The Blame Game

20090807-181851-pic-80916081_t756It’s amazing to me that so many people can get so worked up about one mid level bureaucrat in the White House who is a repentant communist and says he accidentally signed a 9-11 truther petition thinking it was just a request for more information on what the White House knew prior to those terrorist attacks. Meanwhile, we have a Secretary Treasury whose taken gifts from banks, underpaid his taxes by more money than I personally see in years, and seems completely captured by Wall Street and unable to draft decent regulation containing their gambling addiction. Then, there is the fact that I continually write about the same people in Wall Street and the Investment Banking community cooking up death derivatives and going about their merry way, subsidized, unpunished, and totally unrepentant over causing the worst financial crisis since 1929.

I just have to scream: WTF is wrong with you people? Why are we punishing some one for his venture into social activism while completely ignoring people that are making off with our national treasure and the lifeblood of our mixed market economy? These are folks that drove your house prices down, ruined your pension plans and your 401k, and are taking bailouts by the billions. Where’s the sense of balance? How does this resemble justice?

Here’s a REALLY good example from today’s NY Times. Written by Gretchen Morgensen, it’s called “Fair Game-They Left Fannie Mae, but we got the Legal Bills.” It’s all about the government having to bail out Fannie Mae because of the extremely bad management practices, and yes, illegal accounting practices that stuck us with a huge mess and an even bigger bill. Morgensen interviews Representative Alan Grayson, a Florida Democrat, who is one congress critter doing his oversight responsibility while others wallow in the political contributions from their regulatees.

With all the turmoil of the financial crisis, you may have forgotten about the book-cooking that went on at Fannie Mae. Government inquiries found that between 1998 and 2004, senior executives at Fannie manipulated its results to hit earnings targets and generate $115 million in bonus compensation. Fannie had to restate its financial results by $6.3 billion.

Almost two years later, in 2006, Fannie’s regulator concluded an investigation of the accounting with a scathing report. “The conduct of Mr. Raines, chief financial officer J. Timothy Howard, and other members of the inner circle of senior executives at Fannie Mae was inconsistent with the values of responsibility, accountability, and integrity,” it said.

That year, the government sued Mr. Raines, Mr. Howard and Leanne Spencer, Fannie’s former controller, seeking $100 million in fines and $115 million in restitution from bonuses the government contended were not earned. Without admitting wrongdoing, Mr. Raines, Mr. Howard and Ms. Spencer paid $31.4 million in 2008 to settle the litigation.

When these top executives left Fannie, the company was obligated to cover the legal costs associated with shareholder suits brought against them in the wake of the accounting scandal.

Now those costs are ours. Between Sept. 6, 2008, and July 21, we taxpayers spent $2.43 million to defend Mr. Raines, $1.35 million for Mr. Howard, and $2.52 million to defend Ms. Spencer.

“I cannot see the justification of people who led these organizations into insolvency getting a free ride,” Mr. Grayson said. “It goes right to the heart of what people find most disturbing in this situation — the absolute lack of justice.”

What’s the difference between getting justice and getting retribution? Well, in terms of missing it by light years, compare the treatment between social activist Van Jones and practitioners of accounting malpractice like Raines, Howard and Spencer (or tax dodgers who get gifts from Wall Street Bankers like our SOT). It’s the difference between a slap on the wrist and a slap across the face.

Read the rest of this entry »

It’s just a little bit of Policy Fail Repeating

bad-bank-2When you let lobbyists make public policy, failure is an acceptable outcome. That’s because the point of the policy isn’t the public and isn’t necessarily doing what will work. The point of the policy is to enrich and perpetuate the entrenched interests. Every other possible goal becomes expendable including those that have to do with protecting the public purse and welfare.

Imagine my lack of surprise when I saw that the creation of a “bad bank” policy is back in today’s WaPo headlines. Go take a look at “U.S. Considers Remaking Mortgage Giants:’Bad Bank’ Would Wipe the Slate Clean for Fannie Mae, Freddie Mac by Taking Their Toxic Loans” and weep. This administration will reward bad players as long as there is a political reason for them to exist. So, instead of real reform of Fannie and Freddie, they’re proposing a solution that sweeps past mistakes under the rug and allows these failed institutions to operate in the same irresponsible way that brought them their current fate. There is no such thing as the discipline of the market or the bankruptcy court when you’re big enough to hire K Street impresarios to keep your show running and the federal government enables you.

The Obama administration is considering an overhaul of Fannie Mae and Freddie Mac that would strip the mortgage finance giants of hundreds of billions of dollars in troubled loans and create a new structure to support the home-loan market, government officials said.

The bad debts the firms own would be placed in new government-backed financial institutions — so-called bad banks — that would take responsibility for collecting as much of the outstanding balance as possible. What would be left would be two healthy financial companies with a clean slate.

The moves would represent one of the most dramatic reorderings of the badly shattered housing finance system since District-based Fannie Mae was created by Congress to support mortgage lending during the Great Depression. Both Fannie Mae and Freddie Mac, based in McLean, have government charters to buy home loans from banks, which they then repackage and sell to investors. The banks can then use the proceeds to offer more loans to home buyers.

The leviathans became emblematic of the financial crisis when they were effectively nationalized in September amid a market meltdown that revealed much of their holdings to be troubled. The government has since pledged more than $1.5 trillion, including $85 billion in direct aid, to keep the mortgage market working through Fannie Mae and Freddie Mac.

The proposal, which is preliminary and one of several under discussion, is scheduled to be taken up by the White House’s National Economic Council on Thursday.

What about the Japanese lost decade and all the papers and studies written about the bad bank policy did these folks miss? Well, of course, you do know that the head of the “White House’s National Economic Council ” is La-La Summers, right? Mister, I got mine from Wall Street? Let’s look at the other players who buy into this. I’ll just highlight them so you can see that it’s basically the same players that had some kind of supporting role in the original failure. Why does Washington D.C. continue to reward the very same people and players? It has too be some thing pathological.

Read the rest of this entry »

Bernanke Rules

atlant-fed-eagleIs The Fed under Chairman Ben Bernanke  finally beginning to adopt the tougher lending regulations and rules that would’ve prevented much of the havoc of the last two years?  In a speech on April 17, Bernanke stated that damage done to the economy was not likely to be undone any time soon.  This gives more credence to the idea that we may see an L-shaped recovery.  In other words, be prepared to scuttle across the bottom for a very long time. But did the speech deliver the assurances we need that necessary steps and regulations w lending practices and financial innovations are in the works?  I don’t think so.

Here’s some interesting analysis by Craig Torres at

Federal Reserve Chairman Ben S. Bernanke said the collapse of U.S. lending will probably cause “long-lasting” damage to home prices, household wealth and borrowers’ good credit score.

“One would be forgiven for concluding that the assumed benefits of financial innovation are not all they were cracked up to be,” the Fed chairman said today in a speech at the central bank’s community affairs conference in Washington. “The damage from this turn in the credit cycle — in terms of lost wealth, lost homes, and blemished credit histories — is likely to be long-lasting.”

The U.S. central bank has cut the benchmark lending rate to as low as zero and taken unprecedented steps to stem the credit crisis through direct support of consumer finance and mortgage lending. The Fed plans to purchase as much as $1.25 trillion in agency mortgage-backed securities this year to support the housing market and is providing financing for securities backed by loans to consumers and small businesses.

Bernanke and the Federal Reserve Board approved rules last July to toughen restrictions on mortgages, banning high-cost loans to borrowers with no verified income or assets and curbing penalties for repaying a loan early. The action came after members of Congress and other regulators urged the Fed to use its authority to prevent abusive lending.

This suggests Bernanke does not see home values going back up any time soon.  It also suggests that the lending markets are not likely to return to their heyday.  Does this mean, however, that we’re finally going to see the regulation and enforcement of prudent underwriting standards and no more hide the trash in a bundle and pass it to the next sucker?

Read the rest of this entry »

Who let the Sharks Out?

As the economy continues its slide towards recession, we now have a pork-laden rescue of many of the folks both responsible for the recession as well as the crisis.  TARP may unfreeze the credit markets, but until we responsibly regulate the financial markets that are now shoveling troubled assets onto taxpayers and until we support the prices of their underlying assets (that would be folks’ homes), we will not solve the problem.

I focused recently on the lax lending standards that helped to create the housing bubble (fueled also by the Fed who kept interest rates too low, too long after 2001).  It was the red meat thrown into the piranha pool.  Let’s talk about what the piranhas did with the red meat once they had it. 

Let me mention first that we’ve nearly been here before when Long-Term Capital Management (LTCM) came close to collapse in September 1998 at the time when Russia had difficult repaying its debt. The Fed rescued the fund and showed that some guys are  just “too-big-to-fail”. The Fed wanted to stop possible contagion coming from the failure from spreading to commercial banks.  Studies at the time showed that losses to investment banks during this type of contagion could be huge  (including one done by my Financial Intermediaries Seminar prof).  They noticed that investment banks would be far more vulnerable to losses than depository institutes. This small crisis that most folks probably don’t even remember was the canary in the coal mine. 

Meanwhile, the primary mortgage market was coming under the spell of the underwrite-nearly-everything mentality spurred on by Fannie and Freddie. We’ve mentioned that Fannie and Freddie also imply a government guarantee.  Now, we have a situation where the Fed has shown its readiness to put the tax payer’s money behind anything it deems too big to fail. Both actions were like chumming the waters.  Rising house prices were just more blood on the water. It was only time before the piranhas and sharks came to feed.  They were being encouraged to ignore risk and that’s not a wise thing to do.

Five investment banks, including Goldman Sachs, approached the SEC with a proposal around 2004.  They sought an exemption for their brokerage units from old depression-era regulations that limited the amount of debt they could incur.  An exemption from this leverage rule would free up a heckuva lot of money to invest in some new-fangled investments:  mortgage-backed securities, credit derivatives, and credit default swaps.  They got permission. Enter the net capital rule that enabled the piranhas and the sharks.  During the next few years, leverage ratios increased until for about every dollars worth of equity held by an investment bank, there was around $30 in debt.

Credit default swaps act like insurance.  They are instruments intended to cover losses to banks and bondholders when companies fail to pay their debts.  Since 2000, the market has boomed from about $900 billion to more than $45.5 trillion.  This about twice the size of the entire U.S. stock market.  The market for credit default swaps as well as the market for mortgage securities were left unregulated.  Many folks have been worried about this market for some time.

The Comptroller of the Currency, a federal bank regulator warned that increased trade in swaps during 2007 was putting a strain on processing systems that were used to handle swaps.  Swaps are essentially what brought down AIG.  Back in the beginning of the year, AIG found that it had incorrectly valued some of the swaps and announced that mistake would cause the company to lose $6.3 billion more than they had estimated before.

Placing correct values on Swaps and Mortgage securities is very difficult.   Big banks, insurance companies and hedge funds are among the financial institutions that trade these derivatives.  CDS tend to be private agreements where buyers of the protection/insurance agrees to pay a premium to the seller over time.  (Much like an insurance policy premium).  The seller pays only if a particular crisis occurs.  These contracts can also be bought and sold.  Because the market is basically unregulated, no one quite knows when the swaps are sold and to whom they are sold.  This can be a problem when the protection is required, say like when the Hurricane Katrina of asset bubbles bursts in the housing market.  Just so you know, the largest players in this market are JP Morgan Chase, Citibank, and Bank of American.  All WAY too big to fail, right?

Enter speculators as this market gets large.  Speculators (read HEDGE FUNDS) have used these instruments to bet on a company or a bank’s failure. Funny thing is there is actually more value now out there in the derivatives than there is in the underlying assets.  Remember, this is BEFORE the bubble bursts and brings the asset prices down even further. So credit default swaps are basically default insurance, although they can’t be named that.  So what happens when every one needs to make a claim on their insurance and can’t exactly locate your contract and it probably resides with some one who is in worse shape than you?  (Ah, let your imaginations run away with you, it’s bad.)

So, let’s get back to our Pirahanas and Sharks.  They’re being encouraged to loosen up those lending standards by Fannie and Freddie AND they can buy insurance too if their bad loans go bad.  How can you lose with a deal like that?  It doesn’t appear that you can, does it?  So what do you do?  Continue underwriting loans for folks without income, folks without credit, folks that are even dead. (Yes, dead, I’m not making that up.)

I think you can see that what we have here is the perfect storm.  So let me get back to what this bill doesn’t do.  It DOESN’T stop the assets from continuing to go bad, at least in the housing end of things.  It DOESN’T regulate any of the players in this market although the investment banks are now under the jurisdictions of bank holding companies and basically the FED.  It DOESN’T deal with the leverage issue.  It DOESN’T punish any one for lending bad loans even.  No one is getting yelled at for encouraging this — not Fannie and Freddie, not the FED and not the SEC.  Definitely not the congresscritters that enabled them either, at least not yet.

What we are witnessing is the creation of more TOO BIG TO FAIL critters AND we’re giving them more money to lend out and we have inadequate regulation.  It’s time to take the chum out of the water, folks!

Back to the Roots of the Problem (cross-posted at The Confluence)

I feel a strong need to remind people at this time of the roots of this financial crisis. They are not found beneath Wall Street, but in Washington, D.C. with Freddie Mac and Fannie Mae and the senators and congressman that empowered them.  

The beginning of this crisis was the subprime mortgage market and the loose underwriting standards encouraged by FNMA and FHMLC on mortgage loans.  Fannie (FNMA) and Freddie (FHLMC) are involved with about half of the mortgage loan originations in that market.  Loose standards were set up to expand home ownership to folks who couldn’t pay home loans back and to improve the odds of high compensation for its CEOs.  Before any bail-out, rescue, or whatever you want to call it,  regulation has to be put in place to STOP this from happening again.  It’s really a nice social goal to increase the level of minority ownership in the country and to move the poor into homes of their own, but you can’t force it by giving folks loans they are not prepared to handle.  The House and Senate Democrats, and specifically the Black Caucus, are squarely behind this problem.  It is folks like Chris Dodd and Barack Obama–folks expected to clean up this mess–that were the beneficiaries of Fannie and Freddie largess that created very poor public policy and lack of regulation that led to this problem.

Wall Street did buy up these loans up after they were “packaged” into securities by Freddie and Fannie.  Freddie and Fannie bonds have been assumed to be nearly as safe as Treasury bonds so no one figured there were these toxic loans stuck into the mix.  Banks are also allowed to invest in Fannie and Freddie bonds.  They can’t invest in really risky assets like equities.  Who would have thought that Fannie and Freddie would be so poorly run that what they were investing in, what they were originating and selling to Fannie and Freddie, and what was being put together by Fannie and Freddie, would be so risky as to send their capital into regulator  panicking levels?   Ask Jim Johnson.  Ask Franklin Reines.  Ask Barack Obama and the Black Caucus.  They felt prudent underwriting was basically discriminatory and worked hard to change banks into speculators.

Here’s some examples:

Credit History: Lack of credit history should not be seen as a negative factor…. In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower–income applicants in particular, unforeseen expenses can have a disproportionate effect on an otherwise positive credit record. In these instances, paying off past bad debts or establishing a regular repayment schedule with creditors may demonstrate a willingness and ability to resolve debts….

If you’d like to know more about the loosening of standards,  here’s a really good study to check out:

Recently, there were an entirely inexcusable number of underwriting lapses allowed and in fact, encouraged  by Fannie and Freddie (including spurious sources of income and no down payments) that increased the demand for housing by allowing people that should not have been in the housing market, into the housing market.  This drove up prices and led to the bubble and increasing speculation.  Once it became apparent, that there was increasing risk popping up in mortgages,  the financial innovations of derivatives (Wall Street enters now) popped up to help banks manage the risk and pass them on to folk supposedly more able handle the risk.  These things were supposed to act as insurance and were valued based on the idea that traditional Fannie and Freddie were very risk-free and there was implied government oversight, regulation, and back-up.

It is no wonder that the FBI is now looking at Fannie and Freddie.  It should also look at the democratic appointees and the senators and congressman that enabled them.  When credible economist like Greg Mankiw came to the senate and congressional committees to warn of this problem in 2003, folks like Barney Frank yelled at him for worrying more about safety and soundness rather than housing for the little guy.  The Wall Street Journal was all over this back then.

This is the same Barney Frank that is bloviating and stomping his foot about the inability of House Republicans to get with his program.  Well, Congressman, it was your program that put us in this position to begin with so why would we trust you now?

House and Senate Democrats also had a chance in 2005 to increase oversight and regulation of Fannie and Freddie.  John McCain was a co-sponsor of this bill called Federal Housing Enterprise Regulatory Reform Act of 2005.  At the time McMcain made this comment that seems almost psychic now.

“If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.”

You know how Senator Obama is going around saying the Bush administration is the one that hates regulation and led to this?  As a professional economist and Puma, may I just say this: liar, liar pants on fire!

 WASHINGTON – Treasury Secretary John Snow urged Congress to restrain Fannie Mae and Freddie Mac, giving the Bush administration’s blessing to efforts to create a new regulator with broad power over the huge mortgage companies.

If you read the article, you’ll see that Allan Greenspan was also in front of congress and the senate begging for more oversight.

More from that article:

“The statements by Greenspan and Snow lent support to a new effort by Republican lawmakers to tighten controls on Fannie Mae and Freddie Mac, which hold or guarantee more than 45 percent of all mortgage loans in the country. Legislation recently proposed would set up a regulatory agency with the power to compel the companies to sell off any assets deemed not to be in line with their mission of making homeownership more widely available.

Notice the guarantee point.  Wall Street and Banks rely on these instruments to be low risk basically because of that guarantee.  This includes AIG and all the investment banks that just crashed.  They undervalued the risk on these instruments because of the implicit guarantee.

My point here?  Congressional republicans (who I usually find a source of great evil) are NOT the bad guys here for once.  They tried but were told they were racist and that they hated poor people if they didn’t go along with the plan of extending house loans to people that basically could not afford them.  Most of the blame for this financial crisis belongs squarely in Washington and the Democrats are relying on our extremely short memories.  Since all of this comes under my teaching and research responsibilities, I cannot have a short memory. The MSM should start asking Biden, Obama, Frank, and Dodd some very tough questions.  First Questions?  Why didn’t you support regulating Fannie and Freddie back before all of this snowballed into a financial crisis?  Why are you now saying that you always supported more oversight and regulation and Republicans and the Bush Administration did not when the record clearly shows it was the opposite?

I’d like to suggest one of the first CEOs to turn back his salary and face the FBI is Franklin Raines.

He turned Fannie Mae into a mortgage factory to get higher bonuses and was investigated for cooking the books.  He is undoubtedly one of the folks that has interested the FBI.  Another person is Jim Johnson. (You’ll recognize these names because they are both Obama friends and advisors).

In late 2004, Fannie Mae was under investigation for its accounting practices. The Office of Federal Housing Enterprise Oversight released a report  on September 20, 2004, alleging widespread accounting errors, including shifting of losses so Raines and others could earn bonuses.

In June 2008, the Wall Street Journal reported that two former CEOs of Fannie Mae, James A. Johnson (1991-1998) and Franklin Raines (1999-2004) had received loans below market rate from Countrywide Financial. Fannie Mae was the biggest buyer of Countrywide’s mortgages.  Don’t forget the three biggest recipient of FNMA money are Dodd, Kerry, and Obama. Dodd also appears to have a sweetheart mortgage deal.  The Democrats are not the white knights in this mess.  They would probably like to get this deal through as quickly as possible so voters do not find out that the bailout is not just a Wall Street Mess.  It is a K Street and Washington-created mess.  There is plenty of blame and greed to go around.

The very same people that created this mess are the ones writing the terms of the bail-out.  Be afraid!  Be very afraid!  I never put a steak on the kitchen counter and leave the dog alone in the room with it.  I would not leave the U.S. economy in the hands of these folks who are deciding the fineprint in a room with closed doors either.