mortgage meltdown

The Wall Street Journal today writes about how the Obama administration is repeating the “mistakes of the past by intimidating banks into lending to minority borrowers at below-market rates in the name of combating discrimination.” Assistant Attorney General for Civil Rights Thomas Perez has argued that bankers who don’t make as many loans to blacks as whites (because they make lending decisions based on traditional lending criteria like credit scores, which tend to be higher among white applicants than black applicants) are engaged in a “form of discrimination and bigotry” as serious as “cross-burning.” Perez has compared bankers to “Klansmen,” and extracted settlements from banks “setting aside prime-rate mortgages for low-income blacks and Hispanics with blemished credit,” treating welfare “as valid income in mortgage applications” and providing “favorable interest rates and down-payment assistance for minority borrowers with weak credit,” notes Investors Business Daily.

Under Perez’s “disparate impact” theory, banks are guilty of racial discrimination even if they harbor no discriminatory intent, and use facially-neutral lending criteria, as long as these criteria weed out more black than white applicants. The Supreme Court has blessed a more limited version of this theory in the workplace, but has rejected this “disparate impact” theory in most other contexts, such as discrimination claims brought under the Constitution’s equal protection clause; discrimination claims alleging racial discrimination in the making of contracts; and discrimination claims brought under Title VI, the civil-rights statute governing racial discrimination in education and federally-funded programs. Despite court rulings casting doubt on this “disparate impact” theory outside the workplace, the Obama administration has paid liberal trial lawyers countless millions of dollars to settle baseless “disparate impact” lawsuits brought against government agencies by minority plaintiffs, even after federal judges have expressed skepticism about those very lawsuits, suggesting that they were meritless.

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Ed Pinto, who was an executive at Fannie Mae long before it went into the toilet and nearly took the financial system down with it, notes that “the financial crisis resulted from an unprecedented accumulation of weak and risky Non-Traditional Mortgages (NTMs)” promoted by both the government and the government-sponsored mortgage giant Fannie Mae. “Each type of NTM featured increased borrower leverage and risk.”

In Government Housing Policy: The Sine Qua Non of the Financial Crisis, he describes in detail how government housing policy explicitly promoted massive increases in leverage and moral hazard by both borrowers and investors and chronicles the central role played by Fannie Mae and Freddie Mac as the clearly-acknowledged kings of moral hazard and leverage. As he points out, government involvement included the facts that (1) Congress, at the behest of community advocacy groups, forced Fannie and Freddie to replace conservative underwriting with flexible underwriting knowing that banks would follow suit; (2) Fannie vowed to transform the housing finance system using flexible underwriting, in an effort to protect its charter privileges bestowed by Congress; and (3) HUD, after a decade of effort, proudly took credit for a revolution in affordable lending. This revolution then led directly to the 2008 financial crisis, which precipitated a $160 billion bailout of Fannie Mae and Freddie Mac, the nation’s two government-sponsored mortgage giants.

(Unlike the private banks, which repaid their bailouts with interest, Fannie Mae and Freddie Mac are not expected to repay taxpayers, and their bailout tab may rise to $1 trillion, according to Bloomberg News. The Obama administration earlier lifted the $400 billion limit on bailouts for Fannie Mae and Freddie Mac, so that they could continue to buy up junky mortgages at taxpayer expense, and showered their executives with $42 million in compensation. In May 2010, the administration and its congressional allies blocked efforts to reform Fannie Mae and Freddie Mac.)

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In 2010, Obama administration allies proposed a trillion-dollar bailout for those lucky mortgage borrowers whose loans were owned by the government-backed mortgage giants Fannie Mae and Freddie Mac — including wealthy borrowers who have no difficulty paying their mortgage — in order to increase their disposable income and temporarily pump up the economy through the next election. Now, Obama administration officials such as Associate Attorney General Tom Perrelli are trying to achieve the same goal on a much smaller scale in settlement talks with the nation’s four biggest banks. Perrelli is demanding that they reduce the mortgages of certain favored underwater borrowers (many of whom are underwater because they didn’t make a substantial downpayment, the way thrifty people do), using the banks’ unrelated foreclosure paperwork violations as a pretext (benefiting lucky borrowers who were never foreclosed upon, much less treated improperly in any way).

But as Mark Calabria notes, this demand makes no sense at all economically. Any mortgage write-off that increases the disposable income of borrowers will reduce the disposable income of investors whose mortgage-backed securities are worth less after mortgages are partly written off. The government’s demand reflects irrational, magical thinking, a kind of voodoo economics. This  proposed rip-off of investors would not create any wealth or income, but rather merely redistribute wealth and income from investors to borrowers (reducing the disposable income of the suddenly poorer investors), discouraging future investment.

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Analysts who once downplayed the government’s role in causing the financial crisis now have changed their tune, concluding that government regulations that promoted risky loans played a major role in spawning the crisis. In a May 3 note to clients, Michael Cembalest, the Chief Investment Officer of JP Morgan Private Bank, revised his 2009 account of what caused the financial crisis.  Under the heading, “Retractions – the primary catalyst for the US housing crisis,” he wrote:

US Agencies played a larger role in the housing crisis than we first reported. In January 2009, I wrote that the housing crisis was mostly a consequence of the private sector… However, over the last 2 years, analysts have dissected the housing crisis in greater detail. What emerges from new research is something quite different: government agencies now look to have guaranteed, originated or underwritten 60% of all “non-traditional” mortgages, which totaled $4.6 trillion in June 2008. What’s more, this research asserts that housing policies instituted in the early 1990s were explicitly designed to require US Agencies to make much riskier loans, with the ultimate goal of pushing private sector banks to adopt the same standards.”  (emphasis in original)

Clinton-era affordable housing mandates were also a key reason for the risky lending. The Washington Examiner cited a recent study by Peter Wallison, who had prophetically warned about risky financial practices for years, finding that two-thirds of all bad mortgages were either “bought by government agencies or required to be bought by private companies under government pressure.”

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Post image for Federal Government and State Attorneys General Push Arbitrary Mortgage Bailout

Back before the election, intellectuals with ties to the Obama administration proposed a trillion-dollar bailout for some (but not all) underwater mortgage borrowers, as a way to increase consumer spending.

Last week, The Washington Post reported that bureaucrats at the newly-created Consumer Financial Protection Bureau (CFPB) want to do something similar on a smaller scale. Their proposal would require banks to write off part of the mortgages of certain (but not all) mortgage borrowers who owe more on their mortgage than their house is worth. Worse, they would require mortgage servicers to write off loan principal on loans owned by other institutions, like pension funds, violating their property rights.

Virtually all of America’s pension funds own mortgage-backed securities. Pension funds that millions of people rely on for their retirements would lose billions of dollars due to reduced mortgage value. These demands are contained in a 27-page proposed settlement sent to the banks by the CFPB, the Justice Department, and state attorneys general who sued the banks over their recent foreclosure documentation lapses. Such demands flout court rulings like Louisville Joint Stock Land Bank v. Radford (1935), which overturned a federal law that wiped out mortgage value.

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The Obama administration is now working with state attorney generals to rip off pension funds to bail out mortgage borrowers who don’t even need help. Pension funds that millions of Americans rely on for their retirement will suffer. Bank shareholders will also suffer. I  explain how and why in a commentary at The Washington Examiner website. The government is trying to get mortgage servicers to write off portions of loans that are owned by other people or institutions — like the pension funds that millions depend on. That undermines property rights. Last fall, intellectuals with ties to the Obama administration proposed a much larger, but conceptually similar, bailout that could cost taxpayers a trillion dollars, the idea being to temporarily increase consumer spending through the next election.

Fannie Mae and Freddie Mac were bailed out at a cost to taxpayers of between $148 billion and $363 billion. Their recklessness and wrongdoing was so obvious that even Treasury Secretary Geithner admits that “Fannie and Freddie were a core part of what went wrong” in the financial crisis. The two government-sponsored mortgage giants engaged in massive accounting fraud, and their allies in the Obama administration have now spent $160 million in taxpayer money defending them against various charges.

Yet, their longtime defenders, like the Washington Post’s Steven Pearlstein, are completely unrepentant. They continue to suggest that only right-wing ideologues could want to eliminate scandal-plagued Fannie and Freddie. Pearlstein long dismissed warnings from conservatives like the Wall Street Journal’s Paul Gigot about the dangers these mortgage giants posed to our financial system.

Incredibly, Pearlstein still believes that what’s good for Fannie and Freddie is good for America. In the January 23 Washington Post, Pearlstein showed he has learned nothing from the financial crisis.  Pearlstein called House Republicans “free-market ideologues” for wanting to rein in the two companies. He praised “low-income-housing advocates and the Obama administration” for opposing this reform effort.  He suggested that access to mortgages (and thus, homeownership) would suffer without Fannie and Freddie, ignoring the fact that homeownership rates are higher in countries like Chile and Italy that have nothing like Fannie or Freddie.

The last thing America needs is to keep Fannie and Freddie around to help spawn the next financial crisis. Fannie and Freddie helped spawn the current mortgage crisis by buying up risky mortgages and repackaging them as prime mortgages, thus creating an artificial market for junk: “From the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime.” As Government-Sponsored Enterprises, they were not subject to the sort of capital requirements that apply to private entities, so they did not have enough reserves to cover their losses when their mortgages started defaulting.

Congressional Democrats last year blocked a GOP amendment that would have reformed the  government-sponsored mortgage giants, Fannie Mae and Freddie Mac.  The Obama administration lifted a $400 billion limit on bailing them out and showered their executives with $42 million in pay.

At the direction of the Obama administration, Freddie Mac ran up more than $30 billion in losses to bail out mortgage borrowers, some of whom had high incomes. Federal regulators sought to make Freddie Mac hide the resulting losses from the SEC and the public.

Obama received $125,000 in contributions from Fannie Mae and Freddie Mac executives as a senator, second only to the Senator Chris Dodd, who was forced to retire last year over financial improprieties (such as his real estate gift from a lobbyist and “sweetheart mortgage from Countrywide Financial“), yet was the chief drafter of the Dodd-Frank financial “reform” law.  (Dodd-Frank harms the economy, and violates both the Constitution’s separation of powers, and private property and equal-protection rights).

Despite the devastating financial impact of Fannie Mae and Freddie Mac’s mistakes, their defenders are as unrepentant, and perhaps as influential, as ever.  Don’t expect their allies in the Obama administration to endorse any meaningful reforms.

Under government mortgage bailout/modification programs, the mortgage payments of many delinquent borrowers were cut to 31 percent of income, even for borrowers with high incomes and big houses. That cut was based on the false assumption that anything over that percentage was unaffordable (and perhaps even predatory lending). But people often pay far more than that in rent and mortgage payments, especially in prosperous regions like Washington, D.C. So mortgage deadbeats are sometimes getting their payments cut well below what their responsible neighbors have to pay — not merely getting relief from a bad deal.

“One in five renters and one in seven homeowners in the Washington area spend more than half their income on housing, according to census figures,” notes a recent Washington Post storyMuch of the population in the counties surrounding Washington, D.C. spent more than 30 percent: “In Fairfax County, for example, more than half the renters with household incomes of $50,000 to $75,000 spent more than 30 percent of their income last year to keep a roof over their heads,” as did “more than six out of 10 homeowners in that income bracket in Prince George’s and Prince William counties,” and “more than half” in Washington, D.C. itself.

Senior government officials, who mostly purchased their homes long ago, long before the housing bubble (and thus often have mortgage payments that are just a tiny fraction of their income), seem oblivious to this reality.

Many borrowers aren’t making any payments at all. They’re just defaulting on their mortgages, knowing that it will take years for the bank to evict them for non-payment: 492 days is the average number of days since the typical borrower in foreclosure last made a mortgage payment.  As law professor Glenn Reynolds notes, this all “seems calculated to make people who are struggling to make their payments feel like suckers.”

These mortgage bailout programs are harming the economy, say some economists and real estate experts.

I understated things a bit when I noted earlier that some mortgage deadbeats had their mortgage payments cut to just 31 percent of income. Actually, it’s lower than that. That 31 percent figure includes not just mortgage payments but also real estate taxes.  So if a delinquent borrower has a mortgage that’s 20 percent of income, and property taxes that are another 15 percent of income (for a total of 35 percent of income), that borrower could have gotten a reduction in mortgage payments under the 31 percent test, despite having a modest mortgage.

“Taxpayers and the federal government would be among the biggest losers if officials heed calls from some legislators and homeowners rights groups to stop millions of foreclosures across the country because of possible paperwork problems,” reports the Washington Times. “The Treasury Department is majority owner of one of the biggest mortgage companies, Ally Financial, formerly GMAC.”

“Despite much political posturing over improperly assigned foreclosure documents, ‘robo’ signatures and other irregularities . . . there does not appear to be any substantive questions’ about the legal rights of banks and investors to foreclose against long-delinquent homeowners in most cases,” said Ed Pinto, a mortgage analyst and former chief credit officer for Fannie Mae (a position he held back in the days before it began buying up and mislabeling vast numbers of subprime mortgage loans, leading to its current taxpayer bailout).

A moratorium would also impose huge losses on investors and retired people.  As noted earlier, if your 401(K) has shrunken recently, it may be due to falling bank stocks, like Bank of America stock, which has fallen from over $19 a share to less than $12 a share over the last six months.   Many if not most 401(K)s indirectly own Bank of America stock, through their mutual fund holdings.  Its stock value has fallen due to the possibility that paperwork errors and securitization may thwart repossession of homes though foreclosure.   Law professor Richard Epstein says a halt to foreclosures would be a disaster for “prudent borrowers and lenders,” while AOL’s Marty Robins says it would delay “economic recovery” and increase mortgage “interest rates.”  A news story illustrated the negative ripple effects of halting foreclosures.  Bank of America also reported a $10 billion loss due to restrictions on debit cards contained in the 2010 Dodd-Frank Act, restrictions that will also harm consumers.

When Obama was elected, he claimed he would “go through our federal budget– page by page, line by line–eliminating those programs we don’t need.” But as president, he seems to have forgotten about this pledge. The Cato Institute reminds him of it in a full-page advertisement in today’s Washington Post and other newspapers, identifying $525 billion he could cut annually from the federal budget by eliminating unnecessary or harmful programs.

For example, it notes that “Federal interference in housing markets has done enormous damage to our cities and the economy at large. HUD subsidies have concentrated poverty and fed urban blight, while Fannie Mae and Freddie Mac stoked the financial crisis by putting millions of people into homes they couldn’t afford. Getting the government out of the housing business will save $45 billion annually.” It also notes that “Federal workers enjoy far greater job security than their private sector counterparts—and far better total compensation: an average of $120,000 a year in wages and benefits. Cut federal compensation by 10 percent to save $20 billion annually.”

In 2008, Obama pledged to implement a “net spending cut,” but he has instead exploded government spending.  Federal domestic spending increased by a record 16 percent in 2010.  In 2010, the Congressional Budget Office concluded that “President Obama’s policies would add more than $9.7 trillion to the national debt over the next decade.”

The Obama administration’s housing spending is particularly wasteful.  It is now using regulations and billions in tax dollars to promote more of the risky lending that led to the financial crisis.  It is ratcheting up affordable-housing mandates that created markets for junk sub-prime mortgages (thus spawning the mortgage meltdown, as even the liberal Village Voice has conceded), and it is increasing regulatory pressure on banks to make risky loans.  A $75 billion federal mortgage bailout program harmed the very real estate markets it was supposed to help.