Saturday, 19 July 2008
IT's the stuff of every banking regulator's nightmare: angry mobs outside a bank demanding their money. It became reality on Monday this week as customers queued outside the failed IndyMac Bank in California, after the Federal Deposit Insurance Corporation took over its operations and reopened for business. At one branch in the San Fernando Valley, police were called as the long lines of people waiting to reclaim their deposits became impatient.
Last Friday's collapse was the third biggest in US history, but certainly not the first in recent times. Why then, was there such panic in the air?
On the other side of the country in Washington, the banking regulators were busy going public on their latest rescue plan for the US banking system, but it was not IndyMac they were worrying about.
Last Saturday the US Treasury and the Federal Reserve held urgent talks to stabilise Freddie Mac and Fannie Mae, the two biggest players in the secondary mortgage market. Compared with IndyMac, which is an ordinary retail bank, Freddie and Fannie's problems were of an entirely different order.
That's because they are the grease in the US mortgage market. Set up during the Great Depression to try to make housing more affordable, they hold or guarantee 50 per cent of the $US12 trillion ($12.36 trillion) in mortgages in the US. Their business is to buy mortgages from the retail banks and mortgage brokers who write the loans, package them up into securities and sell them to investment banks and investors from Wall Street to Sydney. This frees up the brokers and banks to lend more money.
For this service, Fannie and Freddie earn fees. But their big advantage is that, although they are now listed companies, they were originally set up by the government and still have an implicit government guarantee, enabling them to borrow money more cheaply.
In short, they make the US mortgage market go round.
But with the subprime crisis still unfolding and foreclosures now likely to claim more than a million homes this year, shareholders in the two companies had become extremely nervous about their potential exposure. Shares fell sharply, raising questions about the companies' capitalisation and their ability to get away a bond issue, scheduled for early this week.
It was all hands to the pump. The Treasury Secretary, Hank Paulson, the Federal Reserve chairman, Ben Bernanke, and even President George Bush went public to sell the rescue package to the markets and to Congress.
Fannie Mae and Freddie Mac "represent the only functioning secondary mortgage market," Paulson told the Senate banking committee on Tuesday.
"Our plan is aimed at supporting the stability of financial markets, not just these two companies."
Bernanke said the two companies were in "no danger of failing". Actual credit-related losses at Fannie and Freddie have been relatively small. In the first quarter Fannie Mae reported $US3.2 billion of credit-related expenses, mostly provisions for expected losses on mortgage defaults. That is a fraction of the $US3 trillion of mortgages Fannie owns or guarantees.
The issue, Bernanke stressed, was about their share price, and whether they faced future problems in raising capital. If they were unable to raise capital, the mortgage market could grind to a halt, because the securitisation process packaging loans and then selling them to investors so they can write more loans would falter.
Put like that, a rescue seems logical. But the dramatic intervention - following the rescue buyout of Bear Stearns engineered by the Federal Reserve in March and emergency lines of credit put in place for other major investment banks in May - has again raised questions.
How is it that the regulators did not see this coming? Has deregulation failed the American public? Why are US taxpayers being asked to bail out the top end of town when thousands of people are losing their houses every day? And lastly, the big question: where the hell is the US economy headed?
There is already a big rethink under way about the cost of deregulation. So far, efforts have focused on the regulation of mortgage practices at one end (fraud on the part of mortgage brokers appears to have been widespread) and new rules to try to prevent the rampant short-selling of shares at the other.
Treasury has produced a discussion paper on streamlining the multiplicity of regulators for its financial sector, but for the time being the preference has been for greater oversight in the crisis rather than regulation.
That might be about to change.
William Galston, a senior fellow at the think tank Brookings Institution, says the US is at a hinge point.
"The strong presumption in favour of markets, which has dominated public policy since the late 1970s, has been thrown very much into question," he said.
For example, the US has been happy to have insurance for banks that go under - with account holders getting up to $US100,000 back on their deposits - rather than taking the Australian approach of setting prudential limits on banks and in return providing a government guarantee on their deposits. A few bank failures, plus a consumer backlash about lost funds over and above $US100,000, is likely to cause a rethink.
The head of the House of Representatives' banking and finance committee, Barney Frank, says its already under way.
"Ben Bernanke is reversing a policy of Alan Greenspan," he said this week. "Greenspan had the authority under a congressional statute from 1994 to take action to ban irresponsible subprime mortgages. He refused to do it because of his anti-regulatory theory. Bernanke is promulgating those as we sit here, so that, going forward, you are going to see some of the subprime mortgages, many of them that got us into trouble, banned."
Then there is the question of who, morally, should bear the cost of failure.
Paulson's actions in propping up Fannie and Freddie, the big daddies of the mortgage market, with promises that American taxpayers will buy their shares and lend them money if needed, has again raised questions about the principle of moral hazard - and even allegations of helping mates.
Paulson was head of the investment bank Goldman Sachs before he became Treasury Secretary. The former chairman of Fannie Mae, Jim Johnson, was head of Goldman Sach's remuneration committee, where he helped set Paulson's healthy salary.
But the bigger question is: if the Government and taxpayers bail out market players, how do they learn the lessons of mistakes?
President Bush's former economic director Lawrence Lindsey, now a financial consultant, was so incensed by Paulson's intervention that he wrote to clients saying: "Surely things are somewhat amiss when a country's finance minister plays bond salesman for a supposedly privately owned company."
As for where it is all going, the big problem facing US regulators is that no one can really anticipate where the next problem will emerge in their deregulated and complex financial system, only to ripple through the sharemarket, credit markets, manufacturing sector and then into the global market.
And that makes people jump at almost any rumour.
Even big banks like the Bank of America are being wildly marked up and down. Its share price has gyrated 40 per cent over two days.
Bernanke insisted this week that the US banking system was "well capitalised", although he added that he was watching the situation closely. He said he was more concerned about the banks' ability to extend the credit the economy needed to keep growing.
Commentators believe a few smaller banks will go under but do not think there will be a wholesale collapse in the sector, as occurred in 1929. Bush, who rarely does press conferences these days, appeared in the Rose Garden at the White House to repeat the message that the banking sector was sound.
But taking a step back, it is pretty clear the worst is not yet over.
Most analysts agree that the subprime crisis has a way to run. The number of mortgages in default at the end of June was 631,000, up from 313,000 a year ago. But the really scary number is that about 1.5 million subprime loans are still scheduled to "reset" this year. That is when the interest rate jumps 3 to 4 per cent and home owners find their repayments increase by 30 to 40 per cent.
Lawrence Summers, a Treasury secretary in the Clinton administration, has predicted there will be more than 2 million foreclosures over the next two years and that as many as 15 million home owners will owe more than their houses are worth.
That has enormous implications both socially and economically.
The big waves of foreclosures are still driving down house prices as banks, worried about the backlog of stock, slash prices to get sales away. That then helps drive down the price of neighbouring houses. As of March, the S&P/Case-Shiller national home-price index had fallen about 16 per cent from its peak in the second quarter of 2006, but this average masks the severity of the downturn in some markets.
Prices in California were down about 29 per cent over the same period, and there are dozens of anecdotal stories about four-bedroom houses bought for $US1.5 million in 2006 in places like Scottsdale, Arizona, now selling for $US855,000.
"House-price declines are at the root of all our economic and financial problems," says Mark Zandi, chief economist at Moody's Economy.com and author of Financial Shock, a new book about the collapse of the subprime mortgage market.
"Investors can't tell where the bottom is or how far mortgage-related assets have to be written down. That's shaking even blue-chip institutions like Fannie and Freddie."
There are other storm clouds on the horizon for the US economy as well.
The credit drought is starting to hit small business, freezing expansion. Consumer spending is slowing. Despite $US152 billion being pumped into the economy by way of a stimulus package last month, consumers have cut their spending, especially on expensive items like cars and furniture.
Bernanke said this week it was not as bad as it could be, and that retail spending and rising exports were keeping the economy moving at "a sluggish pace".
But not fast enough for some companies. General Motors announced this week that it would cut 20 per cent from its costs, and analysts say as many as 6000 US jobs could go.
Unemployment has risen from 4.6 per cent a year ago to 5.5 per cent last month, and will only exacerbate the housing market problems at the heart of America's economic woes.
As the week came to an end, economists around the world were left pondering how the next chapter in the wild ride in the US financial system might play out.
A fall in oil prices this week caused a rally in global sharemarkets and brought a few smiles to traders' faces.
But oil and food prices remain high, fuelling inflationary pressures around the world as well as in the US.
In further evidence that energy prices are hurting the US economy, consumer prices rose 1.1 per cent last month, the biggest rise since 1982, taking the annualised rate to 5.5 per cent.
That presents the Federal Reserve with a dilemma: to focus on the threat of inflation and increase rates, or keep them low to keep the economy moving.
In past eras bad lending practices by mortgage brokers in the suburbs of California or Florida might have felt like a domestic issue. Now we are learning that bad loans in Florida have ramifications in China, Europe and Australia.
We are learning that a policy to help Iowa corn farmers turn corn into ethanol will have implications for a poor village in Mexico or Africa, and that blind faith in markets can send the entire world into financial chaos.
That is why, over coming weeks, every sneeze in the US markets will be monitored worldwide. Perhaps the US regulators can steer the global economy away from the reefs that lurk beneath the surface in coming months. But no one, not even Bernanke, is entirely sure.
News and politics
"I challenge our nation to commit to producing 100 percent of our electricity from renewable energy and truly clean carbon-free sources within 10 years," Gore told thousands of people who packed into a conference hall near the White House to hear the 2007 Nobel Peace Prize winner speak.
"When president John F. Kennedy challenged our nation to land a man on the moon and bring him back safely in 10 years, many people doubted we could accomplish that goal," Gore said.
"But eight years and two months later, Neil Armstrong and Buzz Aldrin walked on the surface of the moon," Gore told the crowd, eliciting a huge cheer.
Just as Kennedy, in 1961, urged Americans to "take a clearly leading role in space achievement, which in many ways may hold the key to our future on earth", Gore said the shift to new energy sources was needed to ensure "the survival of the United States of America as we know it."
"Even more, the future of human civilization is at risk," he told the crowd.
Nay-sayers would say the shift to renewable energy could not be achieved, or that 10 years was not enough time to make the transition.
But Gore dismissed them as having "a vested interest in perpetuating the current system no matter how high a price the rest of us will have to pay," and again citing the history-making speech in which Kennedy called on Americans to enter the space race and put a man on the moon.
"Once again, we have an opportunity to take a giant leap for humankind," Gore said, echoing the words spoken by Armstrong when he became the first man to set foot on the moon on July 20, 1969.
The chief obstacle to achieving 100 percent renewable energy in 10 years was a dysfunctional US political system that panders to special interests, said Gore, who served as vice president for two terms in the 1990s under Democratic president Bill Clinton.
"In recent years, our politics has tended toward incremental proposals made up of small policies designed to avoid offending special interests ..." Gore told the rally organized by environmental activist group wecansolveit.org.
Scientists and researchers applauded Gore's leadership and urged Americans to heed his call to rapidly move over to renewable energy sources.
"Responding to climate change requires the full engagement of national, state and local public officials, business executives, religious and community leaders, and every citizen," said Alden Hayden of the Union of Concerned Scientists.
"By uniting in this common purpose and mobilizing America's ingenuity and can-do spirit, we can rise to this challenge. We can revitalize our economy, increase our energy security, and do our part to cut global warming pollution, all at the same time," he said.
Going over to renewable energy would "cure our carbon addiction and stimulate the economy. It would be the turning point that is needed to lead the world to a stable climate," said James Hansen, director of the NASA Goddard Institute for Space Studies.
And Jonathan Lash, head of the environmental think-tank, the World Resources Institute, said: "America has led every major technological shift in the last 100 years, and we can lead the next one as well.
"The problem is not technology, it is political will," he said.
Gore, who narrowly lost the 2000 presidential election to President George W. Bush, was awarded the 2007 Nobel Peace Prize jointly with the Intergovernmental Panel on Climate Change (IPCC), a UN body of 3,000 scientists, for work on global warming.
To a rousing cheer and standing ovation, Gore, who jokingly calls himself the man who used to be the next president of the United States, called on Americans to take concrete steps to halt climate change.
Americans need to change "not just light bulbs, but laws," he said.
News and politics
Danny Schechter, executive editor of MediaChannel.org. He is a documentary filmmaker and author. His latest film is titled In Debt We Trust. He is author of the forthcoming book Plunder: Investigating Our Economic Calamity and the Sub Crime Scandal.
Max Fraad Wolff, economist and writer. He is an instructor at the Graduate Program in International Affairs, New School University. He is a frequent contributor to Huffington Post, Asia Times and The Independent.
JUAN GONZALEZ: It has been a tough seven days for the US economy. On Friday, the FDIC seized control of the failed California-based IndyMac Bank. It was second largest bank failure in US history. Analysts project another 150 banks could collapse. On Sunday, Treasury Secretary Henry Paulson announced extraordinary moves to bail out the mortgage giants Freddie Mac and Fannie Mae, which hold nearly half of the nation’s mortgages. On Monday, stock in General Motors fell to a fifty-four-year low. And on Tuesday, the Dow Jones Industrial Average dipped below 11,000 for the first time since 2006, and the dollar hit a record low against the euro. And yesterday, it was announced that inflation is now rising at its fastest pace in twenty-six years. It was also revealed the FBI is investigating nearly two dozen banks, including IndyMac, for mortgage fraud.
AMY GOODMAN: Economist and investor George Soros warned Monday the current financial market turmoil represents the most serious financial crisis of our lifetime. Meanwhile, President Bush has attempted to put a positive spin on the state of the economy.
PRESIDENT GEORGE W. BUSH: I think the system basically is sound. I truly do. And I understand there’s a lot of nervousness, and—but the economy is growing. Productivity is high. Trade’s up. People are working. It’s not as good as we’d like, but—and to the extent that we find weakness, we’ll move. It’s one thing about this administration: we’re not afraid of making tough decisions.
AMY GOODMAN: To talk more about the economy, we’re joined by two guests. Danny Schechter is executive editor of MediaChannel.org. He’s a documentary filmmaker and author. His latest film is called In Debt We Trust. He’s author of the forthcoming book Plunder: Investigating Our Economic Calamity and the Sub Crime Scandal. Max Fraad Wolff is economist and writer. He’s an instructor at the Graduate Program in International Affairs, New School University. He’s a frequent contributor to The Huffington Post, to the Asia Times and The Indypendent.
And we welcome you both to Democracy Now!
MAX FRAAD WOLFF: Thank you very much.
AMY GOODMAN: What’s happening in the economy? Danny Schechter, let’s begin with you.
DANNY SCHECHTER: Well, when I came on your show when the first subprime crisis manifested itself in August 2007, you know, I said I think we’re going to be in for much worse. I was right on that, unfortunately. I said that this is not just a market correction, but a criminal matter, and I called subprime “subcrime.” The FBI seems to agree with me now, and they have 1,200 investigations underway, including an investigation into Bear Stearns and to what happened there, IndyMac, and other banks. So, I think when the dust shifts, you know, finally, we’re going to find out that this is a criminal action—cabal, really—by people in the market who were out, driven by greed, to make as much money as they can. The victims of all this can be seen in the mounting foreclosures that are sweeping the nation.
Yesterday, the Associated Press reported a fear of Nile fever in California, West Nile, coming back because of all the swimming pools that have been abandoned, have become infested with mosquitoes. And this has already caused cases of West Nile fever in California and in Florida. There’s fear even of malaria. So, the consequences of this crisis are just being felt by many, many people, and it’s not pretty.
JUAN GONZALEZ: But, Danny, in terms of what the role of the regulating agencies were in this whole situation, because, obviously, whether it’s the SEC or whether it’s the Federal Deposit Insurance Corporation or the Federal Reserve, they all had a role, in terms of what they were doing to prevent this kind of collapse.
DANNY SCHECHTER: I think the more operative phrase, Juan, is “what they were not doing,” OK, because the regulators were asleep at the switch, for the most part. They were not doing their job, even with the regulations that existed. These were, in many cases, so-called exotic new instruments, derivative products and the like, which maybe they weren’t set up to monitor, but they didn’t make the effort.
Also at fault here is our great media system which failed to investigate this when it was happening and something might have been done. And that’s what I talk about in Plunder, this relationship between this credit and debt complex that really dominates our economy, regulating body and bodies that are not regulating, and a media that’s looking the other way.
AMY GOODMAN: Max Fraad Wolff, explain what Freddie Mac and Fannie Mae are and what this bailout means for them?
MAX FRAAD WOLFF: OK. What they are are historically an American dream machine set up in the ’30s and then later to help low- and middle-income people get housing. How do they do that? They buy the loans that banks have already made to relieve banks from the risk of owning those loans and to allow banks to loan more money to buy more houses to loan middle-income people. They really are kind of the American dream machine.
And looking at them in the situation that they’re in right now—and they kind of became the American nightmare machine in the boom of the ’90s and later—looking at them now is a real sort of metric, it’s a near terminal fever in the American dream machine. Their sickness is a sickness of opportunity for low- and middle-income people to move into houses. So they’re an elaborate federally subsidized system that allows low- and moderate-income people to get home mortgages to get houses in order for us to build more houses and have more people become homeowners, particularly lower down the income ladder.
Until very recently, they were not allowed to be involved in mortgages worth more than $430,000. So, you know, it’s not the most fancy houses. It’s not Palm Beach mansions and such. And even now, with their new increased ability to loan higher sums, it’s still only about $730,000, so it excludes the very wealthy, who presumably don’t need help.
They grew too big. They were privatized in the ’70s and ’80s, and they’re victims of a crisis in this country, where people borrowed much more than they can pay back, and then there’s a small number of cases that they’re willing to pay back. And they now have somewhere on the order of $5.078 trillion worth of mortgage risk exposure, and they have $80 billion worth of capital. And basically, more than their immediate sicknesses, which are real, and their losses, which are real, there’s been a loss of confidence in them and in the system and in the mortgages that they’ve written and that they’ve backed.
And the reason this matters, writ large, is because our housing markets are already sliding, and if anything happens to make them less robust, less able to buy and back mortgages, you can go ahead and expect maybe another five to 15 percent decline in the average house price. And there again, it’s the death of the middle class and the death of the American dream, because if your house is your major asset, it’s already slid 15, 20 percent, and the structures that help support it, particularly low- and moderate-income homes, are weakened, you can expect further pain, further damage and further trouble. So, I mean—
JUAN GONZALEZ: But let me—I just want to ask Max about Fannie Mae and Freddie Mac. Weren’t they presumably—they were, to some degree, immune from the subprime crisis, because they were not—the kinds of loans that they bought usually required at least a minimal down payment and good credit, so that supposedly they were not supposed to get caught up in the subprime crisis.
MAX FRAAD WOLFF: Absolutely correct. I mean, in fact, it is subprime, because it’s nonconforming. That’s what the industry calls it. And by “nonconforming” it means it doesn’t conform to the standards for Freddie and Fannie. So, yeah, they didn’t directly intervene, but a funny thing happened. They weren’t directly making subprime loans; private firms were. But because their mandate is to assist homeownership in low- and moderate-income communities and Americans, they actually ended up buying bundles of subprime loans. They were rated AAA by the S&P, Fitch and Moody’s, but they ended up buying some of those loan bundles, and that’s where they took their initial losses and some of their big losses.
DANNY SCHECHTER: But they were propping up this whole subcrime-subprime system, let’s face it. And now the government wants to bail them out. The Bush administration, big free marketeers, want to now nationalize, in essence, even further, you know, Fannie Mae and Freddie Mac, if they are in danger. And this means potentially billions of dollars in taxpayer money and also increasing potentially the national debt by $5 trillion, if everything collapses.
That’s why homeowners, organizations like NACA, are taking a different position. They’re saying we need to restructure current loans. We need to get bankers to recognize that unless they make loans affordable to low- and middle-income people, these people are going to be facing foreclosure with the ripple effects that foreclosures cause. And this weekend in Washington, NACA is bringing thousands of homeowners to try to restructure their loans and negotiate on it, and if the banks don’t go along, they’re going to Congress to demand congressmen call the bankers to try to negotiate fair settlements for people at risk. And this is a different kind of intervention. It’s not just protest that’s serving this constituency of people who’ve been victimized by the crisis, and also confronting Congress, not for a bailout, but for action.
AMY GOODMAN: We’re going to go to break. When we come back, we’re also going to talk about IndyMac, what does it mean, the lines outside the bank for people to get their money reminding us of 1929 Wall Street. We’re talking with Danny Schechter, executive editor of mediachannel.org. His new book that is just coming out is called Plunder. We’re also joined by Max Fraad Wolff, economist and writer and instructor at New School University. Stay with us.
AMY GOODMAN: Our guests, Danny Schechter, the News Dissector, executive editor of Media Channel, author of the new book Plunder; Max Fraad Wolff, also with us, economist and writer, a lecturer at the Graduate Program of International Affairs at the New School.
Max Fraad, please talk about IndyMac and what happened with it.
MAX FRAAD WOLFF: Alright. So it’s the largest bank failure since 1984, which was some time ago, so it has drama. I think, sadly, it’s going to lose that record probably within six months or less. But for now it’s—
AMY GOODMAN: To who?
MAX FRAAD WOLFF: Probably to a couple others. I mean, I wouldn’t want to rank who’s coming first, but it’s not the last. I think there’s pretty much universal agreement on that. Royal Bank of Scotland, which is not, you know, poo-pooing banking, for many obvious reasons, is estimating 150 to 300 small to midsize failures in the next eighteen months, and that’s not considered sort of off the charts.
IndyMac is sort of an interesting story, because it was partially seated by two fellows from Countrywide, which much of your audience is probably familiar with—didn’t have the best track record in the mortgage business—and they really specialized in a sort of small slice of the business called Alt-A. In the industry, when I was doing research, when we worked on this, we called these “liar loans”—probably wasn’t a bad name. Formally, they’re called no-doc, lo-doc, or Alternative A loans, which means you don’t have to provide a lot of credit history or income verification. And so, they did a lot of lending to people who were unwilling or unable to provide basic background information to their creditors. And it was concentrated in California and the Southwest.
Roughly, looking back from this particular vantage point, this is about the worst business to possibly be in on earth, so when Mr. Schumer wrote the letter that got all the attention, he was kind of stating something that everyone who’s been following it knew, if in a little bit more obvious form. And basically, the relationship between the amount of money they had lent and the amount of money they have and the amount of money they had lost moved into a situation where it was just a question of time until the federal government came in and exercised what it has to do, ideally, to keep people’s faith in the banking system and shut it down, take it over and employ FDIC or federal deposit insurance, so that people don’t lose on their accounts. I would also mention that the FDIC cost of insuring all those accounts is probably equal to about ten percent of the total money in FDIC, which means they’re going to have to charge a much higher premium, or they, themselves, will have to be bailed out by another part of the federal government.
DANNY SCHECHTER: Let me just add to this, because I spoke with Sheila Bair, who’s the head of the FDIC, last December. I asked her, “How many banks are going to fail?” She phumphered around and came up with the number seventy-six. Now we’re talking over 300 potentially. So this crisis is just beginning, and this is one of the problems here. We read the headlines as if everything has already happened, the worst has happened. It hasn’t yet. And that’s what we have to brace ourselves for.
JUAN GONZALEZ: Well, Danny, I want to ask about that, because yesterday’s Wall Street Journal had a big front-page story about how the Securities and Exchange Commission is trying to stop private investment companies that are shorting banks, that are investing in the—on the belief that these banks’ stocks are going to go down. And they’re claiming this is having an even more negative effect on banks, in essence, that there’s speculation going on in the collapse of banks. Your response to this whole issue of shorting? And even—and a lot of these banks, weren’t they involved in helping to finance these kinds of short investments?
DANNY SCHECHTER: Absolutely. In fact, the New York Sun today, you know, says that one of the problems here was that the regulators weren’t paying attention to all these rumors and all these shorting processes. And this is what the FBI is looking into. My favorite headline is this one in The Onion: “Recession-Plagued Nation Demands New Bubble to Invest In.” I think they’re closest to the mark once again.
MAX FRAAD WOLFF: I do think there’s something important in yesterday’s SEC decision. Christopher Cox, SEC chairman under President Bush, is the Michael Brown of this, and he’s actually underperformed Michael Brown, and he’s going to be remembered as the Michael Brown of the debt tsunami here or the debt flood, pretty easily, in addition to which, there’s a big debate—
JUAN GONZALEZ: Michael Brown, the former FEMA director.
MAX FRAAD WOLFF: The former FEMA director.
DANNY SCHECHTER: Brownie. Brownie.
MAX FRAAD WOLFF: Yeah, Brownie and the Arabian horse-racing specialist who ended up in a job perhaps he was ill-suited for. But there’s also another thing. On Wall Street, there was a lot of derision for Mr. Cox. And it’s not exactly clear if the law he announced is in fact not a law that was passed in 1998 and which he was unaware of and which he moderately embarrassed himself with one of his first major pronouncements, being in fact a nine-and-a-half-year-old piece of legislation, which wouldn’t, of course, not be a great sign if you’ve taken so long to interact in the markets and you’re now doing something that’s, in fact, already been done.
AMY GOODMAN: What about the comments of former senator Phil Gramm, top economic adviser to Republican presidential candidate John McCain, Gramm recently claiming the country is merely in a mental recession.
PHIL GRAMM: No politician can talk about, well, things are not as bad as you think, because that sounds like they don’t care. And yet, you just hear this constant whining, complaining about our loss of our competitiveness, America in decline. We’ve never been more dominant. We’ve never had more natural advantages than we have today. We’ve sort of become a nation of whiners.
AMY GOODMAN: That was Phil Gramm. Senator McCain says he’s no longer speaking for him.
DANNY SCHECHTER: The interesting thing about Gramm also is he was directly personally involved as a lobbyist for subprime lenders. He was involved, as, you know, your show reported, in actually creating a provision in the law that allowed the whole subprime-subcrime boom to happen. In fact, when Bruce Marks was fighting the banks up in Boston, he went on the floor of the Senate and called him a terrorist—a terrorist—for challenging predatory lending practices. So, Fred Gramm—I mean, Dr. Phil II here has been, you know, involved on the wrong side of this issue for many, many years.
JUAN GONZALEZ: And what about the Democratic—presumptive Democratic nominee, Senator Obama? What’s been his position in terms of the crisis, the continuing and developing crisis?
DANNY SCHECHTER: Well, you know, to my chagrin, the Obama campaign has not fully confronted this financial crisis. On Saturday last, Obama said he expects the government to do the right thing in terms of Fannie Mae and Freddie Mac, without really spelling it out.
Neither of the candidates have really spoken to this crisis, and neither has the progressive movement. We’re much more interested in what’s on the cover of The New Yorker than what’s happening to millions of families in America. And I think that this is something that has to change, that we have to become much more aware of, informed about these economic issues and engaged in trying to fight back against what’s happening to the middle class, to the working class now, ordinary Americans. Wealthy Americans are also being affected by this. We all are. Inflation goes up, our money loses value.
MAX FRAAD WOLFF: But all these things are really dangerous, because you’ve entered a space that’s both too big to fail and too big to bail. These are too large to bail out and too large and too important to let fail. And so, everybody’s kind of caught a little bit deer in the headlights, from the regulators and others, trying to figure out what to do. They want to partially bail it, but it’s so much money, and it’s ideologically difficult after twenty years of free market rhetoric, and so they kind of hope they can jawbone it and patch it and things will work themselves out. And that really hasn’t proved to be a strategy that yields a lot of fruit. But people are kind of stuck in the shock mode and in the too big to bail and too big to fail.
JUAN GONZALEZ: And, Max, I’d like to ask you, in terms of internationally, because many of these securitized loans were being bought by institutions and pension funds all over the world. What’s the impact worldwide on this?
MAX FRAAD WOLFF: A lot of losses, possibly more losses to come, and maybe most importantly, a slowing of the amount of money being lent into the United States, which in a credit-addicted society is potentially fatal for segments of the American middle class—and for American business, it’s terrible—and a general loss in faith in the quality of American assets. And that already has an expression in what you started your show with, which is an all-time new low for the dollar, because if you’re not loaning money to the United States and you’re not really interested in investing here or you’re a little nervous about it, then you do less of it, and the value of our currency, as well as our prestige, decline in combo. And by the way, that then triggers rising oil and food prices, which are smashing into the same people hit by the foreclosures and making them poorer as they face more expensive basic life costs. And that’s a bit of a perfect storm.
AMY GOODMAN: And inflation rising at its fastest rate in twenty-six years?
MAX FRAAD WOLFF: Yeah.
AMY GOODMAN: The significance of this?
MAX FRAAD WOLFF: And that’s inflation numbers that the federal government does everything short of illicit to keep down. So actual numbers would be higher. If you didn’t manipulate with seasonal adjustments and these other weird hedonic adjustments and manipulations in the statistics, the number would be even higher. And it’s high enough to say that American families and people are in a scissors crisis, hit from above by loss of wealth and a softening job market and hit from below by rising basic costs for food, fuel, etc.
DANNY SCHECHTER: That’s a new word for me: “hedonic.” I like that one. You know, but this is happening. I was in South Africa recently; inflation is beginning to climb there. England is being buffeted. There’s a bank failure in Denmark. I mean, this is spreading.
Related Democracy Now! Stories
- Five Ways Wall Street and Washington Set Us Up for the Crash: Author Nomi Prins Explains Where Congress Went Wrong on Lending (7/9/2008)
News and politics
Monday, 14 July 2008
"The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value – right now almost 10 times their market worth. The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
". . . The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC . . . .
"What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back."1
The thought could send a chill through even the most powerful of investment bankers, including Treasury Secretary Henry Paulson himself, who was head of Goldman Sachs during the heyday of toxic subprime paper-writing from 2004 to 2006. Mortgage fraud has not been limited to the representations made to borrowers or on loan documents but is in the design of the banks’ "financial products" themselves. Among other design flaws is that securitized mortgage debt has become so complex that ownership of the underlying security has often been lost in the shuffle; and without a legal owner, there is no one with standing to foreclose. That was the procedural problem prompting Federal District Judge Christopher Boyko to rule in October 2007 that Deutsche Bank did not have standing to foreclose on 14 mortgage loans held in trust for a pool of mortgage-backed securities holders.2 If large numbers of defaulting homeowners were to contest their foreclosures on the ground that the plaintiffs lacked standing to sue, trillions of dollars in mortgage-backed securities (MBS) could be at risk. Irate securities holders might then respond with litigation that could indeed threaten the existence of the banking Goliaths.
States Leading the Charge
MBS investors with the power to bring major lawsuits include state and local governments, which hold substantial portions of their assets in MBS and similar investments. A harbinger of things to come was a complaint filed on February 1, 2008, by the State of Massachusetts against investment bank Merrill Lynch, for fraud and misrepresentation concerning about $14 million worth of subprime securities sold to the city of Springfield. The complaint focused on the sale of "certain esoteric financial instruments known as collateralized debt obligations (CDOs) . . . which were unsuitable for the city and which, within months after the sale, became illiquid and lost almost all of their market value."3
The previous month, the city of Baltimore sued Wells Fargo Bank for damages from the subprime debacle, alleging that Wells Fargo had intentionally discriminated in selling high-interest mortgages more frequently to blacks than to whites, in violation of federal law.4
Another innovative suit filed in January 2008 was brought by Cleveland Mayor Frank Jackson against 21 major investment banks, for enabling the subprime lending and foreclosure crisis in his city. The suit targeted the investment banks that fed off the mortgage market by buying subprime mortgages from lenders and then "securitizing" them and selling them to investors. City officials said they hoped to recover hundreds of millions of dollars in damages from the banks, including lost taxes from devalued property and money spent demolishing and boarding up thousands of abandoned houses. The defendants included banking giants Deutsche Bank, Goldman Sachs, Merrill Lynch, Wells Fargo, Bank of America and Citigroup. They were charged with creating a "public nuisance" by irresponsibly buying and selling high-interest home loans, causing widespread defaults that depleted the city’s tax base and left neighborhoods in ruins.
"To me, this is no different than organized crime or drugs," Jackson told the Cleveland newspaper The Plain Dealer. "It has the same effect as drug activity in neighborhoods. It’s a form of organized crime that happens to be legal in many respects." He added in a videotaped interview, "This lawsuit said, ‘You’re not going to do this to us anymore.’"5
The Plain Dealer also interviewed Ohio Attorney General Marc Dann, who was considering a state lawsuit against some of the same investment banks. "There’s clearly been a wrong done," he said, "and the source is Wall Street. I’m glad to have some company on my hunt."
However, a funny thing happened on the way to the courthouse. Like New York Governor Eliot Spitzer, Attorney General Dann wound up resigning from his post in May 2008 after a sexual harassment investigation in his office.6 Before they were forced to resign, both prosecutors were hot on the tail of the banks, attempting to impose liability for the destructive wave of home foreclosures in their jurisdictions.
But the hits keep on coming. In June 2008, California Attorney General Jerry Brown sued Countrywide Financial Corporation, the nation’s largest mortgage lender, for causing thousands of foreclosures by deceptively marketing risky loans to borrowers. Among other things, the 46-page complaint alleged that:
"‘Defendants viewed borrowers as nothing more than the means for producing more loans, originating loans with little or no regard to borrowers’ long-term ability to afford them and to sustain homeownership’ . . .
"The company routinely . . . ‘turned a blind eye’ to deceptive practices by brokers and its own loan agents despite ‘numerous complaints from borrowers claiming that they did not understand their loan terms.’
". . . Underwriters who confirmed information on mortgage applications were ‘under intense pressure . . . to process 60 to 70 loans per day, making careful consideration of borrowers’ financial circumstances and the suitability of the loan product for them nearly impossible.’
"‘Countrywide’s high-pressure sales environment and compensation system encouraged serial refinancing of Countrywide loans.’"7
Similar suits against Countrywide and its CEO have been filed by the states of Illinois and Florida. These suits seek not only damages but rescission of the loans, creating a potential nightmare for the banks.
An Avalanche of Class Actions?
Massive class action lawsuits by defrauded borrowers may also be in the works. In a 2007 ruling in Wisconsin that is now on appeal, U.S. District Judge Lynn Adelman held that Chevy Chase Bank had violated the Truth in Lending Act by hiding the terms of an adjustable rate loan, and that thousands of other Chevy Chase borrowers could join the plaintiffs in a class action on that ground. According to a June 30, 2008 report in Reuters:
"The judge transformed the case from a run-of-the-mill class action to a potential nightmare for the U.S. banking industry by also finding that the borrowers could force the bank to cancel, or rescind, their loans. That decision was stayed pending an appeal to the 7th U.S. Circuit Court of Appeals, which is expected to rule any day.
"The idea of canceling tainted loans to stem a tide of foreclosures has caught hold in other quarters; a lawsuit filed last week by the Illinois attorney general asks a court to rescind or reform Countrywide Financial mortgages originated under ‘unfair or deceptive practices.’
". . . The mortgage banking industry already faces pressure from state and federal regulators, who have accused banks of lowering underwriting standards and forcing some borrowers, through fraud, into costly adjustable loans that the banks later bundled and sold as high-interest investment vehicles."
The Truth in Lending Act (TILA) is a 1968 federal law designed to protect consumers against lending fraud by requiring clear disclosure of loan terms and costs. It lets consumers seek rescission or termination of a loan and the return of all interest and fees when a lender is found to be in violation. The beauty of the statute, says California bankruptcy attorney Cathy Moran, is that it provides for strict liability: the aggrieved borrowers don’t have to prove they were personally defrauded or misled, or that they had actual damages. Just the fact that the disclosures were defective gives them the right to rescind and deprives the lenders of interest. In Moran’s small sample, at least half of the loans reviewed contained TILA violations.8 If class actions are found to be available for rescission of loans based on fraud in the disclosure process, the result could be a flood of class suits against banks all over the country.9
Shifting the Loss Back to the Banks
Rescission may be a remedy available not only for borrowers but for MBS investors. Many loan sale contracts provide by their terms that lenders must take back loans that default unusually quickly or that contain mistakes or fraud. An avalanche of rescissions could be catastrophic for the banks. Banks were moving loans off their books and selling them to investors in order to allow many more loans to be made than would otherwise have been allowed under banking regulations. The banking rules are complex, but for every dollar of shareholder capital a bank has on its balance sheet, it is supposed to be limited to about $10 in loans. The problem for the banks is that when the process is reversed, the 10 to 1 rule can work the other way: taking a dollar of bad debt back on a bank’s books can reduce its lending ability by a factor of 10. As explained in a BBC News story citing Prof. Nouriel Roubini for authority:
"[S]ecuritisation was key to helping banks avoid the regulators’ 10:1 rule. To make their risky loans appear attractive to buyers, banks used complex financial engineering to repackage them so they looked super-safe and paid returns well above what equivalent super-safe investments offered. Banks even found ways to get loans off their balance sheets without selling them at all. They devised bizarre new financial entities - called Special Investment Vehicles or SIVs - in which loans could be held technically and legally off balance sheet, out of sight, and beyond the scope of regulators’ rules. So, once again, SIVs made room on balance sheets for banks to go on lending.
"Banks had got round regulators’ rules by selling off their risky loans, but because so many of the securitised loans were bought by other banks, the losses were still inside the banking system. Loans held in SIVs were technically off banks’ balance sheets, but when the value of the loans inside SIVs started to collapse, the banks which set them up found that they were still responsible for them. So losses from investments which might have appeared outside the scope of the regulators’ 10:1 rule, suddenly started turning up on bank balance sheets. . . . The problem now facing many of the biggest lenders is that when losses appear on banks’ balance sheets, the regulator’s 10:1 rule comes back into play because losses reduce a banks’ shareholder capital. ‘If you have a $200bn loss, that reduced your capital by $200bn, you have to reduce your lending by 10 times as much,’ [Prof. Roubini] explains. ‘So you could have a reduction of total credit to the economy of two trillion dollars.’"10
You could also have some very bankrupt banks. The total equity of the top 100 U.S. banks stood at $800 billion at the end of the third quarter of 2007. Banking losses are currently expected to rise by as much as $450 billion, enough to wipe out more than half of the banks’ capital bases and leave many of them insolvent.11 If debtors were to deluge the courts with viable defenses to their debts and mortgage-backed securities holders were to challenge their securities, the result could be even worse.
Putting the Genie Back in the Bottle
So what would happen if the mega-banks engaging in these irresponsible practices actually went bankrupt? These banks are widely acknowledged to be at fault, but they expect to be bailed out by the Federal Reserve or the taxpayers because they are "too big to fail." The argument is that if they were allowed to collapse, they would take the economy down with them. That is the fear, but it is not actually true. We do need a ready source of credit, so we need banks; but we don’t need private banks. It is a little-known, well-concealed fact that banks do not lend their own money or even their depositors’ money. They actually create the money they lend; and creating money is properly a public, not a private, function. The Constitution delegates the power to create money to Congress and only to Congress.12 In making loans, banks are merely extending credit; and the proper agency for extending "the full faith and credit of the United States" is the United States itself.
There is more at stake here than just the equitable treatment of injured homeowners and investors in mortgage-backed securities. Banks and investment houses are now squeezing the last drops of blood from the U.S. government’s credit rating, "borrowing" money and unloading worthless paper on the government and the taxpayers. When the dust settles, it will be the banks, investment brokerages and hedge funds for wealthy investors that will be saved. The repossessed will become the dispossessed; and unless your pension fund has invested in politically well-connected hedge funds, you can probably kiss it goodbye, as teachers in Florida already have.
But the banking genie is a creature of the law, and the law can put it back in the bottle. The imminent failure of some very big banks could provide the government with an opportunity to regain control of its finances. More than that, it could provide the funds for tackling otherwise unsolvable problems now threatening to destroy our standard of living and our standing in the world. The only solution that will be more than a temporary fix is to take the power to create money away from private bankers and return it to the people collectively. That is how it should have been all along, and how it was in our early history; but we are so used to banks being private corporations that we have forgotten the public banks of our forebears. The best of the colonial American banking models was developed in Benjamin Franklin’s province of Pennsylvania, where a government-owned bank issued money and lent it to farmers at 5 percent interest. The interest was returned to the government, replacing taxes. During the decades that that system was in operation, the province of Pennsylvania operated without taxes, inflation or debt.
Rather than bailing out bankrupt banks and sending them on their merry way, the Federal Deposit Insurance Corporation (FDIC) needs to take a close look at the banks’ books and put any banks found to be insolvent into receivership. The FDIC (unlike the Federal Reserve) is actually a federal agency, and it has the option of taking a bank’s stock in return for bailing it out, effectively nationalizing it. This is done in Europe with bankrupt banks, and it was done in the United States with Continental Illinois, the country’s fourth largest bank, when it went bankrupt in the 1990s.
A system of truly "national" banks could issue "the full faith and credit of the United States" for public purposes, including funding infrastructure, sustainable energy development and health care.13 Publicly-issued credit could also be used to relieve the subprime crisis. Local governments could use it to buy up mortgages in default, compensating the MBS investors and freeing the real estate for public disposal. The properties could then be rented back to their occupants at reasonable rates, leaving people in their homes without the windfall of acquiring a house without paying for it. A program of lease-purchase might also be instituted. The proceeds would be applied toward repaying the credit advanced to buy the mortgages, balancing the money supply and preventing inflation.
Local and Private Solutions
While we are waiting for the federal government to act, there are also private and local possibilities for relieving the subprime crisis. Chris Cook is a British strategic market consultant and the former Compliance Director for the International Petroleum Exchange. He recommends getting all the parties to settle by forming a pool constituted as an LLC (limited liability company), in a partnership framework that brings together occupiers and financiers as co-owners under a neutral custodian. The original owners would pay an affordable rental, and the resulting pool of rentals would be "unitized" (divided into unit interests, similar to a REIT or real estate investment trust). Among other advantages over the usual mortgage-backed security, there would be no loans at interest, since the property would be owned outright by the LLC. Eliminating interest substantially reduces costs. The former owners would be able to occupy the property at an affordable rental, with the option to buy an equity stake in it. For the banks, the advantage would be that they would be able to find investors again, since the risk would have been taken out of the investment by insuring full occupancy at affordable rates; and for the investors, the advantage would be a secure investment with a dependable return.14
Carolyn Betts is an Ohio attorney who served in Washington as issuer’s counsel for MBS trusts formed by various federal governmental entities, and represented Resolution Trust Corporation in its auction of defaulted commercial mortgage loans during the last real estate crisis. She proposes a squeeze play by the states, in the style of that brought against the tobacco companies by a consortium of state attorneys general in the 1990s. She notes that at the end of 2007, at least 20% of the funds held by the Ohio Public Employees’ Retirement System (PERS) were in mortgage backed securities and similar investments. That makes Ohio public money a major investor in these mortgage-related securities. Ohio governments have an interest in not having homes foreclosed upon, since foreclosures destroy local real estate markets, contribute to lower tax revenues and losses on PERS investments, and cause a strain on state and local affordable housing systems. A coordinated series of actions brought by state attorneys general could eliminate the culpable banker middlemen and return the properties to local ownership and control.
Andrew Jackson reportedly told Congress in 1829, "If the American people only understood the rank injustice of our money and banking system, there would be a revolution before morning." A wave of private actions, class actions and government lawsuits aimed at redressing injurious banking practices could spark a revolution in banking, returning the power to advance "the full faith and credit of the United States" to the United States, and returning community assets to local ownership and control.
Ellen Brown, J.D., developed her research skills as an attorney practicing civil litigation in Los Angeles. In Web of Debt, her latest book, she turns those skills to an analysis of the Federal Reserve and "the money trust." She shows how this private cartel has usurped the power to create money from the people themselves and how we the people can get it back. Her websites are www.webofdebt.com and www.ellenbrown.com.