The treasurer has stated on numerous occasions that a Texas law firm helped recover funds from the NCFE case, and has said he is not sure whether Goddard's office is entitled to the full 35 percent.
The state treasury lost $14.3 million to NCFE. So far, the state has recovered about 53 percent of $131 million in losses, Martin said.
An accompanying provision was touted by Martin as a means to ensure independent attorneys could be hired only to handle complex cases such as securities, bankruptcy matters and to offer financial advice.
The fraud, committed in 2002 by National Century Financial Enterprises, cost Arizona governments approximately $131 million. Two-hundred local Arizona governmental entities and many governments in other states invested in NCFE, which made loans to inner-city Medicare hospitals,...
January 27, 2009
Breaking News
Changes coming for bill on state Treasurer’s legal counsel
By Christian Palmer, christian.palmer@azcapitoltimes.com
A bill intended to allow the Office of the State Treasurer to hire his own attorney to handle complex financial cases was held by a House committee on Jan. 27 after its sponsor raised concerns the legislation would have more sweeping effects.The decision to hold H2103 came from Rep. Sam Crump, the chairman of the House Government Committee. Crump also was the prime sponsor of the proposal, which State Treasurer Dean Martin told committee members could cut costs and help end a longstanding "political turf war."
In official capacity, Martin is represented by the Attorney General's Office, but Crump's bill would attach the Treasurer's Office to a list of nine agencies allowed to hire and pay for their own representation.
An accompanying provision was touted by Martin as a means to ensure independent attorneys could be hired only to handle complex cases such as securities, bankruptcy matters and to offer financial advice.
However, House analysts contested Martin's translation of the bill. They said the measure, as written, would allow the state treasurer to secure lawyers separate from the Attorney General's Office for any matters.
David Gass, a legislative liaison for the Attorney General Terry Goddard, told committee members the option to hire outside legal counsel should not be extended to the Treasurer's Office, which conducts business with almost all state agencies on a daily basis.
The frequent interaction - and the prospect of differing opinions on legal matters - can provide the foundation for interagency conflict, he said.
"You create a conflict that's statewide," Gass said.
Yet, Martin said the benefits to the state presented by the law change are apparent. State law dictates the attorney general is entitled to collect a 35-percent fee on recovered funds, an amount Martin regards as outlandish and far more expensive than bills that would be incurred through specialized private-sector attorneys.
Crump said he will amend the bill and give it another try.
"Let's get it right and bring it back," he told members of the committee.
The issue of the treasurer's access to independent counsel stems from a years-long dispute between Goddard and Martin over a legal bill Martin's office was asked to pay in return for money recouped in a national fraud settlement.
The fraud, committed in 2002 by National Century Financial Enterprises, cost Arizona governments approximately $131 million. Two-hundred local Arizona governmental entities and many governments in other states invested in NCFE, which made loans to inner-city Medicare hospitals, before collapsing in 2002 in a fraud scandal involving $3 billion in lost investments.
After the legal battle, then-Chief Deputy Treasurer Blaine Vance refused to transfer payment for the attorney general's legal services without written approval from the state solicitor general. But in June of 2006, the state Treasurer's Office agreed to pay the Attorney General's Office $1.9 million for legal expenses associated with recouping the lost investments.
The payment was not disclosed to the state Board of Investment, which oversees the state's investment portfolio.
The deal came months after agents with Goddard's office seized computers, 15,000 pages of documents and other materials from the Treasurer's Office as part of an investigation into allegations that Petersen had committed several felonies by using his office to promote character-building teaching materials sold by Character First.
Initially, Petersen faced charges of theft, fraud and conflict of interest. But weeks after resigning in October 2006, he pleaded guilty to a single misdemeanor count for failing to disclose a $4,200 commission he received for selling Character First products.
Martin, as a candidate running for treasurer in 2006, cast suspicions on the payment and criticized Petersen's sentence, which included three years of probation, as a "slap on the wrist."
Goddard has defended the payment repeatedly; pointing out that state law authorizes the Attorney General's Office to receive 35 percent of all state funds it recovers.
Upon taking office, Martin stopped issuing Goddard's office a portion of the fraud settlement, which was being distributed to the state periodically, and asked Maricopa County Attorney Andrew Thomas and Maricopa County Sheriff Joe Arpaio to investigate the payment.
Martin has asked for separate legal counsel to review the deal and to conclude how much the Attorney General's Office should be paid. The treasurer has stated on numerous occasions that a Texas law firm helped recover funds from the NCFE case, and has said he is not sure whether Goddard's office is entitled to the full 35 percent.
The state treasury lost $14.3 million to NCFE. So far, the state has recovered about 53 percent of $131 million in losses, Martin said.
Showing posts with label Banks in America. Show all posts
Showing posts with label Banks in America. Show all posts
Wednesday, February 4, 2009
Sunday, December 21, 2008
2002, 'GW Bush : Plan for the Economy'
Articles in this series are exploring the causes of the financial crisis.
THE BLUEPRINTS In June 2002, President Bush spoke in Atlanta to unveil a plan to increase minority homeownership.
By JO BECKER, SHERYL GAY STOLBERG and STEPHEN LABATON
Published: December 20, 2008
The ReckoningWhite House Philosophy Stoked Mortgage Bonfire
“We can put light where there’s darkness, and hope where there’s despondency in this country. And part of it is working together as a nation to encourage folks to own their own home.” — President Bush, Oct. 15, 2002
WASHINGTON — The global financial system was teetering on the edge of collapse when President Bush and his economics team huddled in the Roosevelt Room of the White House for a briefing that, in the words of one participant, “scared the hell out of everybody.”
It was Sept. 18. Lehman Brothers had just gone belly-up, overwhelmed by toxic mortgages. Bank of America had swallowed Merrill Lynch in a hastily arranged sale. Two days earlier, Mr. Bush had agreed to pump $85 billion into the failing insurance giant American International Group.
The president listened as Ben S. Bernanke, chairman of the Federal Reserve, laid out the latest terrifying news: The credit markets, gripped by panic, had frozen overnight, and banks were refusing to lend money.
Then his Treasury secretary, Henry M. Paulson Jr., told him that to stave off disaster, he would have to sign off on the biggest government bailout in history.
Mr. Bush, according to several people in the room, paused for a single, stunned moment to take it all in.
“How,” he wondered aloud, “did we get here?”
Eight years after arriving in Washington vowing to spread the dream of homeownership, Mr. Bush is leaving office, as he himself said recently, “faced with the prospect of a global meltdown” with roots in the housing sector he so ardently championed.
There are plenty of culprits, like lenders who peddled easy credit, consumers who took on mortgages they could not afford and Wall Street chieftains who loaded up on mortgage-backed securities without regard to the risk.
But the story of how we got here is partly one of Mr. Bush’s own making, according to a review of his tenure that included interviews with dozens of current and former administration officials.
From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone.
He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.
Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency.
As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a “rough patch.”
The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis.
“There is no question we did not recognize the severity of the problems,” said Al Hubbard, Mr. Bush’s former chief economics adviser, who left the White House in December 2007. “Had we, we would have attacked them.”
Looking back, Keith B. Hennessey, Mr. Bush’s current chief economics adviser, says he and his colleagues did the best they could “with the information we had at the time.” But Mr. Hennessey did say he regretted that the administration did not pay more heed to the dangers of easy lending practices. And both Mr. Paulson and his predecessor, John W. Snow, say the housing push went too far.
“The Bush administration took a lot of pride that homeownership had reached historic highs,” Mr. Snow said in an interview. “But what we forgot in the process was that it has to be done in the context of people being able to afford their house. We now realize there was a high cost.”
For much of the Bush presidency, the White House was preoccupied by terrorism and war; on the economic front, its pressing concerns were cutting taxes and privatizing Social Security. The housing market was a bright spot: ever-rising home values kept the economy humming, as owners drew down on their equity to buy consumer goods and pack their children off to college.
Lawrence B. Lindsay, Mr. Bush’s first chief economics adviser, said there was little impetus to raise alarms about the proliferation of easy credit that was helping Mr. Bush meet housing goals.
“No one wanted to stop that bubble,” Mr. Lindsay said. “It would have conflicted with the president’s own policies.”
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Today, millions of Americans are facing foreclosure, homeownership rates are virtually no higher than when Mr. Bush took office, Fannie and Freddie are in a government conservatorship, and the bailout cost to taxpayers could run in the trillions.
As the economy has shed jobs — 533,000 last month alone — and his party has been punished by irate voters, the weakened president has granted his Treasury secretary extraordinary leeway in managing the crisis.
Never once, Mr. Paulson said in a recent interview, has Mr. Bush overruled him. “I’ve got a boss,” he explained, who “understands that when you’re dealing with something as unprecedented and fast-moving as this we need to have a different operating style.”
Mr. Paulson and other senior advisers to Mr. Bush say the administration has responded well to the turmoil, demonstrating flexibility under difficult circumstances. “There is not any playbook,” Mr. Paulson said.
The president declined to be interviewed for this article. But in recent weeks Mr. Bush has shared his views of how the nation came to the brink of economic disaster. He cites corporate greed and market excesses fueled by a flood of foreign cash — “Wall Street got drunk,” he has said — and the policies of past administrations. He blames Congress for failing to reform Fannie and Freddie. Last week, Fox News asked Mr. Bush if he was worried about being the Herbert Hoover of the 21st century.
“No,” Mr. Bush replied. “I will be known as somebody who saw a problem and put the chips on the table to prevent the economy from collapsing.”
But in private moments, aides say, the president is looking inward. During a recent ride aboard Marine One, the presidential helicopter, Mr. Bush sounded a reflective note.
“We absolutely wanted to increase homeownership,” Tony Fratto, his deputy press secretary, recalled him saying. “But we never wanted lenders to make bad decisions.”
A Policy Gone Awry
Darrin West could not believe it. The president of the United States was standing in his living room.
It was June 17, 2002, a day Mr. West recalls as “the highlight of my life.” Mr. Bush, in Atlanta to unveil a plan to increase the number of minority homeowners by 5.5 million, was touring Park Place South, a development of starter homes in a neighborhood once marked by blight and crime.
Mr. West had patrolled there as a police officer, and now he was the proud owner of a $130,000 town house, bought with an adjustable-rate mortgage and a $20,000 government loan as his down payment — just the sort of creative public-private financing Mr. Bush was promoting.
“Part of economic security,” Mr. Bush declared that day, “is owning your own home.”
A lot has changed since then. Mr. West, beset by personal problems, left Atlanta. Unable to sell his home for what he owed, he said, he gave it back to the bank last year. Like other communities across America, Park Place South has been hit with a foreclosure crisis affecting at least 10 percent of its 232 homes, according to Masharn Wilson, a developer who led Mr. Bush’s tour.
“I just don’t think what he envisioned was actually carried out,” she said.
Park Place South is, in microcosm, the story of a well-intentioned policy gone awry. Advocating homeownership is hardly novel; the Clinton administration did it, too. For Mr. Bush, it was part of his vision of an “ownership society,” in which Americans would rely less on the government for health care, retirement and shelter. It was also good politics, a way to court black and Hispanic voters.
But for much of Mr. Bush’s tenure, government statistics show, incomes for most families remained relatively stagnant while housing prices skyrocketed. That put homeownership increasingly out of reach for first-time buyers like Mr. West.
So Mr. Bush had to, in his words, “use the mighty muscle of the federal government” to meet his goal. He proposed affordable housing tax incentives. He insisted that Fannie Mae and Freddie Mac meet ambitious new goals for low-income lending.
Concerned that down payments were a barrier, Mr. Bush persuaded Congress to spend up to $200 million a year to help first-time buyers with down payments and closing co(Page 3 of 6)
And he pushed to allow first-time buyers to qualify for federally insured mortgages with no money down. Republican Congressional leaders and some housing advocates balked, arguing that homeowners with no stake in their investments would be more prone to walk away, as Mr. West did. Many economic experts, including some in the White House, now share that view.
The president also leaned on mortgage brokers and lenders to devise their own innovations. “Corporate America,” he said, “has a responsibility to work to make America a compassionate place.”
And corporate America, eyeing a lucrative market, delivered in ways Mr. Bush might not have expected, with a proliferation of too-good-to-be-true teaser rates and interest-only loans that were sold to investors in a loosely regulated environment.
“This administration made decisions that allowed the free market to operate as a barroom brawl instead of a prize fight,” said L. William Seidman, who advised Republican presidents and led the savings and loan bailout in the 1990s. “To make the market work well, you have to have a lot of rules.”
But Mr. Bush populated the financial system’s alphabet soup of oversight agencies with people who, like him, wanted fewer rules, not more.
Like Minds on Laissez-Faire
The president’s first chairman of the Securities and Exchange Commission promised a “kinder, gentler” agency. The second was pushed out amid industry complaints that he was too aggressive. Under its current leader, the agency failed to police the catastrophic decisions that toppled the investment bank Bear Stearns and contributed to the current crisis, according to a recent inspector general’s report.
As for Mr. Bush’s banking regulators, they once brandished a chain saw over a 9,000-page pile of regulations as they promised to ease burdens on the industry. When states tried to use consumer protection laws to crack down on predatory lending, the comptroller of the currency blocked the effort, asserting that states had no authority over national banks.
The administration won that fight at the Supreme Court. But Roy Cooper, North Carolina’s attorney general, said, “They took 50 sheriffs off the beat at a time when lending was becoming the Wild West.”
The president did push rules aimed at forcing lenders to more clearly explain loan terms. But the White House shelved them in 2004, after industry-friendly members of Congress threatened to block confirmation of his new housing secretary.
In the 2004 election cycle, mortgage bankers and brokers poured nearly $847,000 into Mr. Bush’s re-election campaign, more than triple their contributions in 2000, according to the nonpartisan Center for Responsive Politics. The administration did not finalize the new rules until last month.
Among the Republican Party’s top 10 donors in 2004 was Roland Arnall. He founded Ameriquest, then the nation’s largest lender in the subprime market, which focuses on less creditworthy borrowers. In July 2005, the company agreed to set aside $325 million to settle allegations in 30 states that it had preyed on borrowers with hidden fees and ballooning payments. It was an early signal that deceptive lending practices, which would later set off a wave of foreclosures, were widespread.
Andrew H. Card Jr., Mr. Bush’s former chief of staff, said White House aides discussed Ameriquest’s troubles, though not what they might portend for the economy. Mr. Bush had just nominated Mr. Arnall as his ambassador to the Netherlands, and the White House was primarily concerned with making sure he would be confirmed.
“Maybe I was asleep at the switch,” Mr. Card said in an interview.
Brian Montgomery, the Federal Housing Administration commissioner, understood the significance. His agency insures home loans, traditionally for the same low-income minority borrowers Mr. Bush wanted to help. When he arrived in June 2005, he was shocked to find those customers had been lured away by the “fool’s gold” of subprime loans. The Ameriquest settlement, he said, reinforced his concern that the industry was exploiting borrowers.
In December 2005, Mr. Montgomery drafted a memo and brought it to the White House. “I don’t think this is what the president had in mind here,” he recalled telling Ryan Streeter, then the president’s chief housing policy analyst.
It was an opportunity to address the risky subprime lending practices head on. But that was never seriously discussed. More senior aides, like Karl Rove, Mr. Bush’s chief political strategist, were wary of overly regulating an industry that, Mr. Rove said in an interview, provided “a valuable service to people who could not otherwise get credit.” While he had some concerns about the industry’s practices, he said, “it did provide an opportunity for people, a lot of whom are still in their houses today.”
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The White House pursued a narrower plan offered by Mr. Montgomery that would have allowed the F.H.A. to loosen standards so it could lure back subprime borrowers by insuring similar, but safer, loans. It passed the House but died in the Senate, where Republican senators feared that the agency would merely be mimicking the private sector’s risky practices — a view Mr. Rove said he shared.
Looking back at the episode, Mr. Montgomery broke down in tears. While he acknowledged that the bill did not get to the root of the problem, he said he would “go to my grave believing” that at least some homeowners might have been spared foreclosure.
Today, administration officials say it is fair to ask whether Mr. Bush’s ownership push backfired. Mr. Paulson said the administration, like others before it, “over-incented housing.” Mr. Hennessey put it this way: “I would not say too much emphasis on expanding homeownership. I would say not enough early focus on easy lending practices.”
‘We Told You So’
Armando Falcon Jr. was preparing to take on a couple of giants.
A soft-spoken Texan, Mr. Falcon ran the Office of Federal Housing Enterprise Oversight, a tiny government agency that oversaw Fannie Mae and Freddie Mac, two pillars of the American housing industry. In February 2003, he was finishing a blockbuster report that warned the pillars could crumble.
Created by Congress, Fannie and Freddie — called G.S.E.’s, for government-sponsored entities — bought trillions of dollars’ worth of mortgages to hold or sell to investors as guaranteed securities. The companies were also Washington powerhouses, stuffing lawmakers’ campaign coffers and hiring bare-knuckled lobbyists.
Mr. Falcon’s report outlined a worst-case situation in which Fannie and Freddie could default on debt, setting off “contagious illiquidity in the market” — in other words, a financial meltdown. He also raised red flags about the companies’ soaring use of derivatives, the complex financial instruments that economic experts now blame for spreading the housing collapse.
Today, the White House cites that report — and its subsequent effort to better regulate Fannie and Freddie — as evidence that it foresaw the crisis and tried to avert it. Bush officials recently wrote up a talking points memo headlined “G.S.E.’s — We Told You So.”
But the back story is more complicated. To begin with, on the day Mr. Falcon issued his report, the White House tried to fire him.
At the time, Fannie and Freddie were allies in the president’s quest to drive up homeownership rates; Franklin D. Raines, then Fannie’s chief executive, has fond memories of visiting Mr. Bush in the Oval Office and flying aboard Air Force One to a housing event. “They loved us,” he said.
So when Mr. Falcon refused to deep-six his report, Mr. Raines took his complaints to top Treasury officials and the White House. “I’m going to do what I need to do to defend my company and my position,” Mr. Raines told Mr. Falcon.
Days later, as Mr. Falcon was in New York preparing to deliver a speech about his findings, his cellphone rang. It was the White House personnel office, he said, telling him he was about to be unemployed.
His warnings were buried in the next day’s news coverage, trumped by the White House announcement that Mr. Bush would replace Mr. Falcon, a Democrat appointed by Bill Clinton, with Mark C. Brickell, a leader in the derivatives industry that Mr. Falcon’s report had flagged.
It was not until 2003, when Freddie became embroiled in an accounting scandal, that the White House took on the companies in earnest. Mr. Bush decided to quit the long-standing practice of rewarding supporters with high-paying appointments to the companies’ boards — “political plums,” in Mr. Rove’s words. He also withdrew Mr. Brickell’s nomination and threw his support behind Mr. Falcon, beginning an intense effort to give his little regulatory agency more power.
Mr. Falcon lacked explicit authority to limit the size of the companies’ mammoth investment portfolios, or tell them how much capital they needed to guard against losses. White House officials wanted that to change. They also wanted the power to put the companies into receivership, hoping that would end what Mr. Card, the former chief of staff, called “the myth of government backing,” which gave the companies a competitive edge because investors assumed the government would not let them fail.
By the spring of 2005 a deal with Congress seemed within reach, Mr. Snow, the former Treasury secretary, said in an interview.
(Page 5 of 6)
Michael G. Oxley, an Ohio Republican and then-chairman of the House Financial Services Committee, had produced what Mr. Snow viewed as “a pretty darned good bill,” a watered-down version of what the president sought. But at the urging of Mr. Card and the White House economics team, the president decided to hold out for a tougher bill in the Senate.
Mr. Card said he feared that Mr. Snow was “more interested in the deal than the result.” When the bill passed the House, the president issued a statement opposing it, effectively killing any chance of compromise. Mr. Oxley was furious.
“The problem with those guys at the White House, they had all the answers and they didn’t think they had to listen to anyone, including the Treasury secretary,” Mr. Oxley said in a recent interview. “They were driving the ideological train. He was in the caboose, and they were in the engine room.”
Mr. Card and Mr. Hennessey said they had no regrets. They are convinced, Mr. Hennessey said, that the Oxley bill would have produced “the worst of all possible outcomes,” the illusion of reform without the substance.
Still, some former White House and Treasury officials continue to debate whether Mr. Bush’s all-or-nothing approach scuttled a measure that, while imperfect, might have given an aggressive regulator enough power to keep the companies from failing.
Mr. Snow, for one, calls Mr. Oxley “a hero,” adding, “He saw the need to move. It didn’t get done. And it’s too bad, because I think if it had, I think we could well have avoided a big contributor to the current crisis.”
Unheeded Warnings
Jason Thomas had a nagging feeling.
The New Century Financial Corporation, a huge subprime lender whose mortgages were bundled into securities sold around the world, was headed for bankruptcy in March 2007. Mr. Thomas, an economic analyst for President Bush, was responsible for determining whether it was a hint of things to come.
At 29, Mr. Thomas had followed a fast-track career path that took him from a Buffalo meatpacking plant, where he worked as a statistician, to the White House. He was seen as a whiz kid, “a brilliant guy,” his former boss, Mr. Hubbard, says.
As Mr. Thomas began digging into New Century’s failure that spring, he became fixated on a particular statistic, the rent-to-own ratio.
Typically, as home prices increase, rental costs rise proportionally. But Mr. Thomas sent charts to top White House and Treasury officials showing that the monthly cost of owning far outpaced the cost to rent. To Mr. Thomas, it was a sign that housing prices were wildly inflated and bound to plunge, a condition that could set off a foreclosure crisis as conventional and subprime borrowers with little equity found they owed more than their houses were worth.
It was not the Bush team’s first warning. The previous year, Mr. Lindsay, the former chief economics adviser, returned to the White House to tell his old colleagues that housing prices were headed for a crash. But housing values are hard to evaluate, and Mr. Lindsay had a reputation as a market pessimist, said Mr. Hubbard, adding, “I thought, ‘He’s always a bear.’ ”
In retrospect, Mr. Hubbard said, Mr. Lindsay was “absolutely right,” and Mr. Thomas’s charts “should have been a signal.”
Instead, the prevailing view at the White House was that the problems in the housing market were limited to subprime borrowers unable to make their payments as their adjustable mortgages reset to higher rates. That belief was shared by Mr. Bush’s new Treasury secretary, Mr. Paulson.
Mr. Paulson, a former chairman of the Wall Street firm Goldman Sachs, had been given unusual power; he had accepted the job only after the president guaranteed him that Treasury, not the White House, would have the dominant role in shaping economic policy. That shift merely continued an imbalance of power that stifled robust policy debate, several former Bush aides say.
(Page 6 of 6)
Throughout the spring of 2007, Mr. Paulson declared that “the housing market is at or near the bottom,” with the problem “largely contained.” That position underscored nearly every action the Bush administration took in the ensuing months as it offered one limited response after another.
By that August, the problems had spread beyond New Century. Credit was tightening, amid questions about how heavily banks were invested in securities linked to mortgages. Still, Mr. Bush predicted that the turmoil would resolve itself with a “soft landing.”
The plan Mr. Bush announced on Aug. 31 reflected that belief. Called “F.H.A. Secure,” it aimed to help about 80,000 homeowners refinance their loans. Mr. Montgomery, the housing commissioner, said that he knew the modest program was not enough — the White House later expanded the agency’s rescue role — and that he would be “flying the plane and fixing it at the same time.”
That fall, Representative Rahm Emanuel, a leading Democrat, former investment banker and now the incoming chief of staff to President-elect Barack Obama, warned the White House it was not doing enough. He said he told Joshua B. Bolten, Mr. Bush’s chief of staff, and Mr. Paulson in a series of phone calls that the credit crisis would get “deep and serious” and that the only answer was big, internationally coordinated government intervention.
“You got to strangle this thing and suffocate it,” he recalled saying.
Instead, Mr. Bush developed Hope Now, a voluntary public-private partnership to help struggling homeowners refinance loans. And he worked with Congress to pass a stimulus package that sent taxpayers $150 billion in tax rebates.
In a speech to the Economic Club of New York in March 2008, he cautioned against Washington’s temptation “to say that anything short of a massive government intervention in the housing market amounts to inaction,” adding that government action could make it harder for the markets to recover.
Dominoes Start to Fall
Within days, Bear Sterns collapsed, prompting the Federal Reserve to engineer a hasty sale. Some economic experts, including Timothy F. Geithner, the president of the New York Federal Reserve Bank (and Mr. Obama’s choice for Treasury secretary) feared that Fannie Mae and Freddie Mac could be the next to fall.
Mr. Bush was still leaning on Congress to revamp the tiny agency that oversaw the two companies, and had acceded to Mr. Paulson’s request for the negotiating room that he had denied Mr. Snow. Still, there was no deal.
Over the previous two years, the White House had effectively set the agency adrift. Mr. Falcon left in 2005 and was replaced by a temporary director, who was in turn replaced by James B. Lockhart, a friend of Mr. Bush from their days at Andover, and a former deputy commissioner of the Social Security Administration who had once run a software company.
On Mr. Lockhart’s watch, both Freddie and Fannie had plunged into the riskiest part of the market, gobbling up more than $400 billion in subprime and other alternative mortgages. With the companies on precarious footing, Mr. Geithner had been advocating that the administration seize them or take other steps to reassure the market that the government would back their debt, according to two people with direct knowledge of his views.
In an Oval Office meeting on March 17, however, Mr. Paulson barely mentioned the idea, according to several people present. He wanted to use the troubled companies to unlock the frozen credit market by allowing Fannie and Freddie to buy more mortgage-backed securities from overburdened banks. To that end, Mr. Lockhart’s office planned to lift restraints on the companies’ huge portfolios — a decision derided by former White House and Treasury officials who had worked so hard to limit them.
But Mr. Paulson told Mr. Bush the companies would shore themselves up later by raising more capital.
“Can they?” Mr. Bush asked.
“We’re hoping so,” the Treasury secretary replied.
That turned out to be incorrect, and did not surprise Mr. Thomas, the Bush economic adviser. Throughout that spring and summer, he warned the White House and Treasury that, in the stark words of one e-mail message, “Freddie Mac is in trouble.” And Mr. Lockhart, he charged, was allowing the company to cover up its insolvency with dubious accounting maneuvers.
But Mr. Lockhart continued to offer reassurances. In a July appearance on CNBC, he declared that the companies were well managed and “worsts were not coming to worst.” An infuriated Mr. Thomas sent a fresh round of e-mail messages accusing Mr. Lockhart of “pimping for the stock prices of the undercapitalized firms he regulates.”
Mr. Lockhart defended himself, insisting in an interview that he was aware of the companies’ vulnerabilities, but did not want to rattle markets.
“A regulator,” he said, “does not air dirty laundry in public.”
Soon afterward, the companies’ stocks lost half their value in a single day, prompting Congress to quickly give Mr. Paulson the power to spend $200 billion to prop them up and to finally pass Mr. Bush’s long-sought reform bill, but it was too late. In September, the government seized control of Freddie Mac and Fannie Mae.
In an interview, Mr. Paulson said the administration had no justification to take over the companies any sooner. But Mr. Falcon disagreed: “They absolutely could have if they had thought there was a real danger.”
By Sept. 18, when Mr. Bush and his team had their fateful meeting in the Roosevelt Room after the failure of Lehman Brothers and the emergency rescue of A.I.G., Mr. Paulson was warning of an economic calamity greater than the Great Depression. Suddenly, historic government intervention seemed the only option. When Mr. Paulson spelled out what would become a $700 billion plan to rescue the nation’s banking system, the president did not hesitate.
“Is that enough?” Mr. Bush asked.
“It’s a lot,” the Treasury secretary recalled replying. “It will make a difference.” And in any event, he told Mr. Bush, “I don’t think we can get more.”
As the meeting wrapped up, a handful of aides retreated to the White House Situation Room to call Vice President Dick Cheney in Florida, where he was attending a fund-raiser. Mr. Cheney had long played a leading role in economic policy, though housing was not a primary interest, and like Mr. Bush he had a deep aversion to government intervention in the market. Nonetheless, he backed the bailout, convinced that too many Americans would suffer if Washington did nothing.
Mr. Bush typically darts out of such meetings quickly. But this time, he lingered, patting people on the back and trying to soothe his downcast staff. “During times of adversity, he bucks everybody up,” Mr. Paulson said.
It was not the end of the failures or government interventions; the administration has since stepped in to rescue Citigroup and, just last week, the Detroit automakers. With 31 days left in office, Mr. Bush says he will leave it to historians to analyze “what went right and what went wrong,” as he put it in a speech last week to the American Enterprise Institute.
Mr. Bush said he was too focused on the present to do much looking back.
“It turns out,” he said, “this isn’t one of the presidencies where you ride off into the sunset, you know, kind of waving goodbye.”
THE BLUEPRINTS In June 2002, President Bush spoke in Atlanta to unveil a plan to increase minority homeownership.
By JO BECKER, SHERYL GAY STOLBERG and STEPHEN LABATON
Published: December 20, 2008
The ReckoningWhite House Philosophy Stoked Mortgage Bonfire
“We can put light where there’s darkness, and hope where there’s despondency in this country. And part of it is working together as a nation to encourage folks to own their own home.” — President Bush, Oct. 15, 2002
WASHINGTON — The global financial system was teetering on the edge of collapse when President Bush and his economics team huddled in the Roosevelt Room of the White House for a briefing that, in the words of one participant, “scared the hell out of everybody.”
It was Sept. 18. Lehman Brothers had just gone belly-up, overwhelmed by toxic mortgages. Bank of America had swallowed Merrill Lynch in a hastily arranged sale. Two days earlier, Mr. Bush had agreed to pump $85 billion into the failing insurance giant American International Group.
The president listened as Ben S. Bernanke, chairman of the Federal Reserve, laid out the latest terrifying news: The credit markets, gripped by panic, had frozen overnight, and banks were refusing to lend money.
Then his Treasury secretary, Henry M. Paulson Jr., told him that to stave off disaster, he would have to sign off on the biggest government bailout in history.
Mr. Bush, according to several people in the room, paused for a single, stunned moment to take it all in.
“How,” he wondered aloud, “did we get here?”
Eight years after arriving in Washington vowing to spread the dream of homeownership, Mr. Bush is leaving office, as he himself said recently, “faced with the prospect of a global meltdown” with roots in the housing sector he so ardently championed.
There are plenty of culprits, like lenders who peddled easy credit, consumers who took on mortgages they could not afford and Wall Street chieftains who loaded up on mortgage-backed securities without regard to the risk.
But the story of how we got here is partly one of Mr. Bush’s own making, according to a review of his tenure that included interviews with dozens of current and former administration officials.
From his earliest days in office, Mr. Bush paired his belief that Americans do best when they own their own home with his conviction that markets do best when let alone.
He pushed hard to expand homeownership, especially among minorities, an initiative that dovetailed with his ambition to expand the Republican tent — and with the business interests of some of his biggest donors. But his housing policies and hands-off approach to regulation encouraged lax lending standards.
Mr. Bush did foresee the danger posed by Fannie Mae and Freddie Mac, the government-sponsored mortgage finance giants. The president spent years pushing a recalcitrant Congress to toughen regulation of the companies, but was unwilling to compromise when his former Treasury secretary wanted to cut a deal. And the regulator Mr. Bush chose to oversee them — an old prep school buddy — pronounced the companies sound even as they headed toward insolvency.
As early as 2006, top advisers to Mr. Bush dismissed warnings from people inside and outside the White House that housing prices were inflated and that a foreclosure crisis was looming. And when the economy deteriorated, Mr. Bush and his team misdiagnosed the reasons and scope of the downturn; as recently as February, for example, Mr. Bush was still calling it a “rough patch.”
The result was a series of piecemeal policy prescriptions that lagged behind the escalating crisis.
“There is no question we did not recognize the severity of the problems,” said Al Hubbard, Mr. Bush’s former chief economics adviser, who left the White House in December 2007. “Had we, we would have attacked them.”
Looking back, Keith B. Hennessey, Mr. Bush’s current chief economics adviser, says he and his colleagues did the best they could “with the information we had at the time.” But Mr. Hennessey did say he regretted that the administration did not pay more heed to the dangers of easy lending practices. And both Mr. Paulson and his predecessor, John W. Snow, say the housing push went too far.
“The Bush administration took a lot of pride that homeownership had reached historic highs,” Mr. Snow said in an interview. “But what we forgot in the process was that it has to be done in the context of people being able to afford their house. We now realize there was a high cost.”
For much of the Bush presidency, the White House was preoccupied by terrorism and war; on the economic front, its pressing concerns were cutting taxes and privatizing Social Security. The housing market was a bright spot: ever-rising home values kept the economy humming, as owners drew down on their equity to buy consumer goods and pack their children off to college.
Lawrence B. Lindsay, Mr. Bush’s first chief economics adviser, said there was little impetus to raise alarms about the proliferation of easy credit that was helping Mr. Bush meet housing goals.
“No one wanted to stop that bubble,” Mr. Lindsay said. “It would have conflicted with the president’s own policies.”
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Today, millions of Americans are facing foreclosure, homeownership rates are virtually no higher than when Mr. Bush took office, Fannie and Freddie are in a government conservatorship, and the bailout cost to taxpayers could run in the trillions.
As the economy has shed jobs — 533,000 last month alone — and his party has been punished by irate voters, the weakened president has granted his Treasury secretary extraordinary leeway in managing the crisis.
Never once, Mr. Paulson said in a recent interview, has Mr. Bush overruled him. “I’ve got a boss,” he explained, who “understands that when you’re dealing with something as unprecedented and fast-moving as this we need to have a different operating style.”
Mr. Paulson and other senior advisers to Mr. Bush say the administration has responded well to the turmoil, demonstrating flexibility under difficult circumstances. “There is not any playbook,” Mr. Paulson said.
The president declined to be interviewed for this article. But in recent weeks Mr. Bush has shared his views of how the nation came to the brink of economic disaster. He cites corporate greed and market excesses fueled by a flood of foreign cash — “Wall Street got drunk,” he has said — and the policies of past administrations. He blames Congress for failing to reform Fannie and Freddie. Last week, Fox News asked Mr. Bush if he was worried about being the Herbert Hoover of the 21st century.
“No,” Mr. Bush replied. “I will be known as somebody who saw a problem and put the chips on the table to prevent the economy from collapsing.”
But in private moments, aides say, the president is looking inward. During a recent ride aboard Marine One, the presidential helicopter, Mr. Bush sounded a reflective note.
“We absolutely wanted to increase homeownership,” Tony Fratto, his deputy press secretary, recalled him saying. “But we never wanted lenders to make bad decisions.”
A Policy Gone Awry
Darrin West could not believe it. The president of the United States was standing in his living room.
It was June 17, 2002, a day Mr. West recalls as “the highlight of my life.” Mr. Bush, in Atlanta to unveil a plan to increase the number of minority homeowners by 5.5 million, was touring Park Place South, a development of starter homes in a neighborhood once marked by blight and crime.
Mr. West had patrolled there as a police officer, and now he was the proud owner of a $130,000 town house, bought with an adjustable-rate mortgage and a $20,000 government loan as his down payment — just the sort of creative public-private financing Mr. Bush was promoting.
“Part of economic security,” Mr. Bush declared that day, “is owning your own home.”
A lot has changed since then. Mr. West, beset by personal problems, left Atlanta. Unable to sell his home for what he owed, he said, he gave it back to the bank last year. Like other communities across America, Park Place South has been hit with a foreclosure crisis affecting at least 10 percent of its 232 homes, according to Masharn Wilson, a developer who led Mr. Bush’s tour.
“I just don’t think what he envisioned was actually carried out,” she said.
Park Place South is, in microcosm, the story of a well-intentioned policy gone awry. Advocating homeownership is hardly novel; the Clinton administration did it, too. For Mr. Bush, it was part of his vision of an “ownership society,” in which Americans would rely less on the government for health care, retirement and shelter. It was also good politics, a way to court black and Hispanic voters.
But for much of Mr. Bush’s tenure, government statistics show, incomes for most families remained relatively stagnant while housing prices skyrocketed. That put homeownership increasingly out of reach for first-time buyers like Mr. West.
So Mr. Bush had to, in his words, “use the mighty muscle of the federal government” to meet his goal. He proposed affordable housing tax incentives. He insisted that Fannie Mae and Freddie Mac meet ambitious new goals for low-income lending.
Concerned that down payments were a barrier, Mr. Bush persuaded Congress to spend up to $200 million a year to help first-time buyers with down payments and closing co(Page 3 of 6)
And he pushed to allow first-time buyers to qualify for federally insured mortgages with no money down. Republican Congressional leaders and some housing advocates balked, arguing that homeowners with no stake in their investments would be more prone to walk away, as Mr. West did. Many economic experts, including some in the White House, now share that view.
The president also leaned on mortgage brokers and lenders to devise their own innovations. “Corporate America,” he said, “has a responsibility to work to make America a compassionate place.”
And corporate America, eyeing a lucrative market, delivered in ways Mr. Bush might not have expected, with a proliferation of too-good-to-be-true teaser rates and interest-only loans that were sold to investors in a loosely regulated environment.
“This administration made decisions that allowed the free market to operate as a barroom brawl instead of a prize fight,” said L. William Seidman, who advised Republican presidents and led the savings and loan bailout in the 1990s. “To make the market work well, you have to have a lot of rules.”
But Mr. Bush populated the financial system’s alphabet soup of oversight agencies with people who, like him, wanted fewer rules, not more.
Like Minds on Laissez-Faire
The president’s first chairman of the Securities and Exchange Commission promised a “kinder, gentler” agency. The second was pushed out amid industry complaints that he was too aggressive. Under its current leader, the agency failed to police the catastrophic decisions that toppled the investment bank Bear Stearns and contributed to the current crisis, according to a recent inspector general’s report.
As for Mr. Bush’s banking regulators, they once brandished a chain saw over a 9,000-page pile of regulations as they promised to ease burdens on the industry. When states tried to use consumer protection laws to crack down on predatory lending, the comptroller of the currency blocked the effort, asserting that states had no authority over national banks.
The administration won that fight at the Supreme Court. But Roy Cooper, North Carolina’s attorney general, said, “They took 50 sheriffs off the beat at a time when lending was becoming the Wild West.”
The president did push rules aimed at forcing lenders to more clearly explain loan terms. But the White House shelved them in 2004, after industry-friendly members of Congress threatened to block confirmation of his new housing secretary.
In the 2004 election cycle, mortgage bankers and brokers poured nearly $847,000 into Mr. Bush’s re-election campaign, more than triple their contributions in 2000, according to the nonpartisan Center for Responsive Politics. The administration did not finalize the new rules until last month.
Among the Republican Party’s top 10 donors in 2004 was Roland Arnall. He founded Ameriquest, then the nation’s largest lender in the subprime market, which focuses on less creditworthy borrowers. In July 2005, the company agreed to set aside $325 million to settle allegations in 30 states that it had preyed on borrowers with hidden fees and ballooning payments. It was an early signal that deceptive lending practices, which would later set off a wave of foreclosures, were widespread.
Andrew H. Card Jr., Mr. Bush’s former chief of staff, said White House aides discussed Ameriquest’s troubles, though not what they might portend for the economy. Mr. Bush had just nominated Mr. Arnall as his ambassador to the Netherlands, and the White House was primarily concerned with making sure he would be confirmed.
“Maybe I was asleep at the switch,” Mr. Card said in an interview.
Brian Montgomery, the Federal Housing Administration commissioner, understood the significance. His agency insures home loans, traditionally for the same low-income minority borrowers Mr. Bush wanted to help. When he arrived in June 2005, he was shocked to find those customers had been lured away by the “fool’s gold” of subprime loans. The Ameriquest settlement, he said, reinforced his concern that the industry was exploiting borrowers.
In December 2005, Mr. Montgomery drafted a memo and brought it to the White House. “I don’t think this is what the president had in mind here,” he recalled telling Ryan Streeter, then the president’s chief housing policy analyst.
It was an opportunity to address the risky subprime lending practices head on. But that was never seriously discussed. More senior aides, like Karl Rove, Mr. Bush’s chief political strategist, were wary of overly regulating an industry that, Mr. Rove said in an interview, provided “a valuable service to people who could not otherwise get credit.” While he had some concerns about the industry’s practices, he said, “it did provide an opportunity for people, a lot of whom are still in their houses today.”
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The White House pursued a narrower plan offered by Mr. Montgomery that would have allowed the F.H.A. to loosen standards so it could lure back subprime borrowers by insuring similar, but safer, loans. It passed the House but died in the Senate, where Republican senators feared that the agency would merely be mimicking the private sector’s risky practices — a view Mr. Rove said he shared.
Looking back at the episode, Mr. Montgomery broke down in tears. While he acknowledged that the bill did not get to the root of the problem, he said he would “go to my grave believing” that at least some homeowners might have been spared foreclosure.
Today, administration officials say it is fair to ask whether Mr. Bush’s ownership push backfired. Mr. Paulson said the administration, like others before it, “over-incented housing.” Mr. Hennessey put it this way: “I would not say too much emphasis on expanding homeownership. I would say not enough early focus on easy lending practices.”
‘We Told You So’
Armando Falcon Jr. was preparing to take on a couple of giants.
A soft-spoken Texan, Mr. Falcon ran the Office of Federal Housing Enterprise Oversight, a tiny government agency that oversaw Fannie Mae and Freddie Mac, two pillars of the American housing industry. In February 2003, he was finishing a blockbuster report that warned the pillars could crumble.
Created by Congress, Fannie and Freddie — called G.S.E.’s, for government-sponsored entities — bought trillions of dollars’ worth of mortgages to hold or sell to investors as guaranteed securities. The companies were also Washington powerhouses, stuffing lawmakers’ campaign coffers and hiring bare-knuckled lobbyists.
Mr. Falcon’s report outlined a worst-case situation in which Fannie and Freddie could default on debt, setting off “contagious illiquidity in the market” — in other words, a financial meltdown. He also raised red flags about the companies’ soaring use of derivatives, the complex financial instruments that economic experts now blame for spreading the housing collapse.
Today, the White House cites that report — and its subsequent effort to better regulate Fannie and Freddie — as evidence that it foresaw the crisis and tried to avert it. Bush officials recently wrote up a talking points memo headlined “G.S.E.’s — We Told You So.”
But the back story is more complicated. To begin with, on the day Mr. Falcon issued his report, the White House tried to fire him.
At the time, Fannie and Freddie were allies in the president’s quest to drive up homeownership rates; Franklin D. Raines, then Fannie’s chief executive, has fond memories of visiting Mr. Bush in the Oval Office and flying aboard Air Force One to a housing event. “They loved us,” he said.
So when Mr. Falcon refused to deep-six his report, Mr. Raines took his complaints to top Treasury officials and the White House. “I’m going to do what I need to do to defend my company and my position,” Mr. Raines told Mr. Falcon.
Days later, as Mr. Falcon was in New York preparing to deliver a speech about his findings, his cellphone rang. It was the White House personnel office, he said, telling him he was about to be unemployed.
His warnings were buried in the next day’s news coverage, trumped by the White House announcement that Mr. Bush would replace Mr. Falcon, a Democrat appointed by Bill Clinton, with Mark C. Brickell, a leader in the derivatives industry that Mr. Falcon’s report had flagged.
It was not until 2003, when Freddie became embroiled in an accounting scandal, that the White House took on the companies in earnest. Mr. Bush decided to quit the long-standing practice of rewarding supporters with high-paying appointments to the companies’ boards — “political plums,” in Mr. Rove’s words. He also withdrew Mr. Brickell’s nomination and threw his support behind Mr. Falcon, beginning an intense effort to give his little regulatory agency more power.
Mr. Falcon lacked explicit authority to limit the size of the companies’ mammoth investment portfolios, or tell them how much capital they needed to guard against losses. White House officials wanted that to change. They also wanted the power to put the companies into receivership, hoping that would end what Mr. Card, the former chief of staff, called “the myth of government backing,” which gave the companies a competitive edge because investors assumed the government would not let them fail.
By the spring of 2005 a deal with Congress seemed within reach, Mr. Snow, the former Treasury secretary, said in an interview.
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Michael G. Oxley, an Ohio Republican and then-chairman of the House Financial Services Committee, had produced what Mr. Snow viewed as “a pretty darned good bill,” a watered-down version of what the president sought. But at the urging of Mr. Card and the White House economics team, the president decided to hold out for a tougher bill in the Senate.
Mr. Card said he feared that Mr. Snow was “more interested in the deal than the result.” When the bill passed the House, the president issued a statement opposing it, effectively killing any chance of compromise. Mr. Oxley was furious.
“The problem with those guys at the White House, they had all the answers and they didn’t think they had to listen to anyone, including the Treasury secretary,” Mr. Oxley said in a recent interview. “They were driving the ideological train. He was in the caboose, and they were in the engine room.”
Mr. Card and Mr. Hennessey said they had no regrets. They are convinced, Mr. Hennessey said, that the Oxley bill would have produced “the worst of all possible outcomes,” the illusion of reform without the substance.
Still, some former White House and Treasury officials continue to debate whether Mr. Bush’s all-or-nothing approach scuttled a measure that, while imperfect, might have given an aggressive regulator enough power to keep the companies from failing.
Mr. Snow, for one, calls Mr. Oxley “a hero,” adding, “He saw the need to move. It didn’t get done. And it’s too bad, because I think if it had, I think we could well have avoided a big contributor to the current crisis.”
Unheeded Warnings
Jason Thomas had a nagging feeling.
The New Century Financial Corporation, a huge subprime lender whose mortgages were bundled into securities sold around the world, was headed for bankruptcy in March 2007. Mr. Thomas, an economic analyst for President Bush, was responsible for determining whether it was a hint of things to come.
At 29, Mr. Thomas had followed a fast-track career path that took him from a Buffalo meatpacking plant, where he worked as a statistician, to the White House. He was seen as a whiz kid, “a brilliant guy,” his former boss, Mr. Hubbard, says.
As Mr. Thomas began digging into New Century’s failure that spring, he became fixated on a particular statistic, the rent-to-own ratio.
Typically, as home prices increase, rental costs rise proportionally. But Mr. Thomas sent charts to top White House and Treasury officials showing that the monthly cost of owning far outpaced the cost to rent. To Mr. Thomas, it was a sign that housing prices were wildly inflated and bound to plunge, a condition that could set off a foreclosure crisis as conventional and subprime borrowers with little equity found they owed more than their houses were worth.
It was not the Bush team’s first warning. The previous year, Mr. Lindsay, the former chief economics adviser, returned to the White House to tell his old colleagues that housing prices were headed for a crash. But housing values are hard to evaluate, and Mr. Lindsay had a reputation as a market pessimist, said Mr. Hubbard, adding, “I thought, ‘He’s always a bear.’ ”
In retrospect, Mr. Hubbard said, Mr. Lindsay was “absolutely right,” and Mr. Thomas’s charts “should have been a signal.”
Instead, the prevailing view at the White House was that the problems in the housing market were limited to subprime borrowers unable to make their payments as their adjustable mortgages reset to higher rates. That belief was shared by Mr. Bush’s new Treasury secretary, Mr. Paulson.
Mr. Paulson, a former chairman of the Wall Street firm Goldman Sachs, had been given unusual power; he had accepted the job only after the president guaranteed him that Treasury, not the White House, would have the dominant role in shaping economic policy. That shift merely continued an imbalance of power that stifled robust policy debate, several former Bush aides say.
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Throughout the spring of 2007, Mr. Paulson declared that “the housing market is at or near the bottom,” with the problem “largely contained.” That position underscored nearly every action the Bush administration took in the ensuing months as it offered one limited response after another.
By that August, the problems had spread beyond New Century. Credit was tightening, amid questions about how heavily banks were invested in securities linked to mortgages. Still, Mr. Bush predicted that the turmoil would resolve itself with a “soft landing.”
The plan Mr. Bush announced on Aug. 31 reflected that belief. Called “F.H.A. Secure,” it aimed to help about 80,000 homeowners refinance their loans. Mr. Montgomery, the housing commissioner, said that he knew the modest program was not enough — the White House later expanded the agency’s rescue role — and that he would be “flying the plane and fixing it at the same time.”
That fall, Representative Rahm Emanuel, a leading Democrat, former investment banker and now the incoming chief of staff to President-elect Barack Obama, warned the White House it was not doing enough. He said he told Joshua B. Bolten, Mr. Bush’s chief of staff, and Mr. Paulson in a series of phone calls that the credit crisis would get “deep and serious” and that the only answer was big, internationally coordinated government intervention.
“You got to strangle this thing and suffocate it,” he recalled saying.
Instead, Mr. Bush developed Hope Now, a voluntary public-private partnership to help struggling homeowners refinance loans. And he worked with Congress to pass a stimulus package that sent taxpayers $150 billion in tax rebates.
In a speech to the Economic Club of New York in March 2008, he cautioned against Washington’s temptation “to say that anything short of a massive government intervention in the housing market amounts to inaction,” adding that government action could make it harder for the markets to recover.
Dominoes Start to Fall
Within days, Bear Sterns collapsed, prompting the Federal Reserve to engineer a hasty sale. Some economic experts, including Timothy F. Geithner, the president of the New York Federal Reserve Bank (and Mr. Obama’s choice for Treasury secretary) feared that Fannie Mae and Freddie Mac could be the next to fall.
Mr. Bush was still leaning on Congress to revamp the tiny agency that oversaw the two companies, and had acceded to Mr. Paulson’s request for the negotiating room that he had denied Mr. Snow. Still, there was no deal.
Over the previous two years, the White House had effectively set the agency adrift. Mr. Falcon left in 2005 and was replaced by a temporary director, who was in turn replaced by James B. Lockhart, a friend of Mr. Bush from their days at Andover, and a former deputy commissioner of the Social Security Administration who had once run a software company.
On Mr. Lockhart’s watch, both Freddie and Fannie had plunged into the riskiest part of the market, gobbling up more than $400 billion in subprime and other alternative mortgages. With the companies on precarious footing, Mr. Geithner had been advocating that the administration seize them or take other steps to reassure the market that the government would back their debt, according to two people with direct knowledge of his views.
In an Oval Office meeting on March 17, however, Mr. Paulson barely mentioned the idea, according to several people present. He wanted to use the troubled companies to unlock the frozen credit market by allowing Fannie and Freddie to buy more mortgage-backed securities from overburdened banks. To that end, Mr. Lockhart’s office planned to lift restraints on the companies’ huge portfolios — a decision derided by former White House and Treasury officials who had worked so hard to limit them.
But Mr. Paulson told Mr. Bush the companies would shore themselves up later by raising more capital.
“Can they?” Mr. Bush asked.
“We’re hoping so,” the Treasury secretary replied.
That turned out to be incorrect, and did not surprise Mr. Thomas, the Bush economic adviser. Throughout that spring and summer, he warned the White House and Treasury that, in the stark words of one e-mail message, “Freddie Mac is in trouble.” And Mr. Lockhart, he charged, was allowing the company to cover up its insolvency with dubious accounting maneuvers.
But Mr. Lockhart continued to offer reassurances. In a July appearance on CNBC, he declared that the companies were well managed and “worsts were not coming to worst.” An infuriated Mr. Thomas sent a fresh round of e-mail messages accusing Mr. Lockhart of “pimping for the stock prices of the undercapitalized firms he regulates.”
Mr. Lockhart defended himself, insisting in an interview that he was aware of the companies’ vulnerabilities, but did not want to rattle markets.
“A regulator,” he said, “does not air dirty laundry in public.”
Soon afterward, the companies’ stocks lost half their value in a single day, prompting Congress to quickly give Mr. Paulson the power to spend $200 billion to prop them up and to finally pass Mr. Bush’s long-sought reform bill, but it was too late. In September, the government seized control of Freddie Mac and Fannie Mae.
In an interview, Mr. Paulson said the administration had no justification to take over the companies any sooner. But Mr. Falcon disagreed: “They absolutely could have if they had thought there was a real danger.”
By Sept. 18, when Mr. Bush and his team had their fateful meeting in the Roosevelt Room after the failure of Lehman Brothers and the emergency rescue of A.I.G., Mr. Paulson was warning of an economic calamity greater than the Great Depression. Suddenly, historic government intervention seemed the only option. When Mr. Paulson spelled out what would become a $700 billion plan to rescue the nation’s banking system, the president did not hesitate.
“Is that enough?” Mr. Bush asked.
“It’s a lot,” the Treasury secretary recalled replying. “It will make a difference.” And in any event, he told Mr. Bush, “I don’t think we can get more.”
As the meeting wrapped up, a handful of aides retreated to the White House Situation Room to call Vice President Dick Cheney in Florida, where he was attending a fund-raiser. Mr. Cheney had long played a leading role in economic policy, though housing was not a primary interest, and like Mr. Bush he had a deep aversion to government intervention in the market. Nonetheless, he backed the bailout, convinced that too many Americans would suffer if Washington did nothing.
Mr. Bush typically darts out of such meetings quickly. But this time, he lingered, patting people on the back and trying to soothe his downcast staff. “During times of adversity, he bucks everybody up,” Mr. Paulson said.
It was not the end of the failures or government interventions; the administration has since stepped in to rescue Citigroup and, just last week, the Detroit automakers. With 31 days left in office, Mr. Bush says he will leave it to historians to analyze “what went right and what went wrong,” as he put it in a speech last week to the American Enterprise Institute.
Mr. Bush said he was too focused on the present to do much looking back.
“It turns out,” he said, “this isn’t one of the presidencies where you ride off into the sunset, you know, kind of waving goodbye.”
Wednesday, December 3, 2008
James K. Happ, 48, formerly a vice president of Dublin-based National Century Financial Enterprises, faces charges of conspiracy, money-laundering con
Happ was in charge of overseeing which accounts receivables were bought by National Century in its final years of business...
Ten executives of the defunct health-care lender have been convicted...
"...federal prosecutors showed that the company advanced billions to health-care companies between 1995 and 2002"
One should ask : "Just prior to arriving at NCFE, where did James K Happ come from?" CFO at (HCA's) Columbia Homecare Group, Inc. (SEC Source) His difficult taks was the 'divestiture' of losing assets. Well , guess where he dumped these?
Go to the 1999 Bankruptcy Case of Medshares, Inc. in Memphis, Tennessee. (On the other side of Nashville--you know where HCA is.)
In 1999, this case was the largest bankruptcy case in the Western District in Tennessee Federal Bankruptcy Court. Low and behold, 2000 the FBI RAIDED NCFE's office in Dublin, Ohio. 2002 company filed bankruptcy.
Some of the largest unsecured loans were given to companies owned wholly or partly by National Century executives.
Happ was "one of the top advancers at NCFE," who approved unsecured loans worth more than $100 million, Assistant U.S. Attorney Doug Squires told jurors yesterday in opening statements.
The advances were no secret, defense attorney Craig A. Gillen countered. They were a common practice known to auditors and rating agencies before Happ started with the company in February 2000 and after he left in the spring of 2002.
His task was to divest the losing Oh and guess what...THE BILLIONAIRE Richard Rainwater is located at the same address as Columbia Homecare Group, Inc.
??? Well, you need to go to another state...TENNESSEE. The largest Bankruptcy case in the hiostory of the . The Medshares ponsi scheme that was ignored.
Fraud trial begins for final company leader
Former vice president accused of approving unsecured loans
Wednesday, December 3, 2008 3:17 AM
By Jodi Andes
THE COLUMBUS DISPATCH
The 11th -- and last -- executive charged in what was dubbed the nation's largest fraud involving a private company went on trial in federal court in Columbus yesterday.
James K. Happ, 48, formerly a vice president of Dublin-based National Century Financial Enterprises, faces charges of conspiracy, money-laundering conspiracy and three counts of wire fraud. He has pleaded not guilty.
The company bought accounts receivables from health-care providers and collected the bills for a fee. Bonds were sold to investors.
Happ was in charge of overseeing which accounts receivables were bought by National Century in its final years of business, which ended with its bankruptcy in 2002. Investors lost more than $2 billion.
Ten executives of the defunct health-care lender have been convicted for their roles in a multibillion-dollar fraud that resulted in the bankruptcies of numerous health-care companies and hurt investors, among them pension funds across the country.
In two previous trials of executives this year, federal prosecutors showed that the company advanced billions to health-care companies between 1995 and 2002 in loans that had no accounts receivable as collateral. The practice was unknown to investors, who were told the bonds were secure.
Some of the largest unsecured loans were given to companies owned wholly or partly by National Century executives.
Happ was "one of the top advancers at NCFE," who approved unsecured loans worth more than $100 million, Assistant U.S. Attorney Doug Squires told jurors yesterday in opening statements.
It was a "staggering misuse of investor money," Squires said.
The advances were no secret, defense attorney Craig A. Gillen countered. They were a common practice known to auditors and rating agencies before Happ started with the company in February 2000 and after he left in the spring of 2002.
Happ then went to work for Tender Loving Care, one of the lender's clients. At that time, National Century's overpaid advances to that company alone totaled about $99 million. After Happ became chief executive of Tender Loving Care, he saw that all the advances from National Century were repaid, Gillen said.
Happ's case is being tried before U.S. District Judge Algenon L. Marbley and is expected to last two to three weeks.
Of the 10 former National Century executives previously convicted, six have been sentenced to terms ranging from four to 15 years in prison.
One, Rebecca S. Parrett, remains at large, having taken off while awaiting sentencing. Former CEO Lance K. Poulsen and two others await sentencing.
jandes@dispatch.com
Ten executives of the defunct health-care lender have been convicted...
"...federal prosecutors showed that the company advanced billions to health-care companies between 1995 and 2002"
One should ask : "Just prior to arriving at NCFE, where did James K Happ come from?" CFO at (HCA's) Columbia Homecare Group, Inc. (SEC Source) His difficult taks was the 'divestiture' of losing assets. Well , guess where he dumped these?
Go to the 1999 Bankruptcy Case of Medshares, Inc. in Memphis, Tennessee. (On the other side of Nashville--you know where HCA is.)
In 1999, this case was the largest bankruptcy case in the Western District in Tennessee Federal Bankruptcy Court. Low and behold, 2000 the FBI RAIDED NCFE's office in Dublin, Ohio. 2002 company filed bankruptcy.
Some of the largest unsecured loans were given to companies owned wholly or partly by National Century executives.
Happ was "one of the top advancers at NCFE," who approved unsecured loans worth more than $100 million, Assistant U.S. Attorney Doug Squires told jurors yesterday in opening statements.
The advances were no secret, defense attorney Craig A. Gillen countered. They were a common practice known to auditors and rating agencies before Happ started with the company in February 2000 and after he left in the spring of 2002.
His task was to divest the losing Oh and guess what...THE BILLIONAIRE Richard Rainwater is located at the same address as Columbia Homecare Group, Inc.
??? Well, you need to go to another state...TENNESSEE. The largest Bankruptcy case in the hiostory of the . The Medshares ponsi scheme that was ignored.
Fraud trial begins for final company leader
Former vice president accused of approving unsecured loans
Wednesday, December 3, 2008 3:17 AM
By Jodi Andes
THE COLUMBUS DISPATCH
The 11th -- and last -- executive charged in what was dubbed the nation's largest fraud involving a private company went on trial in federal court in Columbus yesterday.
James K. Happ, 48, formerly a vice president of Dublin-based National Century Financial Enterprises, faces charges of conspiracy, money-laundering conspiracy and three counts of wire fraud. He has pleaded not guilty.
The company bought accounts receivables from health-care providers and collected the bills for a fee. Bonds were sold to investors.
Happ was in charge of overseeing which accounts receivables were bought by National Century in its final years of business, which ended with its bankruptcy in 2002. Investors lost more than $2 billion.
Ten executives of the defunct health-care lender have been convicted for their roles in a multibillion-dollar fraud that resulted in the bankruptcies of numerous health-care companies and hurt investors, among them pension funds across the country.
In two previous trials of executives this year, federal prosecutors showed that the company advanced billions to health-care companies between 1995 and 2002 in loans that had no accounts receivable as collateral. The practice was unknown to investors, who were told the bonds were secure.
Some of the largest unsecured loans were given to companies owned wholly or partly by National Century executives.
Happ was "one of the top advancers at NCFE," who approved unsecured loans worth more than $100 million, Assistant U.S. Attorney Doug Squires told jurors yesterday in opening statements.
It was a "staggering misuse of investor money," Squires said.
The advances were no secret, defense attorney Craig A. Gillen countered. They were a common practice known to auditors and rating agencies before Happ started with the company in February 2000 and after he left in the spring of 2002.
Happ then went to work for Tender Loving Care, one of the lender's clients. At that time, National Century's overpaid advances to that company alone totaled about $99 million. After Happ became chief executive of Tender Loving Care, he saw that all the advances from National Century were repaid, Gillen said.
Happ's case is being tried before U.S. District Judge Algenon L. Marbley and is expected to last two to three weeks.
Of the 10 former National Century executives previously convicted, six have been sentenced to terms ranging from four to 15 years in prison.
One, Rebecca S. Parrett, remains at large, having taken off while awaiting sentencing. Former CEO Lance K. Poulsen and two others await sentencing.
jandes@dispatch.com
Thursday, November 13, 2008
Thomas Jefferson, 3rd president of US
Thomas Jefferson,
Letter to the Secretary of the Treasury Albert Gallatin (1802)
3rd president of US (1743 - 1826)
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
Letter to the Secretary of the Treasury Albert Gallatin (1802)
3rd president of US (1743 - 1826)
I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.
Tuesday, November 11, 2008
Glass-Steagall: How About Housing?
Just as Congress was repealing Glass-Steagall in 1999, the tech stock bubble was inflating beyond sustainability. It would soon be pricked, ushering in a brief recession during which investors began the hunt for the next big thing.
Glass-Steagall: How About Housing?
The mess that resulted from letting investment and commercial banking join together after the repeal of Glass-Steagall...
In 1999, they got their way with the enactment of the Financial Services Modernization Act. The door was opened to consolidation in the banking industry.
Glass-Steagall: the Banking Act of 1933
Glass-Steagall created the Federal Deposit Insurance Corporation (FDIC) to protect...
The Glass-Steagall Act remained in force for six-and-a-half decades, ...
Glass-Steagall had prevented them from selling debt-backed securities for which they were the underwriters...
Glass-Steagall: Bubble, Bubble...
Glass-Steagall Act: Capital & the Capitol
Banking Act of 1933, usually referred to as the Glass-Steagall Act.
In 1999, they got their way with the enactment of the Financial Services Modernization Act. The door was opened to consolidation in the banking industry.
The biggest factor here was the removal of Glass-Steagall prohibitions, but there were two other important tweakings. The Commodities Futures Modernization Act of 2000, for example, transformed the new mortgage-backed securities (MBS) into a commodity, enabling them to be traded on futures exchanges with little oversight by any federal or state regulatory body.
Glass-Steagall Act: Riding Roughshod Across the Division of Banks
Glass-Steagall: How About Housing?
CURRENTLY we find ourselves in a mess that many are calling the most serious economic crisis since the Great Depression – if not worse, writes Doug Hornig, editor of Big Gold for Casey Research.
A mile-high mountain of paper profits has been set ablaze and reduced to ashes, choking investors who put their faith in houses, stocks, or commodities, or just about anything else you care to name.
The bad news is that no one completely understands what's going on; the good news is that, yes, a measure of sense can be made of the madness. Being armed with that bit of understanding should enable us to survive the tsunami...even prosper.
Glass-Steagall: the Banking Act of 1933
Until recently, average Americans were only dimly aware that there were two types of banks – the commercial banks nearby and the major investment banks located in faraway New York. Understanding the bank where they conducted business, with people they knew, was enough. The big, impersonal Wall Street banks – which dealt in higher-risk investments with potentially higher rewards – were for companies and the very rich only.
But while ordinary citizens thought very little about this distinction among the banks, the government did. Seventy-five years ago, as the Depression deepened, lawmakers were desperately trying to determine the causes of the crisis (read, looking for scapegoats). Some of the things they found were conflicts of interest and opportunities for fraud, all linked to the mixing of commercial and investment banking. So Congress decided to erect a "wall" between commercial and investment banking, and so passed the Banking Act of 1933, usually referred to as the Glass-Steagall Act.
Glass-Steagall created the Federal Deposit Insurance Corporation (FDIC) to protect depositors in commercial banks, and it also forbade commercial banks from underwriting securities or acting as stockbrokers or dealers.
The Glass-Steagall Act remained in force for six-and-a-half decades, although various deregulatory measures and changes in exchange rules chipped away at it. Notably, in 1970 a rule excluding public companies from membership in the New York Stock Exchange was dropped. The last major private institution, Goldman Sachs, went public in 1999. This allowed investment banks to sell stock to any potential investor and greatly expand their capital base.
Over the last two decades of the 20th century, the financial industry lobbied vigorously for the repeal of the Glass-Steagall Banking Act. In 1999, they got their way with the enactment of the Financial Services Modernization Act. The door was opened to consolidation in the banking industry.With one stroke of a pen, commercial bankers could begin turning their loans into investment products. (Glass-Steagall had prevented them from selling debt-backed securities for which they were the underwriters.) So Wall Street investment banks were suddenly in the mortgage business. It would prove to be a marriage made somewhere significantly south of heaven.
Glass-Steagall: Bubble, Bubble...
We're not fans of government regulation, but a deregulated marketplace carries with it certain imperatives. Because it will only function as it should do in the absence of both criminal and boneheaded behavior. We can erect oversights meant to prevent the former and laws to punish it after the fact. But all the regulation in the world won't do much about the latter – the bone-headed behavior of some investors – since both market traders and the regulation itself may be boneheaded.
The biggest factor here was the removal of Glass-Steagall prohibitions, but there were two other important tweakings. The Commodities Futures Modernization Act of 2000, for example, transformed the new mortgage-backed securities (MBS) into a commodity, enabling them to be traded on futures exchanges with little oversight by any federal or state regulatory body.
Completing the trifecta, the Securities and Exchange Commission in 2004 waived its leverage rules. Previously, broker/dealer net-capital rules limited firms to a maximum debt-to-net-capital ratio of 12 to 1. But under the new regulations, five companies – Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns, and Morgan Stanley – were granted an exemption, which they promptly used to lever up 20, 30, even 40 to 1.
That means $1 of equity underpinned up to $40 of investment risk. So a 2.5% drop in asset prices would wipe out the actual cash underlying a position...leaving only debt and losses.
Just as Congress was repealing Glass-Steagall in 1999, the tech stock bubble was inflating beyond sustainability. It would soon be pricked, ushering in a brief recession during which investors began the hunt for the next big thing.
Glass-Steagall: How About Housing?
Back in 1977, Congress had passed the Community Reinvestment Act, which had the goal of extending homeownership to the largest possible pool of Americans. Over the next 25 years, legislative supplements, a robust housing market, and aggressive government enforcement of "fairness in lending" combined to weaken bank standards regarding who did – or didn't – qualify for a loan.
But that was just the beginning. In an effort to end that recession in the new century's first years, the Greenspan Fed reduced interest rates to near zero and poured liquidity into the financial markets. At the same time, capital that had fled the stock market was looking for action. It found it in housing.
The commercial banks – and independent mortgagors like Countrywide Credit – were awash in cash. They started lending it, and every borrower's credentials were deemed excellent, even those with low income, bad credit, and no money for a down payment.
The perfect storm was building. But at first, boy! Did things ever look so rosy? The country's homeownership rate – 62.1% in 1960, rising to only 64.1% in 1994 – shot up to 68.9% by 2006.
As homeowner mania seized hold of the public imagination, people began treating their homes as ATMs. If they needed cash, they borrowed against their growing equity. Real estate speculators flipped houses like crazy. And why not, when there was no risk? Housing prices only head in one direction – up, Up, UP! Right?
It sure looked that way. The yearly average median price of an existing home went from $23,000 in 1970, to $62,200 in 1980, to $97,300 in 1990, to $147,300 in 2000 and crested at $221,900 in 2006. Astonishingly, and despite recessions in the early '80s and early '00s, there wasn't a single down year for US housing as a national average in all of that time.
However, in 2007 housing became the latest bubble to burst, pricked by unrealistic prices, overbuilding, and the retreat from ultra-low interest rates. Concurrently, as house prices finally began to drop, a whole bunch of those no- or low-interest loans began to reset.
Glass-Steagall: Why Do Rational People Act So Stupid?
Despite the well-earned reputation of some Wall Street high rollers, bankers tend not to be a reckless lot, nor financial dunces. In general, they would rather deploy a large amount of capital into a safe, low-yield investment than put a small amount of capital into something with very high risk.
With the new environment, however, the game changed. Commercial bankers found themselves making loans to shakier and shakier recipients, while at the same time, the investment banks and their clients were clamoring for new investment products.
So bankers did what any conservative person would do. They hedged their bets. They bundled up their loans and sold the packages to the investment banks. The outcome was essentially the mortgage business being uprooted from the commercial banks and transplanted into the investment houses, which have far less restrictive requirements about reserve capital, far fewer limits on the buying and selling of securities, and far less regulatory oversight.
The investment banks did not set out, of course, to become landlords. They just wanted to sell some product for which there was a ready market. As capitalist ingenuity collided with profit motive, they found there was no shortage of products that could be created.
The mortgage bundles were sliced, diced, and repackaged into a bewildering array of securities, such as structured investment vehicles (SIVs), collateralized debt obligations (CDOs), mortgage-backed securities (MBSs), and on and on.
The extent of the slicing and dicing into what financial chefs refer to as tranches was such that the original mortgage might be tossed from buyer to buyer, or even itself split into parts. Each time a package was put together and sold, the seller stretched to get top dollar for each tranche, requiring the underlying assets to be risk-rated and then assigned real-world value. In the end, rating services had little idea what they were rating (we're being charitable here), and buyers had no idea what their purchase was really worth.
And always lurking in the background was the possibility that defaults on the mortgages supporting the entire process could have a profound ripple effect, given that these products became increasingly leveraged. Knowing this, traders invented credit default swaps (CDSs), those gnarly little creatures that morphed into Godzilla after 2004.
CDSs are an insurance policy, a way of dealing with fear, and a device for attenuating the risk inherent in trading products one may not fully understand. Those buying the protection pay an upfront amount and yearly premiums to the protection sellers, who agree in return to cover any loss to the face value of the security. The result is a private, two-party contract, devoid of regulatory oversight.
There are a bunch of nasty horseflies in this particular ointment. For one, the holder of that security (who is now "protected" by a CDS) might turn around and sell it to a third party, who might himself insure and resell it, and so on, creating an impossibly complex chain of ownership and obligation. Additionally, the CDS itself can be traded over the counter. Furthermore, any of the underlying assets might also get partitioned into different tranches, adding to the confusion. And finally, short sellers can work on just about any joint in the structure.
And here's the really big rub. Suppose the party providing the initial insurance protection – having already collected its upfront payment and premiums – doesn't have the money to pay the insured buyer when a default occurs. Or suppose the "insurer" goes bankrupt. In either instance, the buyer who thought he was protected finds himself left naked and alone.
However, that possibility seems not to have been considered as the financial world created an interlocking system of derivatives that not even a Cray supercomputer could sort out. The only certainty: it was an arrangement that depended on a robust economy and rising house prices.
Except, of course, things didn't work out that way.
When the housing slump hit, defaults in the relatively small subprime sector (less than 20% of mortgages) started a chain reaction that raced through the derivatives market, the effects compounding geometrically, until finally the world financial structure was facing collapse.
Glass-Steagall Act: Capital & the Capitol
When capital is allocated in a free market, it moves toward the productive, and the economy tends to prosper. By the same token, when it is misallocated, an economy can hit the skids.
We've had decades of misallocated capital in the United States. Instead of saving, we've been spending...and spending way beyond our means. Rather than investing in something productive, we've been gambling, taking on ever greater risks in the hope of the big payoff. Instead of creating the clean balance sheets that support stability – at all levels, personal, corporate, and governmental – we've piled up mountains of unsustainable debt.
The tragedy is that the prudent will suffer right along with the reckless. Misallocations of capital must be unwound, one way or another, before the economy can get back on its feet. It will be no simple task, and it's made even more difficult by those who put themselves in charge of the clean-up: certain residents of Washington, D.C.
At the center of the storm are two men who propose to save the nation, and they could hardly be more different.
Secretary of the Treasury Henry Paulson is the Street's guy. The former CEO of Goldman Sachs, the most powerful and successful investment bank, he brings a Wall Street insider's perspective to the table. However committed to public service he may be, he cannot be expected to act against the interests of his friends in the banking community.
And then there's Fed chairman Ben Bernanke, a pure academician. For better or worse, Bernanke's specialty is America's Great Depression, and he considers himself an expert on the subject. Above all else, he wants to be remembered as the guy who understood how to steer the country away from the shoals of a Second Great Depression.
But there is no question that Big Ben and Hammerin' Hank are trying to navigate in unfamiliar waters. Today's economy hardly mirrors that of a decade ago, much less the conditions of the 1930s. For one thing, the Glass-Steagall Act separating commercial from investment banks has been...and gone.
Back in the spring of 2007, as the initial cracks in the current structure began to appear, few were expecting the broken-levee crisis that has since unfolded. A handful of savants saw it coming and said so, but no one in the mainstream was listening. What was actually happening was that the first dominoes – subprime borrowers who should never have been approved – had begun to fall.
In and of themselves, they would have been little more than straws in the wind. But because of the multiplier effect of the derivatives market, their influence reached far beyond a few blown mortgages. As more and more debtors were unable to pay, mortgage-backed securities lost value. And then the securities based on the MBSs lost value. And then the CDS written and sold against them.
Here's where CDSs were in fact supposed to ride to the rescue. They didn't, for the simple reason that they had long since strayed far from their original insurance intent, and become primarily an instrument that gave derivatives market players access to an asset class (mortgages) without having to actually own the asset.
As MBS values were hammered by defaults on the underlying loans, buyers of CDS protection began trying to collect. That hit CDS sellers, who were being drained of cash. Further out, derivatives speculators who had bet the wrong way defaulted or went bankrupt, sending shockwaves back down the line. Slowly at first, and then with increasing speed, the capital necessary to keep the system alive started drying up.
Glass-Steagall Act: Riding Roughshod Across the Division of BanksEveryone is familiar by now with the institutions that have collapsed or been bought out or taken over by the government. The list of names is stunning: Bear Stearns, Countrywide Credit, MBIA, Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Washington Mutual, Merrill Lynch, Wachovia. Wall Street has undergone a transformation unimaginable a year ago. The big investment banks are gone – bankrupted or swallowed up by someone else. Even the two that remain standing, Goldman and J.P.Morgan, have had to reinvent themselves as bank holding companies to save their own hides, riding still further across the division of commercial and investment banking which Glass-Steagall set up.
The movement of capital among financial institutions is based not only on integrity but on confidence. Right now, that confidence has evaporated. Banks are carrying so much paper of indeterminate value that it's impossible to price in the risk of making a loan. So they aren't lending to each other, out of fear that they'll never get their money back. The credit market, upon which our economy depends, has seized up. When the government finally got around to admitting that there was a problem, it was already too late for any simple fix. So Washington had only two options: stand back and let the market sort things out...or take drastic, emergency action.
No one knows quite what to make of Washington's response to the credit crisis. Some are howling that it's socialism, others that it's fascism or, at best, corporatism, an unholy alliance of private enterprise and the state.
Whatever the name, there is no question that the government is boldly going where none has gone before, helping to bail out some financial institutions and seizing control of others.
The Treasury Department now has $700 billion – albeit with some strings attached – with which it can buy up toxic waste paper through the Troubled Asset Relief Program (TARP). Taking this direction, instead of making direct loans, allows the "assets" they buy to be resold somewhere down the road. And perhaps, the plan's defenders say, even at a profit. Like that's gonna happen!
Proceeding in ways never before tried, in early October the Fed announced it was opening the Commercial Paper Funding Facility. For the first time, it will buy unsecured paper debt. To facilitate this and to cover potential losses, the Treasury will deposit an unspecified amount at the Fed. This is in addition to the Treasury's own buying spree, and the Fannie Freddie conservatorship, and the expansion of the FDIC to cover deposits up to $250,000, a move likely to send that agency back to the Treasury for another fill-up.
So far, however, all the government's actions to date have accomplished precious little. For the time being, credit remains frozen. Banks are still making overnight loans to other banks, but only very selectively. The stock market, despite coming off its lows, is extremely volatile after enduring its worst crash ever. Commodities have sold off. States and municipalities are facing severe budget cuts and, in some cases, bankruptcy. Money markets are in trouble. Pensions and retirement funds are at risk. And recession, or worse, looms increasingly large on the horizon.
Nor is the crisis purely an American problem. Much of the US bad paper was sold to gullible Europeans, and world economies and markets are so interconnected that if one sneezes, someone else catches a cold. Already there have been big bailouts in Germany and the United Kingdom. The Irish government recently announced it was guaranteeing all bank deposits, which attracted a flood of money from elsewhere in the European Union, enraged other members of the EU and raising questions of how long that shaky confederation can endure as each country charts its own path through the economic minefield.
This is a once-in-a-lifetime event, a train to nowhere, and it will cause no end of suffering. Since we can't stop it, we'll do the next best thing, which is to protect ourselves. That means assessing the likely fallout from the government's meddling in the market, and developing guidelines for the best way to ride out the hurricane.
Some consequences are already baked in the cake. Casey Research Chief Economist Bud Conrad has been studying the unfolding crisis for years. Based on his work, this is what we foresee:
More financial institutions will collapse. So will many hedge funds. Money market funds are also shaky; although the government will do all it can to keep them solvent, those that invest in anything but Treasury bills are at risk.
The economy will fall into recession. By most lights, it's already here. It won't be brief, and there is even a chance that despite all the Fed's pump priming, we could drop into a depression. For however long credit remains tight, business will be unable to function normally, and the consumer-driven economy will grind to a halt.
The whole structured finance model under which we've been operating is broken. The packaging of mortgages and other forms of consumer debt is impossible when no one will buy the packages. The trillions of dollars of outstanding mortgage derivatives will have to be unwound somehow.
Without debt leverage, private equity financing is dead. Raising money for business start-ups or expansion will be extremely challenging. IPOs will be few and far between. Leveraged buyouts are gone. Mergers and acquisitions will mostly be limited to distress sales.
At best, the government will succeed at what it's trying to do, i.e., stave off a depression, by sacrificing the dollar and allowing a fairly high level of inflation. If we're lucky, it won't turn into hyperinflation.
Interest rates are going up. On the day of the coordinated, worldwide rate cut, the Fed lowered its discount rate by 50 basis points, yet the yield on the 10-year Treasuries rose from 3.5 to 3.7%. The Fed's credibility is about shot, in other words, as it has debased its own balance sheet by swapping good debt for bad. With more than half of its reserves gone, it could itself become the subject of a Treasury Department bailout.
It is highly likely that the era of US economic dominance, when the almighty Dollar served as the reserve currency of the world, is drawing to a close.
But on the bright side...well, there is no bright side. The hole that we've dug for ourselves will take a while to climb out of, and it won't be easy. But at least you can protect yourself.
Protecting your assets is not just a buzzword anymore, it's mandatory if you want to keep yourself and your family financially safe in these tough times...which will only get tougher in the near future.
Doug Casey, 10 Nov '08
Glass-Steagall: How About Housing?
The mess that resulted from letting investment and commercial banking join together after the repeal of Glass-Steagall...
In 1999, they got their way with the enactment of the Financial Services Modernization Act. The door was opened to consolidation in the banking industry.
Glass-Steagall: the Banking Act of 1933
Glass-Steagall created the Federal Deposit Insurance Corporation (FDIC) to protect...
The Glass-Steagall Act remained in force for six-and-a-half decades, ...
Glass-Steagall had prevented them from selling debt-backed securities for which they were the underwriters...
Glass-Steagall: Bubble, Bubble...
Glass-Steagall Act: Capital & the Capitol
Banking Act of 1933, usually referred to as the Glass-Steagall Act.
In 1999, they got their way with the enactment of the Financial Services Modernization Act. The door was opened to consolidation in the banking industry.
The biggest factor here was the removal of Glass-Steagall prohibitions, but there were two other important tweakings. The Commodities Futures Modernization Act of 2000, for example, transformed the new mortgage-backed securities (MBS) into a commodity, enabling them to be traded on futures exchanges with little oversight by any federal or state regulatory body.
Glass-Steagall Act: Riding Roughshod Across the Division of Banks
Glass-Steagall: How About Housing?
CURRENTLY we find ourselves in a mess that many are calling the most serious economic crisis since the Great Depression – if not worse, writes Doug Hornig, editor of Big Gold for Casey Research.
A mile-high mountain of paper profits has been set ablaze and reduced to ashes, choking investors who put their faith in houses, stocks, or commodities, or just about anything else you care to name.
The bad news is that no one completely understands what's going on; the good news is that, yes, a measure of sense can be made of the madness. Being armed with that bit of understanding should enable us to survive the tsunami...even prosper.
Glass-Steagall: the Banking Act of 1933
Until recently, average Americans were only dimly aware that there were two types of banks – the commercial banks nearby and the major investment banks located in faraway New York. Understanding the bank where they conducted business, with people they knew, was enough. The big, impersonal Wall Street banks – which dealt in higher-risk investments with potentially higher rewards – were for companies and the very rich only.
But while ordinary citizens thought very little about this distinction among the banks, the government did. Seventy-five years ago, as the Depression deepened, lawmakers were desperately trying to determine the causes of the crisis (read, looking for scapegoats). Some of the things they found were conflicts of interest and opportunities for fraud, all linked to the mixing of commercial and investment banking. So Congress decided to erect a "wall" between commercial and investment banking, and so passed the Banking Act of 1933, usually referred to as the Glass-Steagall Act.
Glass-Steagall created the Federal Deposit Insurance Corporation (FDIC) to protect depositors in commercial banks, and it also forbade commercial banks from underwriting securities or acting as stockbrokers or dealers.
The Glass-Steagall Act remained in force for six-and-a-half decades, although various deregulatory measures and changes in exchange rules chipped away at it. Notably, in 1970 a rule excluding public companies from membership in the New York Stock Exchange was dropped. The last major private institution, Goldman Sachs, went public in 1999. This allowed investment banks to sell stock to any potential investor and greatly expand their capital base.
Over the last two decades of the 20th century, the financial industry lobbied vigorously for the repeal of the Glass-Steagall Banking Act. In 1999, they got their way with the enactment of the Financial Services Modernization Act. The door was opened to consolidation in the banking industry.With one stroke of a pen, commercial bankers could begin turning their loans into investment products. (Glass-Steagall had prevented them from selling debt-backed securities for which they were the underwriters.) So Wall Street investment banks were suddenly in the mortgage business. It would prove to be a marriage made somewhere significantly south of heaven.
Glass-Steagall: Bubble, Bubble...
We're not fans of government regulation, but a deregulated marketplace carries with it certain imperatives. Because it will only function as it should do in the absence of both criminal and boneheaded behavior. We can erect oversights meant to prevent the former and laws to punish it after the fact. But all the regulation in the world won't do much about the latter – the bone-headed behavior of some investors – since both market traders and the regulation itself may be boneheaded.
The biggest factor here was the removal of Glass-Steagall prohibitions, but there were two other important tweakings. The Commodities Futures Modernization Act of 2000, for example, transformed the new mortgage-backed securities (MBS) into a commodity, enabling them to be traded on futures exchanges with little oversight by any federal or state regulatory body.
Completing the trifecta, the Securities and Exchange Commission in 2004 waived its leverage rules. Previously, broker/dealer net-capital rules limited firms to a maximum debt-to-net-capital ratio of 12 to 1. But under the new regulations, five companies – Goldman Sachs, Merrill Lynch, Lehman Brothers, Bear Stearns, and Morgan Stanley – were granted an exemption, which they promptly used to lever up 20, 30, even 40 to 1.
That means $1 of equity underpinned up to $40 of investment risk. So a 2.5% drop in asset prices would wipe out the actual cash underlying a position...leaving only debt and losses.
Just as Congress was repealing Glass-Steagall in 1999, the tech stock bubble was inflating beyond sustainability. It would soon be pricked, ushering in a brief recession during which investors began the hunt for the next big thing.
Glass-Steagall: How About Housing?
Back in 1977, Congress had passed the Community Reinvestment Act, which had the goal of extending homeownership to the largest possible pool of Americans. Over the next 25 years, legislative supplements, a robust housing market, and aggressive government enforcement of "fairness in lending" combined to weaken bank standards regarding who did – or didn't – qualify for a loan.
But that was just the beginning. In an effort to end that recession in the new century's first years, the Greenspan Fed reduced interest rates to near zero and poured liquidity into the financial markets. At the same time, capital that had fled the stock market was looking for action. It found it in housing.
The commercial banks – and independent mortgagors like Countrywide Credit – were awash in cash. They started lending it, and every borrower's credentials were deemed excellent, even those with low income, bad credit, and no money for a down payment.
The perfect storm was building. But at first, boy! Did things ever look so rosy? The country's homeownership rate – 62.1% in 1960, rising to only 64.1% in 1994 – shot up to 68.9% by 2006.
As homeowner mania seized hold of the public imagination, people began treating their homes as ATMs. If they needed cash, they borrowed against their growing equity. Real estate speculators flipped houses like crazy. And why not, when there was no risk? Housing prices only head in one direction – up, Up, UP! Right?
It sure looked that way. The yearly average median price of an existing home went from $23,000 in 1970, to $62,200 in 1980, to $97,300 in 1990, to $147,300 in 2000 and crested at $221,900 in 2006. Astonishingly, and despite recessions in the early '80s and early '00s, there wasn't a single down year for US housing as a national average in all of that time.
However, in 2007 housing became the latest bubble to burst, pricked by unrealistic prices, overbuilding, and the retreat from ultra-low interest rates. Concurrently, as house prices finally began to drop, a whole bunch of those no- or low-interest loans began to reset.
Glass-Steagall: Why Do Rational People Act So Stupid?
Despite the well-earned reputation of some Wall Street high rollers, bankers tend not to be a reckless lot, nor financial dunces. In general, they would rather deploy a large amount of capital into a safe, low-yield investment than put a small amount of capital into something with very high risk.
With the new environment, however, the game changed. Commercial bankers found themselves making loans to shakier and shakier recipients, while at the same time, the investment banks and their clients were clamoring for new investment products.
So bankers did what any conservative person would do. They hedged their bets. They bundled up their loans and sold the packages to the investment banks. The outcome was essentially the mortgage business being uprooted from the commercial banks and transplanted into the investment houses, which have far less restrictive requirements about reserve capital, far fewer limits on the buying and selling of securities, and far less regulatory oversight.
The investment banks did not set out, of course, to become landlords. They just wanted to sell some product for which there was a ready market. As capitalist ingenuity collided with profit motive, they found there was no shortage of products that could be created.
The mortgage bundles were sliced, diced, and repackaged into a bewildering array of securities, such as structured investment vehicles (SIVs), collateralized debt obligations (CDOs), mortgage-backed securities (MBSs), and on and on.
The extent of the slicing and dicing into what financial chefs refer to as tranches was such that the original mortgage might be tossed from buyer to buyer, or even itself split into parts. Each time a package was put together and sold, the seller stretched to get top dollar for each tranche, requiring the underlying assets to be risk-rated and then assigned real-world value. In the end, rating services had little idea what they were rating (we're being charitable here), and buyers had no idea what their purchase was really worth.
And always lurking in the background was the possibility that defaults on the mortgages supporting the entire process could have a profound ripple effect, given that these products became increasingly leveraged. Knowing this, traders invented credit default swaps (CDSs), those gnarly little creatures that morphed into Godzilla after 2004.
CDSs are an insurance policy, a way of dealing with fear, and a device for attenuating the risk inherent in trading products one may not fully understand. Those buying the protection pay an upfront amount and yearly premiums to the protection sellers, who agree in return to cover any loss to the face value of the security. The result is a private, two-party contract, devoid of regulatory oversight.
There are a bunch of nasty horseflies in this particular ointment. For one, the holder of that security (who is now "protected" by a CDS) might turn around and sell it to a third party, who might himself insure and resell it, and so on, creating an impossibly complex chain of ownership and obligation. Additionally, the CDS itself can be traded over the counter. Furthermore, any of the underlying assets might also get partitioned into different tranches, adding to the confusion. And finally, short sellers can work on just about any joint in the structure.
And here's the really big rub. Suppose the party providing the initial insurance protection – having already collected its upfront payment and premiums – doesn't have the money to pay the insured buyer when a default occurs. Or suppose the "insurer" goes bankrupt. In either instance, the buyer who thought he was protected finds himself left naked and alone.
However, that possibility seems not to have been considered as the financial world created an interlocking system of derivatives that not even a Cray supercomputer could sort out. The only certainty: it was an arrangement that depended on a robust economy and rising house prices.
Except, of course, things didn't work out that way.
When the housing slump hit, defaults in the relatively small subprime sector (less than 20% of mortgages) started a chain reaction that raced through the derivatives market, the effects compounding geometrically, until finally the world financial structure was facing collapse.
Glass-Steagall Act: Capital & the Capitol
When capital is allocated in a free market, it moves toward the productive, and the economy tends to prosper. By the same token, when it is misallocated, an economy can hit the skids.
We've had decades of misallocated capital in the United States. Instead of saving, we've been spending...and spending way beyond our means. Rather than investing in something productive, we've been gambling, taking on ever greater risks in the hope of the big payoff. Instead of creating the clean balance sheets that support stability – at all levels, personal, corporate, and governmental – we've piled up mountains of unsustainable debt.
The tragedy is that the prudent will suffer right along with the reckless. Misallocations of capital must be unwound, one way or another, before the economy can get back on its feet. It will be no simple task, and it's made even more difficult by those who put themselves in charge of the clean-up: certain residents of Washington, D.C.
At the center of the storm are two men who propose to save the nation, and they could hardly be more different.
Secretary of the Treasury Henry Paulson is the Street's guy. The former CEO of Goldman Sachs, the most powerful and successful investment bank, he brings a Wall Street insider's perspective to the table. However committed to public service he may be, he cannot be expected to act against the interests of his friends in the banking community.
And then there's Fed chairman Ben Bernanke, a pure academician. For better or worse, Bernanke's specialty is America's Great Depression, and he considers himself an expert on the subject. Above all else, he wants to be remembered as the guy who understood how to steer the country away from the shoals of a Second Great Depression.
But there is no question that Big Ben and Hammerin' Hank are trying to navigate in unfamiliar waters. Today's economy hardly mirrors that of a decade ago, much less the conditions of the 1930s. For one thing, the Glass-Steagall Act separating commercial from investment banks has been...and gone.
Back in the spring of 2007, as the initial cracks in the current structure began to appear, few were expecting the broken-levee crisis that has since unfolded. A handful of savants saw it coming and said so, but no one in the mainstream was listening. What was actually happening was that the first dominoes – subprime borrowers who should never have been approved – had begun to fall.
In and of themselves, they would have been little more than straws in the wind. But because of the multiplier effect of the derivatives market, their influence reached far beyond a few blown mortgages. As more and more debtors were unable to pay, mortgage-backed securities lost value. And then the securities based on the MBSs lost value. And then the CDS written and sold against them.
Here's where CDSs were in fact supposed to ride to the rescue. They didn't, for the simple reason that they had long since strayed far from their original insurance intent, and become primarily an instrument that gave derivatives market players access to an asset class (mortgages) without having to actually own the asset.
As MBS values were hammered by defaults on the underlying loans, buyers of CDS protection began trying to collect. That hit CDS sellers, who were being drained of cash. Further out, derivatives speculators who had bet the wrong way defaulted or went bankrupt, sending shockwaves back down the line. Slowly at first, and then with increasing speed, the capital necessary to keep the system alive started drying up.
Glass-Steagall Act: Riding Roughshod Across the Division of BanksEveryone is familiar by now with the institutions that have collapsed or been bought out or taken over by the government. The list of names is stunning: Bear Stearns, Countrywide Credit, MBIA, Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Washington Mutual, Merrill Lynch, Wachovia. Wall Street has undergone a transformation unimaginable a year ago. The big investment banks are gone – bankrupted or swallowed up by someone else. Even the two that remain standing, Goldman and J.P.Morgan, have had to reinvent themselves as bank holding companies to save their own hides, riding still further across the division of commercial and investment banking which Glass-Steagall set up.
The movement of capital among financial institutions is based not only on integrity but on confidence. Right now, that confidence has evaporated. Banks are carrying so much paper of indeterminate value that it's impossible to price in the risk of making a loan. So they aren't lending to each other, out of fear that they'll never get their money back. The credit market, upon which our economy depends, has seized up. When the government finally got around to admitting that there was a problem, it was already too late for any simple fix. So Washington had only two options: stand back and let the market sort things out...or take drastic, emergency action.
No one knows quite what to make of Washington's response to the credit crisis. Some are howling that it's socialism, others that it's fascism or, at best, corporatism, an unholy alliance of private enterprise and the state.
Whatever the name, there is no question that the government is boldly going where none has gone before, helping to bail out some financial institutions and seizing control of others.
The Treasury Department now has $700 billion – albeit with some strings attached – with which it can buy up toxic waste paper through the Troubled Asset Relief Program (TARP). Taking this direction, instead of making direct loans, allows the "assets" they buy to be resold somewhere down the road. And perhaps, the plan's defenders say, even at a profit. Like that's gonna happen!
Proceeding in ways never before tried, in early October the Fed announced it was opening the Commercial Paper Funding Facility. For the first time, it will buy unsecured paper debt. To facilitate this and to cover potential losses, the Treasury will deposit an unspecified amount at the Fed. This is in addition to the Treasury's own buying spree, and the Fannie Freddie conservatorship, and the expansion of the FDIC to cover deposits up to $250,000, a move likely to send that agency back to the Treasury for another fill-up.
So far, however, all the government's actions to date have accomplished precious little. For the time being, credit remains frozen. Banks are still making overnight loans to other banks, but only very selectively. The stock market, despite coming off its lows, is extremely volatile after enduring its worst crash ever. Commodities have sold off. States and municipalities are facing severe budget cuts and, in some cases, bankruptcy. Money markets are in trouble. Pensions and retirement funds are at risk. And recession, or worse, looms increasingly large on the horizon.
Nor is the crisis purely an American problem. Much of the US bad paper was sold to gullible Europeans, and world economies and markets are so interconnected that if one sneezes, someone else catches a cold. Already there have been big bailouts in Germany and the United Kingdom. The Irish government recently announced it was guaranteeing all bank deposits, which attracted a flood of money from elsewhere in the European Union, enraged other members of the EU and raising questions of how long that shaky confederation can endure as each country charts its own path through the economic minefield.
This is a once-in-a-lifetime event, a train to nowhere, and it will cause no end of suffering. Since we can't stop it, we'll do the next best thing, which is to protect ourselves. That means assessing the likely fallout from the government's meddling in the market, and developing guidelines for the best way to ride out the hurricane.
Some consequences are already baked in the cake. Casey Research Chief Economist Bud Conrad has been studying the unfolding crisis for years. Based on his work, this is what we foresee:
More financial institutions will collapse. So will many hedge funds. Money market funds are also shaky; although the government will do all it can to keep them solvent, those that invest in anything but Treasury bills are at risk.
The economy will fall into recession. By most lights, it's already here. It won't be brief, and there is even a chance that despite all the Fed's pump priming, we could drop into a depression. For however long credit remains tight, business will be unable to function normally, and the consumer-driven economy will grind to a halt.
The whole structured finance model under which we've been operating is broken. The packaging of mortgages and other forms of consumer debt is impossible when no one will buy the packages. The trillions of dollars of outstanding mortgage derivatives will have to be unwound somehow.
Without debt leverage, private equity financing is dead. Raising money for business start-ups or expansion will be extremely challenging. IPOs will be few and far between. Leveraged buyouts are gone. Mergers and acquisitions will mostly be limited to distress sales.
At best, the government will succeed at what it's trying to do, i.e., stave off a depression, by sacrificing the dollar and allowing a fairly high level of inflation. If we're lucky, it won't turn into hyperinflation.
Interest rates are going up. On the day of the coordinated, worldwide rate cut, the Fed lowered its discount rate by 50 basis points, yet the yield on the 10-year Treasuries rose from 3.5 to 3.7%. The Fed's credibility is about shot, in other words, as it has debased its own balance sheet by swapping good debt for bad. With more than half of its reserves gone, it could itself become the subject of a Treasury Department bailout.
It is highly likely that the era of US economic dominance, when the almighty Dollar served as the reserve currency of the world, is drawing to a close.
But on the bright side...well, there is no bright side. The hole that we've dug for ourselves will take a while to climb out of, and it won't be easy. But at least you can protect yourself.
Protecting your assets is not just a buzzword anymore, it's mandatory if you want to keep yourself and your family financially safe in these tough times...which will only get tougher in the near future.
Doug Casey, 10 Nov '08
Friday, October 10, 2008
Remarks by Secretary Henry M. Paulson, Jr. in 2007
"...Remarks by Secretary Henry M. Paulson, Jr.
on Current Housing and Mortgage Market Developments"
"...I will spend my time this morning reviewing the current state of the housing and mortgage markets, the implications for our capital markets and economy, and the role government and the private sector should play as we go forward.
The ongoing housing correction is not ending as quickly as it might have appeared late last year."
"...Our bank regulators must evaluate regulatory capital requirements applicable to bank exposures to off-balance sheet vehicles."
"The housing correction has its roots in an eight-year period of exceptional home price appreciation which was fueled by an increased demand for..."
"...abundant supply of easy credit. Speculation also played a significant role, as the share of buying activity by investors or individuals buying second homes more than doubled from 2000 to 2005."
BETWEEN 2000 & 2005!!! HELLO!!!!!October 16, 2007
"...As demand for housing began to slow in 2004,originators, eager to maintain high mortgage origination volumes, further lowered their underwriting standards..."
HP-612
Remarks by Secretary Henry M. Paulson, Jr.
on Current Housing and Mortgage Market Developments
Georgetown University Law Center
Washington, DC--Good morning. As students of law, business and public policy, you have an interest in real life case studies that combine financial markets and policy issues. Current developments in the housing and mortgage markets provide such an example. I will spend my time this morning reviewing the current state of the housing and mortgage markets, the implications for our capital markets and economy, and the role government and the private sector should play as we go forward.
The ongoing housing correction is not ending as quickly as it might have appeared late last year.
And it now looks like it will continue to adversely impact our economy, our capital markets, and many homeowners for some time yet. Even so, I believe we have a healthy, diversified economy that will continue to grow.
The housing correction has its roots in an eight-year period of exceptional home price appreciation which was fueled by an increased demand for, and an abundant supply of easy credit. Speculation also played a significant role, as the share of buying activity by investors or individuals buying second homes more than doubled from 2000 to 2005. Homebuilders responded to the extraordinary demand for more and larger homes as if it would last forever.
As mortgage lenders and investors reached for higher returns this "demand" pressure, coupled with our fragmented mortgage origination process, led to a decline in underwriting standards and a sharp increase in the issuance of riskier mortgage products. As demand for housing began to slow in 2004, originators, eager to maintain high mortgage origination volumes, further lowered their underwriting standards.
While adjustable-rate mortgages (ARMs) are not new, recent years saw an increase in hybrid-ARMs with low teaser rates, interest-only features, low- or no-down payments, and even negative amortization. In fact, about one-quarter of mortgage originations were non-traditional ARMs in 2005 and 2006, exposing mortgage holders to much greater risk than the traditional 30-year fixed rate mortgage with a 20 percent down payment.
This decline in lending standards was not limited to, but was most pronounced, in the case of subprime lending, which grew from only about 2 percent of mortgages in 1998 to nearly 14 percent in mid-2007. A significant percentage of the non-traditional ARMs were marketed and sold to subprime borrowers. Predictably, the result has been progressively higher rates of default on subprime mortgages.
The inevitable correction began in early 2006. Today, average nationwide home prices are barely up in the year through June, sales of existing single-family homes are down by nearly 25 percent from the peak in 2005, and the inventory of unsold homes has increased to levels last seen in the early 1990s. Housing should be analyzed by local or regional markets; averages can be misleading. Areas with the greatest price appreciation prior to the correction, such as Las Vegas, San Diego, central California and a number of cities in Florida, have seen declines. And prices are falling in other parts of the country where economic growth is slower, such as Michigan and parts of Ohio. Working through the housing correction will continue to take time.
As I mentioned earlier, mortgage defaults and foreclosures are rising. While the delinquency rate today is near the 2001 rate, there are over seven times more subprime mortgages today than there were in 2001. At the end of the second quarter of this year, more than 900,000 subprime loans were at least 30 days delinquent. Foreclosures are also up significantly – increasing about 50 percent from 2000 to 2006. Foreclosures on subprime loans are up over 200 percent in that same period. Current trends suggest there will be just over 1 million foreclosure starts this year - of which 620,000 are subprime.
Of the approximately 50 million outstanding mortgages in the U.S. today, approximately 10 million are subprime loans. Many have cited the statistic that 2 million of those subprime mortgages will reset to higher rates in the next 18 months. That statistic is true, relevant, and troubling, but it is not the complete picture of the risk going forward. Many of those borrowers will be able to afford their new mortgage payment or they will be able to refinance into another more affordable mortgage. Yet, the problem today is not limited to subprime mortgages as the number of homeowners having trouble making payments on prime mortgages is also increasing. And finally, the wide geographic variation in home price trends adds to the complexity of sizing this problem with any certainty.
While innovation in the mortgage sector has brought benefits to our economy, the industry and homeowners, it has also introduced some challenges. Gone are the days when a homebuyer only went to the corner bank to take out a mortgage. Today, the mortgage process is disaggregated and less personal. A mortgage loan is likely to be originated, serviced, and owned by three different entities. Originators often sell mortgages to securitizers who package them into mortgage-backed securities, which are then divided and sold again to a global network of investors.
In today's decentralized system, a homeowner having trouble making payments often does not know where to turn for assistance.
In addition to affecting individual homeowners, the housing correction is also having a real impact on our economy. Annual housing starts peaked at an annual rate of almost 2.3 million units in early 2006 before falling off more than 40 percent through August of this year. Employment in residential building, including specialty trade contractors, has dropped by almost 200,000 since early 2006, offsetting about one-quarter of the jobs gained in the housing boom. It looked like housing construction had reached a bottom in the first half of this year, but starts have declined again since June and data on permit applications and inventories of unsold homes suggest further declines lie ahead.
We confront these current challenges against the backdrop of a strong economy – not just in the U.S., but globally. Indeed, this is the first housing downturn in the past three decades in which U.S. GDP growth has not turned negative. Business investment has expanded in recent months, our exports are being boosted by the strong economic growth of our trading partners and the healthy job market has helped consumer spending continue to grow.
But let me be clear, despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.
So where do we go from here and what is the proper role for government?
First, our immediate concern must be for struggling borrowers whose primary residence is at risk. We must help as many able homeowners as possible stay in their homes. Foreclosures are costly and painful for homeowners. They are also costly for mortgage servicers and investors. They can have spillover effects into property values throughout a neighborhood, creating a downward cycle we must work to avoid.
Second, we must minimize the impact of the current downturn on our economy, recognizing the tension between such actions and the possibility of moral hazard.
When investors are relieved of the costs of bad decisions, they are more likely to repeat their mistakes. I have no interest in bailing out lenders or property speculators. Still, we must recognize the very real harms to families affected by the housing downturn. We must take steps to minimize the neighborhood effects and the macroeconomic effects of this housing market correction.
Third, we need to identify public policy changes that will reduce the likelihood of repeating some of the excesses of recent years while maintaining access to credit for able homeowners.
Helping Struggling Homeowners
Today's mortgage market is different than in the past and it requires policymakers to think and act creatively.
A first and important step is to bring mortgage servicers and the mortgage investors together in a coordinated effort to identify struggling borrowers early, connect them to a mortgage counselor and find a sustainable mortgage solution. In August, the President charged Secretary Alphonso Jackson and me to lead this effort. HUD and Treasury have been working closely with mortgage market participants to address the complexities of the modification process, especially in a mortgage market primarily based on a securitization model. The breadth of disaggregation in the mortgage market today is unprecedented, presenting a fundamental, practical problem that does not lend itself to an easy solution.
Recent surveys have shown that as many as 50 percent of the borrowers who have gone into foreclosure never had a prior discussion with a mortgage counselor or their servicer. That must change. Early intervention is critical – the earlier borrowers explore alternative options, the more likely they will find a workable solution and keep their home. We cannot expect to avert every foreclosure and, indeed, some are warranted. Even in years of strong housing performance, we witness several hundred thousand foreclosures. But today many homeowners out there can be helped, and we are committed to efforts designed to do just that.
Last week, I joined a group of mortgage servicers, counselors and investors as they launched a bipartisan alliance, called Hope Now, to coordinate efforts to reach more homeowners and find affordable solutions. I applaud this effort. This challenge is significant and only by working together will we reach more homeowners in need.
We have an immediate need to see more loan modifications and refinancing and other flexibility. For many families, this will be the only viable solution. The current process is not working well. This is not about finger pointing; it is about putting an aggressive plan together and moving forward. This alliance is dedicated to seeing that happen, and I expect to see results. I also call on those servicers who are not yet a part of this alliance to join. You have an obligation to help meet this challenge, and you can do so more effectively as part of an integrated effort.
Not all servicers are staffed for aggressive loss-mitigation. Preventing foreclosures is in investors' interest and investors must take an active role in demanding that all servicers, large or small, are pursuing all available loss-mitigation strategies. Today the industry doesn't have a thorough, standardized set of loss-mitigation metrics with which to evaluate servicers' performance. I expect the Hope Now alliance to quickly develop and begin reporting those metrics so investors, policy makers, and homeowners can measure results.
The efforts of this private sector alliance alone will not solve the problem. But it is a critical piece of the solution. As we work with them, we will all learn and improve the means of reaching and helping homeowners to prevent foreclosures.
We must also take steps to make more affordable mortgage products available for struggling homeowners. In August, the President renewed his call on Congress to pass FHA modernization to make affordable FHA loans more widely available. To facilitate mortgage workouts, the President has also called on Congress to temporarily eliminate taxes on mortgage debt forgiven on a primary residence.
FHA reform is moving through Congress, and I am hopeful that it will reach the President's desk soon. The tax relief proposal has cleared the House and is awaiting further action in the Senate. GSE reform has cleared the House, and also awaits action in the Senate. Congress should enact these bills as quickly as possible.
The GSEs also have a role to play in making affordable mortgage products more widely available. It is their mission. The secondary market in GSE mortgage-backed securities is functioning well. The GSEs could increase the flow of mortgage capital to refinance subprime borrowers if they securitized a greater number of these mortgages. To accomplish this, the GSEs must work closely with their private mortgage insurance company partners in the development of new products. The GSEs have additional capacity to help more blemished-credit struggling homeowners and we are hopeful that they will step up to this challenge.
In addition to these current initiatives, we welcome further input and will openly consider other ideas to assist struggling homeowners.
Public Policy Questions
We also need to make some changes in our laws and rules in order to prevent some of the excesses and abuses of the last few years from happening again. We must do so in a balanced, thoughtful way so as to avoid overreacting and introducing unintended consequences such as those that might shut off credit to able borrowers.
Homeownership brings substantial benefits to our society. For millions of Americans, their home is their largest financial asset, the key to their future financial security. And homeownership gives people a stake in their community that often leads to more civic involvement, better schools and safer neighborhoods.
While financial innovation has helped increase the homeownership rate in recent years, it has also introduced new complexities. Homebuyers today have more choices than ever before in finding a mortgage that best suits their circumstances. Yet, comparing the attractiveness of one mortgage product to another can be difficult. Homebuyer education and effective disclosure are critical to helping borrowers understand the risks of innovative mortgage products.
Furthermore, our complex and fragmented regulatory system complicates an already difficult situation. Existing federal laws address mortgage fraud, disclosures, fair lending, unfair and deceptive practices, and other aspects of the mortgage process. But the regulatory and enforcement authority varies across different federal agencies. States have also enacted an additional layer of regulation, typically applied only to certain institutions that operate within that state and enforced by the state agencies.
This patchwork structure should be streamlined and modernized.
Treasury is already spending considerable energy in developing ideas on how to improve the financial regulatory structure more broadly and, early next year, we will release a blueprint for comprehensive overhaul. Our goal is to improve oversight and allow our financial services industry to better adapt and compete in the global marketplace. However, fundamental changes to our regulatory system will take years to consider and implement. Homeowners should not wait years - we need to move now to make interim improvements to our current mortgage regulatory system.
We can do so by focusing on four key issues: disclosure, origination, predatory lending and liability.
We need simple, clear, and understandable mortgage disclosure. We must identify what information is most critical for borrowers to have so that they can make informed decisions. At closing, homebuyers get writer's cramp from initialing pages and pages of unintelligible and mostly unread boilerplate that appears to be designed to insulate the originator or lender from liability rather than to provide useful information to the borrower. We can and must do better.
The most critical facts, including potential future monthly payments, should be on a single page in clear, easy-to-understand language, to be signed by the borrower and the lender. In my judgment, this may have prevented many of the problems that we are seeing today.
The Federal Reserve is leading on this issue through a comprehensive review of the disclosure regime underlying the Truth in Lending Act. As part of this review, the Federal Reserve is engaged in extensive consumer testing to determine what types of disclosures provide the best information to consumers. I support the Federal Reserve's consumer-oriented approach -- this testing is critical to determining what improved disclosures are going to be most useful. This is hard and necessary work, but it is very important.
Borrowers have responsibility as well. Mortgage providers must offer clear, transparent and understandable information on the mortgage products they sell. And homebuyers have a responsibility to use that information. Buying a home today is a complex process, but that in no way excuses homebuyers from their obligation for due diligence. Just as investors in the stock market have a responsibility to understand the risks associated with their investment, homebuyers have a responsibility to understand their mortgages.
Secondly, we need to bring a higher level of integrity to the mortgage origination process. The development of a uniform national licensing, education, and monitoring system for all mortgage brokers is worth considering.
Some of the conduct and practices that I have learned about are shameful. It is no secret that, while not the norm, some fraudulent activity on behalf of mortgage brokers occurred.
Today, mortgage brokers are regulated at the state level, and the rigor of that regulation varies from state to state. State regulators have begun an effort geared toward uniform licensing and education requirements for mortgage brokers. We support this effort, but since other brokers are employed by federally-regulated entities, this effort will not cover the full universe of mortgage originators. We need to consider a national approach that builds upon the state efforts that are currently underway.
Licensing requirements should take into account prior fraudulent or criminal activity, and should require initial and ongoing education. At a minimum mortgage originators should be able to demonstrate a sound understanding of the products that they will be selling.
Common sense licensing requirements that are uniformly enforced could greatly help in weeding out the bad actors. A nationwide monitoring system that covers all mortgage originators could help prevent unscrupulous mortgage originators from moving across state lines or switching employers to evade detection. This is worth considering.
The third area that also warrants our focus is predatory lending.
Homebuyers must not be subject to unfair and deceptive lending practices. Here too, the Federal Reserve is engaged in a comprehensive review of its authority under the Home Ownership and Equity Protection Act, including its authority to broadly define unfair and deceptive practices. These rules would apply to the entire mortgage industry.
The Federal Reserve can inject greater uniformity and objective standards into the mortgage origination process, and I encourage them to do so.
In addition, there have been calls for legislation to address certain practices that are often associated with predatory lending, such as prepayment penalties or stated-income loans. There are clearly circumstances in which these product features are marketed inappropriately. There are also clearly circumstances in which any one of these features can make sense for the borrower and significantly improve credit availability.
We need to strike a careful balance of providing adequate consumer protection without limiting overall credit availability or consumer choice, especially for those who most need that flexibility.
This is a difficult balance to achieve because each lending determination is relatively unique based on the different facts and circumstances associated with each borrower. Yet, I am hopeful that we can do it.
In my view, it makes a great deal of sense to recognize that certain products are right for some borrowers and not for others. The Federal Reserve has already stated that it will examine some of these specific issues including prepayment penalties, stated-income loans, escrow accounts and ability-to-repay considerations.
The fourth issue that has garnered attention is whether greater liability should be imposed on securitizers and investors. In my view, this is not the answer to the problem. Imposing broad liability provisions on investors and securitizers would very likely generate significant unintended consequences. It would potentially paralyze securitization, a process that has been extremely valuable in extending the availability of credit to millions of homeowners nationwide and lowering the cost of financing. Again, balance is critically important. Congress should proceed with extreme caution so as to avoid cutting off investment inflows to the housing market.
Before concluding I will briefly summarize two other broad-based capital markets related initiatives under way that will also address some of the problems which have arisen in the mortgage market.
Broader Capital Markets Issues
The President's Working Group (PWG) – chaired by Treasury and consisting of the Federal Reserve, the SEC, and the CFTC -- is leading a comprehensive review into the policy implications resulting from current challenges in the credit markets. A number of these issues are directly tied to the mortgage markets; others affect the capital markets more broadly. Given the global nature of our financial markets, I will also work with the G7 and through the Financial Stability Forum to address several of these issues.
One area the PWG has already addressed is hedge funds. Back in February, the PWG produced forward-leaning guidance for the industry and its participants including regulated financial institutions which serve as prime brokers and counterparties to hedge funds. Our principles and guidelines serve as a foundation to enhance vigilance and market discipline, strengthen investor protection and guard against systemic risk. While a small number of hedge funds were forced to wind down in recent months, there were no systemic events associated with their closure, and hedge funds have not proven to be a significant problem.
The real irony is that the material problems arising in recent months were in regulated institutions in certain markets. Many regulated institutions, both in the U.S. and elsewhere, appear not to have fully appreciated all of the risks associated with the securitized assets on their balance sheets or the many risks associated with commitments to provide liquidity to off-balance sheet vehicles, such as conduits and structured investment vehicles.
Deteriorating subprime mortgage performance over the last several months led investors to question their assumptions about the credit quality and value of many assets. In July, as default rates surpassed their models' projections, ratings agencies downgraded billions of dollars worth of subprime mortgage backed securities.
The statement by ratings agencies that they were unable to accurately characterize the default probabilities of subprime mortgages created broader uncertainties in financial markets. Not surprisingly, investors reacted by reassessing and repricing risk across all market segments that relied heavily on the use of ratings, particularly in complex, structured credit products. Predictably, given the interconnectedness of our capital markets, the influence of this development was global.
The reassessment of risk has played out more rapidly in some markets than in others. In certain asset classes, risk has been reassessed and repriced fairly quickly as investors gained confidence in their fundamental assessments. In such markets, liquidity has returned and markets are operating normally. Good examples would include world equity markets, sovereign debt markets, and investment grade corporate debt.
On the other hand, some sectors that are characterized by more complex securities or that rely more heavily on securitization and ratings -- such as the jumbo mortgage market, the leveraged loan market, and the asset backed commercial paper market -- are still operating under some stress with impaired liquidity. Conditions are better than they were a few weeks ago, and we continue to see improvements, but it will take longer for these sectors to fully recover.
Market–based efforts and initiatives are emerging to address some of the current challenges in the capital markets. I am pleased that yesterday a group of commercial banks announced their intent to establish a master conduit to help improve liquidity in the asset-backed commercial paper marketplace. The market participants and investors who may voluntarily participate in this enhanced facility recognize the benefit of such a structure. The leading financial institutions as well as investors realize the importance of improved liquidity in the high quality, asset backed commercial paper sector – a sector of the market with great importance for securitized assets such as mortgages, as well as for the broader capital markets.
This is promising. Just as in the mortgage market, we need to work on parallel tracks, addressing current concerns as well as addressing policy issues to avoid repeating the recent market turmoil.
Treasury and the President's Working Group are conducting a comprehensive review of such issues, including two areas that have a direct relationship to the events in the mortgage markets.
First, it is clear that we must examine the role of credit rating agencies including transparency and potential conflicts of interest. We must also assess if regulations and supervisory policies are encouraging an over-reliance on ratings by financial institutions and investors.
Second, we must continue to address financial institution risk management and related regulatory issues. In particular, we must ensure that they adequately take into account the risks posed by protracted periods of market illiquidity or the risks posed by a reduced ability to securitize and sell loans, including leveraged syndicated loans and mortgages.
Our bank regulators must evaluate regulatory capital requirements applicable to bank exposures to off-balance sheet vehicles. Transparency is important here, so we will also review the accounting rules that are applicable to off-balance sheet vehicles.
We will examine other areas that are indirectly related to the mortgage market which nevertheless impact our capital markets, ranging from enhancing the management of counterparty credit risks, to market infrastructure issues, to issues surrounding reporting and risk disclosure, to evaluating the important role of investors and, finally, how our long-standing regulatory structure and tools respond to today's continuously evolving financial system.
Conclusion
Innovation is the hallmark of our capital markets and it brings with it significant benefits to individual investors and our overall economy. However, innovation often outpaces regulation. That is not surprising, and we would not want it the other way around. If it were, we would have less competitive and efficient markets, which would ultimately stifle economic growth. It would mean fewer jobs and lower wages.
However, when problems arise, we need to shine a light on them and move to address them in a balanced way. Today it is clear that we need to do just that. We have a lot of work to do. We need to ensure yesterday's excesses are not repeated tomorrow.
As the mortgage and credit markets continue to adjust, all of us – policymakers and market participants -- will no doubt learn new lessons. Through a dedicated effort by all parties, we will work to strike the right balance, protect consumers and make mortgage capital widely available to Americans ready to be homeowners.
-30-
on Current Housing and Mortgage Market Developments"
"...I will spend my time this morning reviewing the current state of the housing and mortgage markets, the implications for our capital markets and economy, and the role government and the private sector should play as we go forward.
The ongoing housing correction is not ending as quickly as it might have appeared late last year."
"...Our bank regulators must evaluate regulatory capital requirements applicable to bank exposures to off-balance sheet vehicles."
"The housing correction has its roots in an eight-year period of exceptional home price appreciation which was fueled by an increased demand for..."
"...abundant supply of easy credit. Speculation also played a significant role, as the share of buying activity by investors or individuals buying second homes more than doubled from 2000 to 2005."
BETWEEN 2000 & 2005!!! HELLO!!!!!October 16, 2007
"...As demand for housing began to slow in 2004,originators, eager to maintain high mortgage origination volumes, further lowered their underwriting standards..."
HP-612
Remarks by Secretary Henry M. Paulson, Jr.
on Current Housing and Mortgage Market Developments
Georgetown University Law Center
Washington, DC--Good morning. As students of law, business and public policy, you have an interest in real life case studies that combine financial markets and policy issues. Current developments in the housing and mortgage markets provide such an example. I will spend my time this morning reviewing the current state of the housing and mortgage markets, the implications for our capital markets and economy, and the role government and the private sector should play as we go forward.
The ongoing housing correction is not ending as quickly as it might have appeared late last year.
And it now looks like it will continue to adversely impact our economy, our capital markets, and many homeowners for some time yet. Even so, I believe we have a healthy, diversified economy that will continue to grow.
The housing correction has its roots in an eight-year period of exceptional home price appreciation which was fueled by an increased demand for, and an abundant supply of easy credit. Speculation also played a significant role, as the share of buying activity by investors or individuals buying second homes more than doubled from 2000 to 2005. Homebuilders responded to the extraordinary demand for more and larger homes as if it would last forever.
As mortgage lenders and investors reached for higher returns this "demand" pressure, coupled with our fragmented mortgage origination process, led to a decline in underwriting standards and a sharp increase in the issuance of riskier mortgage products. As demand for housing began to slow in 2004, originators, eager to maintain high mortgage origination volumes, further lowered their underwriting standards.
While adjustable-rate mortgages (ARMs) are not new, recent years saw an increase in hybrid-ARMs with low teaser rates, interest-only features, low- or no-down payments, and even negative amortization. In fact, about one-quarter of mortgage originations were non-traditional ARMs in 2005 and 2006, exposing mortgage holders to much greater risk than the traditional 30-year fixed rate mortgage with a 20 percent down payment.
This decline in lending standards was not limited to, but was most pronounced, in the case of subprime lending, which grew from only about 2 percent of mortgages in 1998 to nearly 14 percent in mid-2007. A significant percentage of the non-traditional ARMs were marketed and sold to subprime borrowers. Predictably, the result has been progressively higher rates of default on subprime mortgages.
The inevitable correction began in early 2006. Today, average nationwide home prices are barely up in the year through June, sales of existing single-family homes are down by nearly 25 percent from the peak in 2005, and the inventory of unsold homes has increased to levels last seen in the early 1990s. Housing should be analyzed by local or regional markets; averages can be misleading. Areas with the greatest price appreciation prior to the correction, such as Las Vegas, San Diego, central California and a number of cities in Florida, have seen declines. And prices are falling in other parts of the country where economic growth is slower, such as Michigan and parts of Ohio. Working through the housing correction will continue to take time.
As I mentioned earlier, mortgage defaults and foreclosures are rising. While the delinquency rate today is near the 2001 rate, there are over seven times more subprime mortgages today than there were in 2001. At the end of the second quarter of this year, more than 900,000 subprime loans were at least 30 days delinquent. Foreclosures are also up significantly – increasing about 50 percent from 2000 to 2006. Foreclosures on subprime loans are up over 200 percent in that same period. Current trends suggest there will be just over 1 million foreclosure starts this year - of which 620,000 are subprime.
Of the approximately 50 million outstanding mortgages in the U.S. today, approximately 10 million are subprime loans. Many have cited the statistic that 2 million of those subprime mortgages will reset to higher rates in the next 18 months. That statistic is true, relevant, and troubling, but it is not the complete picture of the risk going forward. Many of those borrowers will be able to afford their new mortgage payment or they will be able to refinance into another more affordable mortgage. Yet, the problem today is not limited to subprime mortgages as the number of homeowners having trouble making payments on prime mortgages is also increasing. And finally, the wide geographic variation in home price trends adds to the complexity of sizing this problem with any certainty.
While innovation in the mortgage sector has brought benefits to our economy, the industry and homeowners, it has also introduced some challenges. Gone are the days when a homebuyer only went to the corner bank to take out a mortgage. Today, the mortgage process is disaggregated and less personal. A mortgage loan is likely to be originated, serviced, and owned by three different entities. Originators often sell mortgages to securitizers who package them into mortgage-backed securities, which are then divided and sold again to a global network of investors.
In today's decentralized system, a homeowner having trouble making payments often does not know where to turn for assistance.
In addition to affecting individual homeowners, the housing correction is also having a real impact on our economy. Annual housing starts peaked at an annual rate of almost 2.3 million units in early 2006 before falling off more than 40 percent through August of this year. Employment in residential building, including specialty trade contractors, has dropped by almost 200,000 since early 2006, offsetting about one-quarter of the jobs gained in the housing boom. It looked like housing construction had reached a bottom in the first half of this year, but starts have declined again since June and data on permit applications and inventories of unsold homes suggest further declines lie ahead.
We confront these current challenges against the backdrop of a strong economy – not just in the U.S., but globally. Indeed, this is the first housing downturn in the past three decades in which U.S. GDP growth has not turned negative. Business investment has expanded in recent months, our exports are being boosted by the strong economic growth of our trading partners and the healthy job market has helped consumer spending continue to grow.
But let me be clear, despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.
So where do we go from here and what is the proper role for government?
First, our immediate concern must be for struggling borrowers whose primary residence is at risk. We must help as many able homeowners as possible stay in their homes. Foreclosures are costly and painful for homeowners. They are also costly for mortgage servicers and investors. They can have spillover effects into property values throughout a neighborhood, creating a downward cycle we must work to avoid.
Second, we must minimize the impact of the current downturn on our economy, recognizing the tension between such actions and the possibility of moral hazard.
When investors are relieved of the costs of bad decisions, they are more likely to repeat their mistakes. I have no interest in bailing out lenders or property speculators. Still, we must recognize the very real harms to families affected by the housing downturn. We must take steps to minimize the neighborhood effects and the macroeconomic effects of this housing market correction.
Third, we need to identify public policy changes that will reduce the likelihood of repeating some of the excesses of recent years while maintaining access to credit for able homeowners.
Helping Struggling Homeowners
Today's mortgage market is different than in the past and it requires policymakers to think and act creatively.
A first and important step is to bring mortgage servicers and the mortgage investors together in a coordinated effort to identify struggling borrowers early, connect them to a mortgage counselor and find a sustainable mortgage solution. In August, the President charged Secretary Alphonso Jackson and me to lead this effort. HUD and Treasury have been working closely with mortgage market participants to address the complexities of the modification process, especially in a mortgage market primarily based on a securitization model. The breadth of disaggregation in the mortgage market today is unprecedented, presenting a fundamental, practical problem that does not lend itself to an easy solution.
Recent surveys have shown that as many as 50 percent of the borrowers who have gone into foreclosure never had a prior discussion with a mortgage counselor or their servicer. That must change. Early intervention is critical – the earlier borrowers explore alternative options, the more likely they will find a workable solution and keep their home. We cannot expect to avert every foreclosure and, indeed, some are warranted. Even in years of strong housing performance, we witness several hundred thousand foreclosures. But today many homeowners out there can be helped, and we are committed to efforts designed to do just that.
Last week, I joined a group of mortgage servicers, counselors and investors as they launched a bipartisan alliance, called Hope Now, to coordinate efforts to reach more homeowners and find affordable solutions. I applaud this effort. This challenge is significant and only by working together will we reach more homeowners in need.
We have an immediate need to see more loan modifications and refinancing and other flexibility. For many families, this will be the only viable solution. The current process is not working well. This is not about finger pointing; it is about putting an aggressive plan together and moving forward. This alliance is dedicated to seeing that happen, and I expect to see results. I also call on those servicers who are not yet a part of this alliance to join. You have an obligation to help meet this challenge, and you can do so more effectively as part of an integrated effort.
Not all servicers are staffed for aggressive loss-mitigation. Preventing foreclosures is in investors' interest and investors must take an active role in demanding that all servicers, large or small, are pursuing all available loss-mitigation strategies. Today the industry doesn't have a thorough, standardized set of loss-mitigation metrics with which to evaluate servicers' performance. I expect the Hope Now alliance to quickly develop and begin reporting those metrics so investors, policy makers, and homeowners can measure results.
The efforts of this private sector alliance alone will not solve the problem. But it is a critical piece of the solution. As we work with them, we will all learn and improve the means of reaching and helping homeowners to prevent foreclosures.
We must also take steps to make more affordable mortgage products available for struggling homeowners. In August, the President renewed his call on Congress to pass FHA modernization to make affordable FHA loans more widely available. To facilitate mortgage workouts, the President has also called on Congress to temporarily eliminate taxes on mortgage debt forgiven on a primary residence.
FHA reform is moving through Congress, and I am hopeful that it will reach the President's desk soon. The tax relief proposal has cleared the House and is awaiting further action in the Senate. GSE reform has cleared the House, and also awaits action in the Senate. Congress should enact these bills as quickly as possible.
The GSEs also have a role to play in making affordable mortgage products more widely available. It is their mission. The secondary market in GSE mortgage-backed securities is functioning well. The GSEs could increase the flow of mortgage capital to refinance subprime borrowers if they securitized a greater number of these mortgages. To accomplish this, the GSEs must work closely with their private mortgage insurance company partners in the development of new products. The GSEs have additional capacity to help more blemished-credit struggling homeowners and we are hopeful that they will step up to this challenge.
In addition to these current initiatives, we welcome further input and will openly consider other ideas to assist struggling homeowners.
Public Policy Questions
We also need to make some changes in our laws and rules in order to prevent some of the excesses and abuses of the last few years from happening again. We must do so in a balanced, thoughtful way so as to avoid overreacting and introducing unintended consequences such as those that might shut off credit to able borrowers.
Homeownership brings substantial benefits to our society. For millions of Americans, their home is their largest financial asset, the key to their future financial security. And homeownership gives people a stake in their community that often leads to more civic involvement, better schools and safer neighborhoods.
While financial innovation has helped increase the homeownership rate in recent years, it has also introduced new complexities. Homebuyers today have more choices than ever before in finding a mortgage that best suits their circumstances. Yet, comparing the attractiveness of one mortgage product to another can be difficult. Homebuyer education and effective disclosure are critical to helping borrowers understand the risks of innovative mortgage products.
Furthermore, our complex and fragmented regulatory system complicates an already difficult situation. Existing federal laws address mortgage fraud, disclosures, fair lending, unfair and deceptive practices, and other aspects of the mortgage process. But the regulatory and enforcement authority varies across different federal agencies. States have also enacted an additional layer of regulation, typically applied only to certain institutions that operate within that state and enforced by the state agencies.
This patchwork structure should be streamlined and modernized.
Treasury is already spending considerable energy in developing ideas on how to improve the financial regulatory structure more broadly and, early next year, we will release a blueprint for comprehensive overhaul. Our goal is to improve oversight and allow our financial services industry to better adapt and compete in the global marketplace. However, fundamental changes to our regulatory system will take years to consider and implement. Homeowners should not wait years - we need to move now to make interim improvements to our current mortgage regulatory system.
We can do so by focusing on four key issues: disclosure, origination, predatory lending and liability.
We need simple, clear, and understandable mortgage disclosure. We must identify what information is most critical for borrowers to have so that they can make informed decisions. At closing, homebuyers get writer's cramp from initialing pages and pages of unintelligible and mostly unread boilerplate that appears to be designed to insulate the originator or lender from liability rather than to provide useful information to the borrower. We can and must do better.
The most critical facts, including potential future monthly payments, should be on a single page in clear, easy-to-understand language, to be signed by the borrower and the lender. In my judgment, this may have prevented many of the problems that we are seeing today.
The Federal Reserve is leading on this issue through a comprehensive review of the disclosure regime underlying the Truth in Lending Act. As part of this review, the Federal Reserve is engaged in extensive consumer testing to determine what types of disclosures provide the best information to consumers. I support the Federal Reserve's consumer-oriented approach -- this testing is critical to determining what improved disclosures are going to be most useful. This is hard and necessary work, but it is very important.
Borrowers have responsibility as well. Mortgage providers must offer clear, transparent and understandable information on the mortgage products they sell. And homebuyers have a responsibility to use that information. Buying a home today is a complex process, but that in no way excuses homebuyers from their obligation for due diligence. Just as investors in the stock market have a responsibility to understand the risks associated with their investment, homebuyers have a responsibility to understand their mortgages.
Secondly, we need to bring a higher level of integrity to the mortgage origination process. The development of a uniform national licensing, education, and monitoring system for all mortgage brokers is worth considering.
Some of the conduct and practices that I have learned about are shameful. It is no secret that, while not the norm, some fraudulent activity on behalf of mortgage brokers occurred.
Today, mortgage brokers are regulated at the state level, and the rigor of that regulation varies from state to state. State regulators have begun an effort geared toward uniform licensing and education requirements for mortgage brokers. We support this effort, but since other brokers are employed by federally-regulated entities, this effort will not cover the full universe of mortgage originators. We need to consider a national approach that builds upon the state efforts that are currently underway.
Licensing requirements should take into account prior fraudulent or criminal activity, and should require initial and ongoing education. At a minimum mortgage originators should be able to demonstrate a sound understanding of the products that they will be selling.
Common sense licensing requirements that are uniformly enforced could greatly help in weeding out the bad actors. A nationwide monitoring system that covers all mortgage originators could help prevent unscrupulous mortgage originators from moving across state lines or switching employers to evade detection. This is worth considering.
The third area that also warrants our focus is predatory lending.
Homebuyers must not be subject to unfair and deceptive lending practices. Here too, the Federal Reserve is engaged in a comprehensive review of its authority under the Home Ownership and Equity Protection Act, including its authority to broadly define unfair and deceptive practices. These rules would apply to the entire mortgage industry.
The Federal Reserve can inject greater uniformity and objective standards into the mortgage origination process, and I encourage them to do so.
In addition, there have been calls for legislation to address certain practices that are often associated with predatory lending, such as prepayment penalties or stated-income loans. There are clearly circumstances in which these product features are marketed inappropriately. There are also clearly circumstances in which any one of these features can make sense for the borrower and significantly improve credit availability.
We need to strike a careful balance of providing adequate consumer protection without limiting overall credit availability or consumer choice, especially for those who most need that flexibility.
This is a difficult balance to achieve because each lending determination is relatively unique based on the different facts and circumstances associated with each borrower. Yet, I am hopeful that we can do it.
In my view, it makes a great deal of sense to recognize that certain products are right for some borrowers and not for others. The Federal Reserve has already stated that it will examine some of these specific issues including prepayment penalties, stated-income loans, escrow accounts and ability-to-repay considerations.
The fourth issue that has garnered attention is whether greater liability should be imposed on securitizers and investors. In my view, this is not the answer to the problem. Imposing broad liability provisions on investors and securitizers would very likely generate significant unintended consequences. It would potentially paralyze securitization, a process that has been extremely valuable in extending the availability of credit to millions of homeowners nationwide and lowering the cost of financing. Again, balance is critically important. Congress should proceed with extreme caution so as to avoid cutting off investment inflows to the housing market.
Before concluding I will briefly summarize two other broad-based capital markets related initiatives under way that will also address some of the problems which have arisen in the mortgage market.
Broader Capital Markets Issues
The President's Working Group (PWG) – chaired by Treasury and consisting of the Federal Reserve, the SEC, and the CFTC -- is leading a comprehensive review into the policy implications resulting from current challenges in the credit markets. A number of these issues are directly tied to the mortgage markets; others affect the capital markets more broadly. Given the global nature of our financial markets, I will also work with the G7 and through the Financial Stability Forum to address several of these issues.
One area the PWG has already addressed is hedge funds. Back in February, the PWG produced forward-leaning guidance for the industry and its participants including regulated financial institutions which serve as prime brokers and counterparties to hedge funds. Our principles and guidelines serve as a foundation to enhance vigilance and market discipline, strengthen investor protection and guard against systemic risk. While a small number of hedge funds were forced to wind down in recent months, there were no systemic events associated with their closure, and hedge funds have not proven to be a significant problem.
The real irony is that the material problems arising in recent months were in regulated institutions in certain markets. Many regulated institutions, both in the U.S. and elsewhere, appear not to have fully appreciated all of the risks associated with the securitized assets on their balance sheets or the many risks associated with commitments to provide liquidity to off-balance sheet vehicles, such as conduits and structured investment vehicles.
Deteriorating subprime mortgage performance over the last several months led investors to question their assumptions about the credit quality and value of many assets. In July, as default rates surpassed their models' projections, ratings agencies downgraded billions of dollars worth of subprime mortgage backed securities.
The statement by ratings agencies that they were unable to accurately characterize the default probabilities of subprime mortgages created broader uncertainties in financial markets. Not surprisingly, investors reacted by reassessing and repricing risk across all market segments that relied heavily on the use of ratings, particularly in complex, structured credit products. Predictably, given the interconnectedness of our capital markets, the influence of this development was global.
The reassessment of risk has played out more rapidly in some markets than in others. In certain asset classes, risk has been reassessed and repriced fairly quickly as investors gained confidence in their fundamental assessments. In such markets, liquidity has returned and markets are operating normally. Good examples would include world equity markets, sovereign debt markets, and investment grade corporate debt.
On the other hand, some sectors that are characterized by more complex securities or that rely more heavily on securitization and ratings -- such as the jumbo mortgage market, the leveraged loan market, and the asset backed commercial paper market -- are still operating under some stress with impaired liquidity. Conditions are better than they were a few weeks ago, and we continue to see improvements, but it will take longer for these sectors to fully recover.
Market–based efforts and initiatives are emerging to address some of the current challenges in the capital markets. I am pleased that yesterday a group of commercial banks announced their intent to establish a master conduit to help improve liquidity in the asset-backed commercial paper marketplace. The market participants and investors who may voluntarily participate in this enhanced facility recognize the benefit of such a structure. The leading financial institutions as well as investors realize the importance of improved liquidity in the high quality, asset backed commercial paper sector – a sector of the market with great importance for securitized assets such as mortgages, as well as for the broader capital markets.
This is promising. Just as in the mortgage market, we need to work on parallel tracks, addressing current concerns as well as addressing policy issues to avoid repeating the recent market turmoil.
Treasury and the President's Working Group are conducting a comprehensive review of such issues, including two areas that have a direct relationship to the events in the mortgage markets.
First, it is clear that we must examine the role of credit rating agencies including transparency and potential conflicts of interest. We must also assess if regulations and supervisory policies are encouraging an over-reliance on ratings by financial institutions and investors.
Second, we must continue to address financial institution risk management and related regulatory issues. In particular, we must ensure that they adequately take into account the risks posed by protracted periods of market illiquidity or the risks posed by a reduced ability to securitize and sell loans, including leveraged syndicated loans and mortgages.
Our bank regulators must evaluate regulatory capital requirements applicable to bank exposures to off-balance sheet vehicles. Transparency is important here, so we will also review the accounting rules that are applicable to off-balance sheet vehicles.
We will examine other areas that are indirectly related to the mortgage market which nevertheless impact our capital markets, ranging from enhancing the management of counterparty credit risks, to market infrastructure issues, to issues surrounding reporting and risk disclosure, to evaluating the important role of investors and, finally, how our long-standing regulatory structure and tools respond to today's continuously evolving financial system.
Conclusion
Innovation is the hallmark of our capital markets and it brings with it significant benefits to individual investors and our overall economy. However, innovation often outpaces regulation. That is not surprising, and we would not want it the other way around. If it were, we would have less competitive and efficient markets, which would ultimately stifle economic growth. It would mean fewer jobs and lower wages.
However, when problems arise, we need to shine a light on them and move to address them in a balanced way. Today it is clear that we need to do just that. We have a lot of work to do. We need to ensure yesterday's excesses are not repeated tomorrow.
As the mortgage and credit markets continue to adjust, all of us – policymakers and market participants -- will no doubt learn new lessons. Through a dedicated effort by all parties, we will work to strike the right balance, protect consumers and make mortgage capital widely available to Americans ready to be homeowners.
-30-
Monday, September 29, 2008
Background of the Banks’ Role in the Enron Debacle
Although three banks (and others) have settled with the victims for $7.2 billion, several huge banks still named in this suit have not paid a penny to the victims of the fraud.
As the Court’s dissenting Judge summarized, the ruling “immunizes a broad array of undeniably fraudulent conduct from civil liability . . . effectively giving secondary actors license to scheme with impunity, as long as they keep quiet.”
"...testified that many of the banks’ transactions were contrived, deceptive deals done solely to create the false appearance of profits and cash flow. "
Merrill Lynch purchased Nigerian barges from Enron on the last day of 1999 only because Enron secretly promised to buy the barges back within six months, guaranteeing Merrill Lynch a profit of more than 20%. As a result of this fraud, Merrill Lynch ultimately paid $80 million to settle with the SEC.
Where did that $80million go?
Barclays entered into several sham transactions with Enron,
Credit Suisse First Boston engaged in “pre-pay” transactions with Enron
Background on the Enron Victims' Lawsuit to Recover Damages from Wall Street Banks that Orchestrated the Enron Fraud
Background of the Banks’ Role in the Enron Debacle
As a result of the massive fraud at Enron, shareholders lost tens of billions of dollars. Many Enron executives, Enron’s accounting firm and certain bank officials were indicted.
Andrew Fastow, Enron’s now-imprisoned former finance chief, testified that many of the banks’ transactions were contrived, deceptive deals done solely to create the false appearance of profits and cash flow. Internal Enron documents and testimony of bank employees detailed how the banks engineered sham transactions to keep billions of dollars of debt off Enron’s balance sheet and create the illusion of increasing earnings and operating cash flow. For example:
Merrill Lynch purchased Nigerian barges from Enron on the last day of 1999 only because Enron secretly promised to buy the barges back within six months, guaranteeing Merrill Lynch a profit of more than 20%. As a result of this fraud, Merrill Lynch ultimately paid $80 million to settle with the SEC.
Barclays entered into several sham transactions with Enron, including creating a “special purpose entity” called Colonnade, a shell company to hide Enron’s debt, named after the street in London where the bank is headquartered.
Credit Suisse First Boston engaged in “pre-pay” transactions with Enron, including serving as one of the stop-offs for a series of round-trip, risk-free commodities deals in which commodities were never actually transferred or delivered.
Although three banks (and others) have settled with the victims for $7.2 billion, several huge banks still named in this suit have not paid a penny to the victims of the fraud.
The Fifth Circuit’s Decision
After years of preparation and just a few weeks before trial, the Fifth Circuit Court of Appeals vacated the class certification order.
Although the 2-to-1 decision of the Fifth Circuit acknowledged that the banks’ conduct was “hardly praiseworthy,” it ruled that because the banks themselves did not make any false “statements” about their conduct, they could not be liable to the victims even if they knowingly participated in the scheme to defraud Enron’s shareholders.
As the Court’s dissenting Judge summarized, the ruling “immunizes a broad array of undeniably fraudulent conduct from civil liability . . . effectively giving secondary actors license to scheme with impunity, as long as they keep quiet.” In an extraordinary admission, the Court’s two-member majority acknowledged that their ruling runs afoul of “justice and fair play” (“We recognize, however, that our ruling . . . may not coincide, particularly in the minds of aggrieved former Enron shareholders who have lost billions of dollars in a fraud they allege was aided and abetted by the defendants at bar, with notions of justice and fair play.”)
For more background on the Enron lawsuit: www.universityofcalifornia.edu/news/enro
As the Court’s dissenting Judge summarized, the ruling “immunizes a broad array of undeniably fraudulent conduct from civil liability . . . effectively giving secondary actors license to scheme with impunity, as long as they keep quiet.”
"...testified that many of the banks’ transactions were contrived, deceptive deals done solely to create the false appearance of profits and cash flow. "
Merrill Lynch purchased Nigerian barges from Enron on the last day of 1999 only because Enron secretly promised to buy the barges back within six months, guaranteeing Merrill Lynch a profit of more than 20%. As a result of this fraud, Merrill Lynch ultimately paid $80 million to settle with the SEC.
Where did that $80million go?
Barclays entered into several sham transactions with Enron,
Credit Suisse First Boston engaged in “pre-pay” transactions with Enron
Background on the Enron Victims' Lawsuit to Recover Damages from Wall Street Banks that Orchestrated the Enron Fraud
Background of the Banks’ Role in the Enron Debacle
As a result of the massive fraud at Enron, shareholders lost tens of billions of dollars. Many Enron executives, Enron’s accounting firm and certain bank officials were indicted.
Andrew Fastow, Enron’s now-imprisoned former finance chief, testified that many of the banks’ transactions were contrived, deceptive deals done solely to create the false appearance of profits and cash flow. Internal Enron documents and testimony of bank employees detailed how the banks engineered sham transactions to keep billions of dollars of debt off Enron’s balance sheet and create the illusion of increasing earnings and operating cash flow. For example:
Merrill Lynch purchased Nigerian barges from Enron on the last day of 1999 only because Enron secretly promised to buy the barges back within six months, guaranteeing Merrill Lynch a profit of more than 20%. As a result of this fraud, Merrill Lynch ultimately paid $80 million to settle with the SEC.
Barclays entered into several sham transactions with Enron, including creating a “special purpose entity” called Colonnade, a shell company to hide Enron’s debt, named after the street in London where the bank is headquartered.
Credit Suisse First Boston engaged in “pre-pay” transactions with Enron, including serving as one of the stop-offs for a series of round-trip, risk-free commodities deals in which commodities were never actually transferred or delivered.
Although three banks (and others) have settled with the victims for $7.2 billion, several huge banks still named in this suit have not paid a penny to the victims of the fraud.
The Fifth Circuit’s Decision
After years of preparation and just a few weeks before trial, the Fifth Circuit Court of Appeals vacated the class certification order.
Although the 2-to-1 decision of the Fifth Circuit acknowledged that the banks’ conduct was “hardly praiseworthy,” it ruled that because the banks themselves did not make any false “statements” about their conduct, they could not be liable to the victims even if they knowingly participated in the scheme to defraud Enron’s shareholders.
As the Court’s dissenting Judge summarized, the ruling “immunizes a broad array of undeniably fraudulent conduct from civil liability . . . effectively giving secondary actors license to scheme with impunity, as long as they keep quiet.” In an extraordinary admission, the Court’s two-member majority acknowledged that their ruling runs afoul of “justice and fair play” (“We recognize, however, that our ruling . . . may not coincide, particularly in the minds of aggrieved former Enron shareholders who have lost billions of dollars in a fraud they allege was aided and abetted by the defendants at bar, with notions of justice and fair play.”)
For more background on the Enron lawsuit: www.universityofcalifornia.edu/news/enro
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