 dollars:

1976 Median: $156,603 Average: $171,838
1986 Median: $168,306 Average: $208,221
1996 Median: $176,031 Average: $205,198
2006 Median: $243,900 Average: $317,300

That is, across twenty years the median home price increased by about $20,000 and the average by about $35,000. In the next decade–the bubble decade–the median and average prices each grew about three times faster. That’s more froth than Starbucks puts on its biggest latte. And it’s a strong signal of just how far prices have to fall to get to where natural demand would have pushed them.

Excess Supply

But the price peak isn’t the full measure of how far prices need to fall, because supply didn’t remain constant. The price spike drove home builders to add supply beyond what they would have to meet natural demand. This chart from the National Association of Home Builders shows that from 1978-1997 sales of new homes oscillated between approximately 0.4 to 0.8 million homes a year. For twenty years, demand pressure was never great enough to sell more than that in a year. From 1997 through 2007, however, sales went from about 0.8 million to nearly 1.3 million a year and back down to about 0.8 million. That’s 11 years of sales volume that dwarfed the preceding 20.

We’re seeing that part of the market correct, because in 2010 and 2011 more like 0.3 million new houses sold, and that’s roughly the pace this year. But it’s not obvious that three years of below normal sales is enough to balance out that decade of excess. Moreover, all those extra new houses are only one part–a relatively small part–of our current supply excess. Foreclosures have brought far more homes to market, and worse, have far more yet to come, than that new home bulge.

More Foreclosures (Supply) to Come

RealtyTrac data shows foreclosures are increasing again, after slowing down last year. In New York it looks like 100,000 new ones may be coming, based on notices sent in the first quarter of 2012 alone. They’re also on the rise in Pasco County, Florida. But you needn’t look at these stats to understand we’re nowhere near out of the foreclosure crisis yet.

According to the Federal Reserve, about 12 million people owe more than their homes are worth, and CoreLogic reports that falling prices mean their ranks include even new buyers. Being underwater is a strong predictor of default and foreclosure because when life happens (job loss, divorce, illness), the homeowner can’t sell to get out from under the suddenly unaffordable mortgage. In addition, some people will strategically default, like the very wealthy who don’t care about their credit, and people who can otherwise make it work for them.

And then there’s the millions trying to get their loans modified. Banks are forcing far too many of those people into foreclosure even when modification is in everyone’s financial interest. One of many ways the banks turn potential modifications into foreclosures is by wildly overvaluing the home, which skews the critical “net present value” calculation.

Banks Are Manipulating Inventory

Given the grim reality of too many houses at crazy high prices, how come we’re seeing a spate of good housing news stories? Well, those stories reported supply had shrunk so much, prices were rising. One of the most comprehensive was by Nick Tiramos for the Wall Street Journal, detailing that shrunken inventory was leading to some bidding wars in several markets. Local pieces, this Arizona Republic story, continued the theme. Both articles noted that the bidding wars didn’t mean prices had recovered much compared to the bubble years. Nonetheless, if the decreased inventory is for real, the optimism’s justified, right?

Too bad the inventory decrease seems artificial, the result of bank manipulation. Take Phoenix: RealtyTrac identifies 6,611 “bank-owned” properties there. An Arizona realty website lists only 275 for sale. Similarly, Yahoo real estate claims there’s over 8,000 foreclosure properties in Phoenix, but Realtor.com lists less than 4,000 homes of any type.  AZHomeonline.net lists a bit over 4,000, plus 312 foreclosures and shortsales. So are the foreclosures in Phoenix on the order of 300 or 6,600? Makes a wee bit of difference when the non-”distressed” market is about 4,000, don’t you think?

(To Tiramos’s credit, his piece acknowledges the good news may not last because of the bank owned backlog; the more cheerleading articles don’t.)

Phoenix isn’t the only place where banks are holding properties off the market. In Portland, Oregon, banks aren’t selling 80% of the homes they own, The Oregonian reports. All the bank owned inventory statewide represents more than a year and half’s supply of houses all by itself, according to a RealtyTrac executive quoted in the piece. If the housing inventory is that distorted in Oregon, what’s it like in the hardest hit states?

By holding off inventory, the banks provide temporary support to prices, but for how long? The inventory will make its way to market–there’s just too many houses held in reserve for the banks to manage and maintain the properties in a market-price optimizing way. Moreover, this artificial control of inventory means foreclosures do not help a market to bottom; foreclosing cannot “clear” the market.

Where Will Future Demand Come From?

The last aspect of our housing market’s broken fundamentals is on the demand side. Specifically, who can buy a house now?

Not many young college graduates and their young families, normally the quintessential first time buyers. By 2008, over 200,000 young people had over $40,000 in student debt each, and given the explosive growth in debt, many more have that much now. In fact, the 1,781,000 students in the class of 2012 average over $25,000 each. Nope, young people won’t be buying homes for a decade or two. Millions of underwater homeowners can neither trade up nor down. Foreclosed former homeowners don’t have the credit or the cash to re-enter the housing market.

In short, current and future demand for housing is likely to be substantially less than historically normal demand, even as prices keep falling and interest rates hover at historic lows. And that’s still true even if the job market comes back, not that there’s any sign of that.

The banks could substantially boost demand by writing all the underwater mortgages down to market value. People would be able to sell, and buy, and millions of foreclosures would be averted. But the chance the banks will take such drastic action is nil. Not essentially nil, like Powerball odds, but nil.

And nil is also the chance that housing is headed toward a broad based recovery, even if some local markets, unhampered by massive bank-owned inventory and large numbers of underwater homes, show sustained improvement.

Continuing as one of @ddayen’s subs, this post ran earlier today on FireDogLake

Let’s get something straight: we did not have a housing “bubble”, in the usual sense of the word. The mainstream narrative of crazed, greedy, irresponsible homeowner-wannabes driving prices unsustainably high, causing the still ongoing crash is wrong. Yes, we had a housing “bubble” in one sense; prices soared way beyond reality because excess demand fueled irrational bidding wars. The lie deals with why we had a housing bubble. The lie matters because like all problem-defining narratives, it shapes the policy solutions offered. So let’s take a look at the lie.

Consumer Driven Bubbles

The classic example of a demand-driven bubble is Holland’s tulip craze in the 1600s. A much more recent version was the DotCom fever a couple of decades ago. And at the risk of dating myself, the most vivid consumer-good craze of my youth was “Cabbage Patch Dolls” (not that I had one; I wasn’t into dolls.) How did these bubbles happen? Simple. Irrational economic actors, that is, normal people acting as consumers, got a kind of mob/herd madness/fever and outbid each other endlessly, until suddenly reality intruded and they stopped.

But here’s the thing: Houses are not like tulips, shares of stock, dolls, or any other mass-market consumer product. They just cost too much. The only people who can buy a house simply because they want to are cash buyers. No one will argue that cash buyers drove the housing bubble of 2005 onward (or whatever year you want to peg its start.) Cash buyers don’t fuel a foreclosure crisis either, though banks have been known to foreclose on cash buyers anyway.

We didn’t have a housing bubble in the ordinary sense because consumers don’t buy houses; banks buy houses. The housing market cannot undergo a demand-driven bubble without lender collusion and complicity.

No Bubble Without Bankers Blowing It

Home buyers who don’t have enough cash have to get a bank’s permission to buy. The dollars involved are big enough that banks historically did not hesitate to say “No, sorry, I know you want that house, but the house just isn’t worth that much, and besides, even if it were, you’re kidding yourself when you think you can repay the loan you want. No dice. Go find something more reasonable and we can talk again.”

In normal times, meaning, when bankers care if the loan will be repaid, bankers have two basic tools to protect their interests: appraisals and underwriting. Both get used conservatively, because if an appraisal is too high, the collateral isn’t worth the loan the banker’s making, sharply increasing his risks. If an appraisal’s too low, well, the deal might not get done, but from the banker’s perspective, better no deal than a loser. Ditto with underwriting. If the standards are very loose, the loans will default and foreclosures follow; if the standards are very tight, well, that shrinks the market and keeps prices down, but again, the bankers are happy: they’re getting paid back consistently. Bottom line: across most of the housing market’s history, bankers’ self-interest foreclosed any possibility of a housing bubble.

Obviously, the fact that the entire nation underwent a housing bubble shows the last decade or so means something changed. Given the market dynamics, only one thing can have changed: lenders’ incentives. People didn’t suddenly become nuts about housing; Americans have been so nuts about housing for so long the “American Dream” shifted from my immigrant grandparents’ dream of “equal opportunity to get ahead, hard work and talent is all it takes” to the “dream of home ownership.”

Or to put it another way: what evidence is there that circa 2005 wannabe homebuyers became so sophisticated–nationwide, simultaneously–that they could con bankers who cared about ensuring loans made against sufficient collateral would be repaid into making huge numbers of loans that couldn’t be, against collateral that today’s market exposes was worth nowhere near the amounts claimed? Did some evil villain put something in the public water supply that somehow made wannabe homebuyers into talented con men and bankers gullible rubes?

Of course we got a housing bubble because lender behavior changed, not because consumer behavior did. And we can see it clearly by looking at what happened to underwriting and appraisals.

Fraudulent Underwriting

“Stated income loans,” which have become derisively known as “Liar’s loans,” actually have a longstanding and legitimate place serving a very specific, narrow slice of the housing market. Well, longstanding, yes, legitimate, sort of. For years these loans were made to high income self-employed people whose various tax-avoidance strategies didn’t reveal to the IRS all the income they could use to pay a mortgage loan back. So rather than document income with tax returns, these buyers would be allowed to “state” their income to the banks’ underwriters. I made the snide comment about these loans being sort of legitimate because I don’t consider dodging taxes legitimate, even when legal, but from an underwriting perspective they made sense. The stated income was more accurate than the tax returns. One way to see how lenders abandoned underwriting is to see the huge expansion of stated income loans, transforming them into liar’s loans.

To get a flavor of how the volume of liar’s loans exploded during the bubble, see this column by Joe Nocera of the New York Times. A couple of key excerpts:

“…stated-income loans became a means for both borrowers and lenders to commit fraud….Real estate speculators used stated-income loans to buy properties that would otherwise have been out of reach, hoping to flip them quickly, before their lack of income caught up with them. Far more frequently, however, mortgage originators used stated-income loans to put people into homes that were far beyond their means, knowing full well that the chance of the borrower ever paying back the loan was practically nil.”

and from a lawsuit against Countrywide Nocera quotes:

“By about 2006, Countrywide’s internal risk assessors knew that in a substantial number of its stated-income loans — fully a third — borrowers overstated income by more than 50 percent….Countrywide deliberately disregarded these and other signs of fraud in order to increase its market share.”

Lenders did two other things that made all the eventual varieties of liar’s loans (stated income; stated income stated assets; stated income, stated assets, stated job) so fraudulent: they automated underwriting, and they incentivized closing loans. Automated underwriting meant loan officers could game the system, as this one from Chase urged an investment home buyer to do, leading to the classic ‘garbage in, garbage out’ problem. Basing loan officers’ pay on funding loans meant that they would in fact game the system.

Fraudulent Appraisals

Liar’s loans aren’t the only way underwriting disappeared in the bubble years, but they illustrate the point. The other key change was what happened to appraisals. A couple months ago Reuters reported on a Countrywide whistleblower exposing appraisal fraud there. Consider this petition from 2005, which 11,000 appraisers signed with their names and addresses:

We, the undersigned, represent a large number of licensed and certified real estate appraisers in the United States, who seek [government regulators'] in solving a problem facing us on a daily basis. Lenders (meaning any and all of the following: banks, savings and loans, mortgage brokers, credit unions and loan officers in general; not to mention real estate agents) have individuals within their ranks, who, as a normal course of business, apply pressure on appraisers to hit or exceed a predetermined value.

This pressure comes in many forms and includes the following:

• the withholding of business if we refuse to inflate values,
  the withholding of business if we refuse to guarantee a predetermined value,
  the withholding of business if we refuse to ignore deficiencies in the property,
  refusing to pay for an appraisal that does not give them what they want,
  black listing honest appraisers in order to use “rubber stamp” appraisers, etc.

We request that action be taken to hold the lenders responsible for this type of violation and provide for a penalty on any person or business who engages in the practice of pressuring appraisers to do dishonest appraisals that do not provide for independent judgment. We believe that this practice has adverse effects on our local and national economies and that the potential for great financial loss exists. We also believe that many individuals have been adversely affected by the purchase of homes which have been over-valued.

(As of March 2005, when the think tank Demos published a report on appraisal fraud, the above petition had 8,000 signatures; the petition was closed after the 11,000 was reached.) In 2006, the Wall Street Journal reported on appraisal fraud, including a survey of appraisers from 2003 found many faced pressures to inflate values. The author of the Demos report noted nearly a year ago that the narrative is shifting to make banks the victims rather than the organizers of appraisal fraud. (Of course, builders struggling to sell homes complain that today’s appraisals are too low.)

So there you have it: American underwent a massive wealth destroying housing bubble not because crazed consumers got out of hand, as they have in every other bubble in history. No. We got a housing bubble because the lenders’ historical incentives to regulate consumer demand, ensuring accurate property valuations and real ability to repay, evaporated.

Why did lenders’ incentives change? That’s a long story for another day, but it boils down to this: lenders no longer faced consequences if the loans weren’t repaid. They’d offloaded that risk to securities investors.

As long as people continue to believe that crazed consumers created a housing bubble, the kinds of policies needed to end the appraisal, underwriting and securities fraud that really did create the bubble have no chance of succeeding. So make sure your friends understand the housing bubble lie.