naked capitalism

By George Washington of Washington’s Blog.

As I have repeatedly written, the largest U.S. banks have repeatedly gone bankrupt due to wild speculation which was blessed by the Fed, and then the government covered up their bankruptcy.

Indeed, the New York Times writes today about one of the too big to fails:

Over the past 80 years, the United States government has engineered not one, not two, not three, but at least four rescues of the institution now known as Citigroup.

But prominent economist James Galbraith recently told Bill Moyers:

JAMES GALBRAITH: The overwhelming emphasis, in the administration’s program, I think, has been to return things to a condition of normalcy, to use a 1920s word, that prevailed five and ten years ago. That is to say, we’re back to a world in which Wall Street and the major banks are leading, and setting the path–

BILL MOYERS: To restore what was.

JAMES GALBRAITH: To restore what was–

BILL MOYERS: Instead of reform what is.

JAMES GALBRAITH: And I don’t think what was can be restored.

BILL MOYERS: And you say that’s the objective of the administration’s policies? Geithner, Bernanke, Summers, the President himself?

JAMES GALBRAITH: To the extent that there’s a defined objective, that’s it, yes. I think in the immediate day-to-day work, they’ve largely been preoccupied with keeping the existing system from collapsing. And the government is powerful. It has substantially succeeded at that, but you really have to think about, do you want to have a financial sector dominated by a small number of very large institutions, very difficult to manage, practically impossible to regulate, and ruled by, essentially, the same people and the same culture that caused the crisis in the first place.

In other words – as I have repeatedly written – the administration’s talk of reform is just talk … the boys are just trying to restore the status quo.

Galbraith also pointed out – as many other experts have – that confidence in the system cannot be restored unless the fraud which led to the crash is investigated:

JAMES GALBRAITH: That’s the point about the crisis, is that it could have been prevented. The people in authority two, three, five years ago, knew how to prevent it. They chose not to act, because they were getting a political and an economic benefit out of the speculative explosion that was occurring.

BILL MOYERS: You mean, the people who could have prevented the dam from breaking were too busy fishing above it, and reaping big rewards to want to fix the crack in it?

JAMES GALBRAITH: Sure. The Federal Reserve, in particular, knew that the dam was cracking. Alan Greenspan, I think, almost surely knew this, and chose to wait until it had washed away.

BILL MOYERS: Why?

JAMES GALBRAITH: They let all of this run, because they were getting a superficially stronger economy out of it. The ownership society, all that was a scam, basically, designed to lure people who could never afford these mortgages into accepting them. And yes, I think they, any rational person, certainly people in the industry, knew that this was not going to last. There was a little industry code, I’ve learned, IBGYBG. “I’ll be gone. You’ll be gone.”

BILL MOYERS: Really?

JAMES GALBRAITH: Yeah.

BILL MOYERS: The industry being the securities industry?

JAMES GALBRAITH: Well, and the mortgage originators and the bankers, generally.

BILL MOYERS: But that’s criminal fraud.

JAMES GALBRAITH: Oh sure. There was a huge amount of it. The Bush administration did not actively investigate the fraud that they knew, that the FBI knew was occurring, from 2004 onward. And there will have to be full-scale investigation and cleaning up of the residue of that, before you can have, I think, a return of confidence in the financial sector. And that’s a process which needs to get underway.

As the New York Times article notes, the lack of transparency is ongoing, even as between different branches of government:

Representative Lloyd Doggett, a Texas Democrat on the House Ways and Means Committee, recently registered unease about the government’s guarantee of $300 billion in Citigroup assets and how effectively the Treasury secretary, Timothy F. Geithner, was monitoring the bank.

“We cannot know the full scope of the taxpayers’ potential cost from these hasty guarantees,” Mr. Doggett said last week in an e-mail message. “Inexplicably, Secretary Geithner appears unwilling to commit to conduct an analysis, despite my specific request to him in March. A critical and transparent examination of the response to the financial crisis is essential not only to learn from past mistakes, but also to prevent further erosion of the public’s trust in government.”

Mario Seccareccia – editor of the International Journal of Political Economy – points out:

The Great Crash of 1929 taught us that a modern monetary market economy is governed by confidence. As John Maynard Keynes put it, monetary relations and, more precisely, asset values, are held up by one’s belief in the future. Without it, the whole credit-driven economic system comes to a halt and economic agents scramble for cover by seeking to acquire liquidity.

While in a non commodity-based monetary system a central bank can quite easily supply liquidity in its role as lender of last resort, a central bank cannot single-handedly instill confidence in the future. When confidence is lost, monetary policy is impotent in building up asset values, which can only be sustained if people believe in future revenue arising from future production. The economy remains trapped in a state of paralysis in which everyone is seeking to remain liquid. History tells the tale: Excessive optimism prior to the Great Crash turned to hopelessness during the early 1930s.

Without a thorough investigation like the Pecora Commission, and without prosecuting those who are guilty, confidence and hope in the future will not be restored, consumer confidence will remain depressed, and we will remain in an economic slump.

We’ve been waiting for vigilante justice to start against those who profited from the financial crisis, but it should have occurred to us that it would be the foot soldiers, not the kingpins, who’d be the prime targets.

From Reuters (hat tip reader John D):

As Los Angeles housing advocates launched a campaign warning of mortgage rescue scams, a couple hit by foreclosure are charged with torturing two loan-modification agents they suspected of fraud, authorities said on Monday.

The couple, Daniel Weston and Mary Ann Parmelee, and three other people are accused of luring their two victims to an office where the men were tied up, held for hours and beaten, a spokeswoman for the Los Angeles County district attorney said.

Police were called after one of the victims managed to escape, said the spokeswoman, Shiara Davila-Morales. The incident occurred on Wednesday in the town of Glendale, just north of Los Angeles.

Weston, Parmelee and the three other defendants each were charged with two counts of torture, two counts of false imprisonment by violence and two counts of second-degree robbery, according to a criminal complaint filed against them….

“The two allegedly sought loan modification assistance from the victims but believed that nothing was being done and wanted their money back,” a statement from the district attorney’s office said….

Weston and another man, who previously served time for assault, are accused of carrying out the beatings in front of their three co-defendants, who prosecutors say had prior business ties with the two victims by having funneled loan-modification referrals to them.

Now the real question is whether this couple had actually sought advice, or whether they thought they had been cheated on their referral fees, and got aggressive in their collection methods, and the claim that they were cheated clients is to attempt at a better sounding justification for their actions. Either way, it speaks to a sordid underground in the mortgage arena.

Hoisted from comments:

I am a lawyer who has been involved in corporate finance for over 25 years. First, if you beleive that securitization offers benefits (cost reductions) to consumers then MERS is not per se a bad thing in that it reduces overall transation costs which should in part be passed on to the homeowner borrower. As you note, the problem is more a change in standards (perhaps ethics and morality) in the last ten years in the industry.

The problem is not MERs by itself but how the securitization industry has changed in recent years to the detriment of cosumers and investors in the banks and other companies that have blown up as a result of an important industry being turned into basically a circus. I can share my own expereince as a homeowner to demonstrate how crazy things have become.

I had a mortgage on my home that was originated over 15 years ago at a local bank. The mortgage had been sold (through five intervening transactions)over the years to Washington Mutual. Two years ago I decided to pay the loan off. At the end of a month, I sent in a check for the full balance of principal and interest on the loanand requested a deed release be filed. This was all in accordance with the terms of my promissory note and mortgage the legal agreement governing all parties.

Two weeks later I received my check back in the mail from WMU with a letter stating that the payoff was not in accordance with Washington Mutual policy. No one at Washington Mutual had bothered to read the mortgage agreement (the legal agreement binding the parties). Instead the letter stated that payoffs had to be preceeded by paying $75 for a “payoff quotation” and must be made by wire transfer and other terms which were obviously made to increase the profitablity to WMU which had no basis in the legal agreements.

Since WMU had no legal basis for its demands, I stopped paying my mortgage. Within three months my credit score had been lowered 300 points, all of my credit cards were canceled (I never kept a balance on any card) and I was receiving daily harrassing collection calls. Eventually, I sent a couple of letters to the WMU General Counsel’s office and began to work towards a class action lawsuit. Despite this, it took another three months to get someone’s attention at WMU who could put two and two together and I finally received a call and letter from a senior attorney who agreed to forgive thousands of dollars in interest, put a person full time on reestoring my FICO score etc etc. and fix the problems that never should have occured.

The point is that the securitization industry 5-10 years ago made a collective choice to ignore the terms of contracts, state and local laws and legal convesntions developed over hundreds of years. Why? Because they could. Our legal system and conventions were built on the assumption that most businesses would choose to follow them. Instead, the securitization industry simply developed a cost/benefit approach to following the law and adhering to contracts. It worked quite well becaseu most individuals just aren’t equipped to read and enforce their mortgage agreements or fully understand the law.

This is why the banks are fighting so hard against the Consumer Financil Protection Agency. The CFPA will have the ability to level the playig field and thus change the economics of banks simply ignoring laws, contracts and convention.

Note this mess got resolved only because the consumer in question was an attorney, and he still had to threaten a class action suit to get the servicer’s attention. And even then, it took months to clear matters up, and completely trashed his credit score in the meantime, resulting in the loss of ALL his credit cards.

How many people can afford that? Seriously. For instance, if you need to rent cars or stay in hotels in your line of work, and either your company does not provide you a corporate credit card, or you are self employed (business credit is based on your personal FICO), you’d be stuck. And if you were looking for a job, many employers pull a credit report and will not consider a candidate with a low FICO.

In other words, very few people are able to contest abusive behavior and overbilling by servicers due to the hard costs (attorney’s fees) and soft ones (damage to credit score).

Update 5:20 PM: Another sighting courtesy reader i on the ball patriot:

Bank of America and Countrywide Home Loans destroyed mortgage documents, and “recreate” them by “insert(ing) data as they see fit,” to cover up their own failure to keep records – or their fraud – according to a federal RICO class action.

Article continues here.
Update 9:30 PM: Further detail from the lawyer who provided the comment at the start of the post:

To clarify:

1. I sent WAMU a personal check for the full mortgage balance in accordance with the terms of my Promissory Note.

2. WAMU returned the check -not cashed- becasue I had not paid the additional fees that WAMU had unilaterally imposed as a precondition to paying off the mortgage. I stopped paying because I had a legal right to do so after tendering the correct payoff.

3. Yes, I was in a position that the vast majority of consumers are not – both as an attorney and being able to live without credit of any sort for an extended period. I’m old school and never borrowed except for home mortgages.

I beleive the fallout from the mass assignments (and re-assignments) is just starting from an administrative standpoint. I helped a friend this summer who had sold her house in Boston but was unable to close the sale because an earlier mortgage lender had failed to file a Deed of Release after being paid off with a refinancing a couple of years ago.

The prior lender had flipped the mortgage and had gone bankrupt. The payoff went to a lender three links down the chain and the attorney handling the refi never obtained copies of assignements or the Deed of Release from the parties. The immediate resolution was to close the current sale (a neceesity given the market) and hold all of the sale proceeds in escrow until a Deed of Release could be obtained. I spent two months tracking down a senior executive fromn the bankrupt lender who after weeks of cajoling and ultimately legal threats agreed to sign a Deed of Release which we filed. The ironic part of it is that the executive actually had no legal right to sign the Deed of Release becasue the bankrupt lender had sold the loan and had no right to sign the release.

Sounds like a nightmare right? It was and would have cost my friend probably $25K to get it resolved. I know because I spoke with a couple of attorneys who are are speacilizing in this kind of thing – a very recent specialization caused by the increasing frequency of problems associated with the caviler treatment of assignments by the industry.

Lastly,I would add that the reason for MERs existence is transitory. Electronic signatures are now valid in every state I beleive and deed registrys across the country are adopting electronic filings and records. I estimate 3-5 years before all the filings are done online.

Submitted by Edward harrison of Credit Writedowns

Yves covered this in an earlier post overnight. Here’s my take. This is probably my fourth post on the tangled web woven by securitization, which puts a considerable distance between home owners and mortgagees which own a mortgage.  The issue is causing huge problems in bankruptcy and foreclosure in courts around the U.S. 

Update: I now see Barry Ritholtz has a piece out on this as well.

This morning, Gretchen Morgenson has another good piece out describing how a judge nixed all claims by mortgagee which refused to modify a home owner’s mortgage.

The debtors’ revolt is on.

For decades, when troubled homeowners and banks battled over delinquent mortgages, it wasn’t a contest. Homes went into foreclosure, and lenders took control of the property.

On top of that, courts rubber-stamped the array of foreclosure charges that lenders heaped onto borrowers and took banks at their word when the lenders said they owned the mortgage notes underlying troubled properties.

In other words, with lenders in the driver’s seat, borrowers were run over, more often than not…

But some judges are starting to scrutinize the rules-don’t-matter methods used by lenders and their lawyers in the recent foreclosure wave. On occasion, lenders are even getting slapped around a bit.

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

I see this as a watershed case in jurisprudence surrounding mortgage-related bankruptcies and foreclosures.  The reason this is huge is that it echoes the case in Kansas I have written about in two previous posts:

• “Why mortgages aren’t modified and what a ruling stopping foreclosures means”
• “What are the legal rights of lenders and homeowners in foreclosure?”)

At issue is the question of what legal rights do lenders or their agents have in foreclosure in the new byzantine world of securitized mortgages.  In the New York case the judge nixed the entire claim as the mortgagee could not prove it had legal claim to the mortgage note. With the mortgagee unable to show ownership, the homeowner might even be able to stay in his home mortgage-free, Morgenson attests. That’s huge – and we should definitely expect an appeal.

In the Kansas case, MERS, a mortgage registrar, and a second-mortgage mortgagee were not informed of the homeowners bankruptcy and disposition of assets and claims before judgment was made. Nevertheless, the district court, the appeals court AND the Kansas supreme court all upheld the original summary judgment arguing that MERS was not contingently necessary.  While I would expect this case to be appealed because of the precedent it could set, I don’t see how it can be overturned after affirmation in every court – that is except through a politicization of the verdict.

Notice how PHH and MERS, the two lender agents in each cases, are not the actual owners of the mortgages. They are the agents of the mortgagees. This is why these cases have a lot to do with securitization

See also: How much money is Wells Fargo really making? for how some of this affects earnings at money center banks.

Morgenson had another article of merit on this topic last week. See her piece The Mortgage Machine Backfires.  This could get interesting.

Oh, and in an unrelated case, but also involving bank customers successfuly contesting big finance, Citibank Belgium is being held liable by state prosecutors for duping its savers into taking safe money out of their savings account and investing it in Lehman Brothers. When Lehman went bust, 128 million euros of their savings money went poof. See my story here. Agence France Press has covered it, but don’t expect it to get huge coverage in the U.S. Mish thinks Citigroup is in “serious trouble” globally. So do I. Let the backlash against reckless finance begin.

Gretchen Morgenson of the New York Times reports on the latest instance of judges taking issue with the rather haphazard procedures of lenders and servicers in handling mortgage assignments.

As most people know (and many by first hand experience) mortgages often pass through a lot of hands, and the securitization industry has played plenty fast and loose in making sure the transfers are handled properly. The system by which these sales are executed is coming under increasing scrutiny. From Pam Martens:

The problems grew out of the steps required to structure a mortgage securitization. In order to meet the test of an arm’s length transaction, pass muster with regulators, conform to accounting rules and to qualify as an actual sale of the securities in order to be removed from the bank’s balance sheet, the mortgages get transferred a number of times before being sold to investors. Typically, the original lender (or a sponsor who has purchased the mortgages in the secondary market) will transfer the mortgages to a limited purpose entity called a depositor. The depositor will then transfer the mortgages to a trust…

Because of the expense, time and paperwork it would take to record each of the assignments of the thousands of mortgages in each securitization, Wall Street firms decided to just issue blank mortgage assignments all along the channel of transfers, skipping the actual physical recording of the mortgage at the county registry of deeds.

Yves here. I know I have said this before, but I am gobsmacked every time I read this stuff. When I was briefly in the securities business (early 1980s), even a teeny weeny error in a securities offering was completely unacceptable, a career limiting event for lawyers and bankers involved. And even though due diligence wasn’t what it should have been, there were certain steps that were absolutely necessary to avoid liability (having the deal counsel read the issuer’s board minutes and having someone from the lead manager visit the major facilities of a first-time issuer, for instance).

The finesse in mortgage securitizations was a company called MERS. Fore those not familiar with their procedures, Marten gives a good overview:

on August 28, 2009, Judge Eric S. Rosen of the Kansas Supreme Court took an intensive look at a “straw man” some Wall Street firms had set up to handle the dirty work of foreclosure and serve as the “nominee” as the mortgages flipped between the various entities. Called MERS (Mortgage Electronic Registration Systems, Inc.) it’s a bankruptcy-remote subsidiary of MERSCORP, which in turn is owned by units of Citigroup, JPMorgan Chase, Bank of America, the Mortgage Bankers Association and assorted mortgage and title companies…

In recent years, MERS has become less of an electronic registration system and more of a serial defendant in courts across the land…

MERS doesn’t have a big roster of employees or lawyers running around the country foreclosing and defending itself in lawsuits. It simply deputizes employees of the banks and mortgage companies that use it as a nominee. It calls these deputies a “certifying officer.” Here’s how they explain this on their web site: “A certifying officer is an officer of the Member [mortgage company or bank] who is appointed a MERS officer by the Corporate Secretary of MERS by the issuance of a MERS Corporate Resolution. The Resolution authorizes the certifying officer to execute documents as a MERS officer.”

Kansas Supreme Court Judge Rosen wasn’t buying MERS’ story… Judge Rosen wrote:

“The relationship that MERS has to Sovereign [Bank] is more akin to that of a straw man than to a party possessing all the rights given a buyer… What meaning is this court to attach to MERS’s designation as nominee for Millennia [Mortgage Corp.]? The parties appear to have defined the word in much the same way that the blind men of Indian legend described an elephant — their description depended on which part they were touching at any given time. Counsel for Sovereign stated to the trial court that MERS holds the mortgage ‘in street name, if you will, and our client the bank and other banks transfer these mortgages and rely on MERS to provide them with notice of foreclosures and what not.’ ” (Landmark National Bank v. Boyd A. Kesler)

Yves here. So you see what happened? The securitization industry decided to impose the convenience of “street name” holdings of securities to mortgages, simply ignoring hundreds of years of precedent and a thicket of local laws (no joke here, the US precedent on the primacy of title documents goes back to at least 1818 in the US. No deed is like “no tickie, no laundry.”) Back to Marten:

Lawyers for homeowners see a darker agenda to MERS. Timothy McCandless, a California lawyer, wrote on his blog as follows:

“…all across the country, MERS now brings foreclosure proceedings in its own name — even though it is not the financial party in interest. This is problematic because MERS is not prepared for or equipped to provide responses to consumers’ discovery requests with respect to predatory lending claims and defenses. In effect, the securitization conduit attempts to use a faceless and seemingly innocent proxy with no knowledge of predatory origination or servicing behavior to do the dirty work of seizing the consumer’s home. While up against the wall of foreclosure, consumers that try to assert predatory lending defenses are often forced to join the party — usually an investment trust — that actually will benefit from the foreclosure. As a simple matter of logistics this can be difficult, since the investment trust is even more faceless and seemingly innocent than MERS itself. The investment trust has no customer service personnel and has probably not even retained counsel. Inquiries to the trustee — if it can be identified — are typically referred to the servicer, who will then direct counsel back to MERS. This pattern of non-response gives the securitization conduit significant leverage in forcing consumers out of their homes. The prospect of waging a protracted discovery battle with all of these well funded parties in hopes of uncovering evidence of predatory lending can be too daunting even for those victims who know such evidence exists. So imposing is this opaque corporate wall, that in a ‘vast’ number of foreclosures, MERS actually succeeds in foreclosing without producing the original note — the legal sine qua non of foreclosure — much less documentation that could support predatory lending defenses.”

Yves again. Again, I know this has been rumbling around in the news for months, but it is hard for me to believe this has gone on as long as it has. I have heard (from my attorney first hand on situations she has been involved in, not urban legend) of a corporate lawsuit being thrown out of court because the contract between the parties had the name of the entities wrong….by a comma! Now real estate law is a different area, but title is one of its fundamental principles. Selling securities in a trust when the trust does not have clear title to assets in the trust is fraud. If judges keep nixing foreclosures based on the servicer (acting on behalf of the trust) not being able to demonstrate ownership, we could see a very interesting knock-on, of investor litigation against the trusts. But it’s too early to tell.

But it isn’t surprising that judges are plenty unsympathetic, and in cases, outraged. The law is all about sanctity of process, both the underlying law and court proceedings. Cases typically revolve around disputes of fact or grey areas of the law. This isn’t grey (whether a party has standing to file a suit is fundamental) and the law in this area is well established. Basically, the securitization industry tried creating rules outside any established legal framework and judges are having none of it.

Morgenson offers an interesting new sighting, involving a Federal judge in the Southern District of New York. This is significant because the Federal bench is generally pretty high caliber, and the Southern District of NY is particularly well respected. Moreover the ruling can’t be dismissed as a judge favoring the locals over the big bad out of town servicer:

…..on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

Yves here. Translation: the judge was pissed. He could have dismissed the case without prejudice, meaning PHH could get its ducks in a row and try again, but he sent a much stronger message. Back to the story:

….the case is an alert to lenders that dubious proof-of-ownership tactics may no longer be accepted practice. They may even be viewed as a fraud on the court…..

Yves here. Lawyers can correct me, but I believe “fraud on the court” would mean that lawyers that bringing that sort of action could be sanctioned. Back to Morgenson:

According to court documents, the borrower bought the house in 2001 with a mortgage from Wells Fargo; four and a half years later she refinanced with Mortgage World Bankers Inc.

She fell behind in her payments, and David B. Shaev, a consumer bankruptcy lawyer in Manhattan, filed a Chapter 13 bankruptcy plan…

Mr. Shaev said that when he filed the case, he had simply hoped to persuade PHH to modify his client’s loan. But after months of what he described as foot-dragging by PHH and its lawyers, he asked for proof of PHH’s standing in the case…..

Mr. Shaev received a letter stating that PHH was the servicer of the loan but that the holder of the note was U.S. Bank, as trustee of a securitization pool. But U.S. Bank was not a party to the action.

Mr. Shaev then asked for proof that U.S. Bank was indeed the holder of the note. All that was provided, however, was an affidavit from Tracy Johnson, a vice president at PHH Mortgage, saying that PHH was the servicer and U.S. Bank the holder.

Among the filings supplied to support Ms. Johnson’s assertion was a copy of the assignment of the mortgage. But this, too, was signed by Ms. Johnson, only this time she was identified as an assistant vice president of MERS, the Mortgage Electronic Registration System. This bank-owned registry eliminates the need to record changes in property ownership in local land records.

Another problem was that the document showed the note was assigned on March 26, 2009, well after the bankruptcy had been filed….

According to a transcript of the Sept. 29 hearing, Mr. DiCaro [representing PHH] said: “In the secondary market, there are many cases where assignment of mortgages, assignment of notes, don’t happen at the time they should. It was standard operating procedure for many years.”

Judge Drain rejected that argument, concluding that what had been presented to the court just did not add up. “I think that I have a more than 50 percent doubt that if the debtor paid this claim, it would be paying the wrong person,” he said. “That’s the problem. And that’s because the claimant has not shown an assignment of a mortgage.”….

Late last week, PHH appealed the judge’s ruling. But Mr. DiCaro and PHH are in something of a bind. Either they will return to court with a clear claim on the property — including all the transfers and sales that are necessary in the securitization process — or they won’t be able to produce that documentation. If they do produce it, they will then have to explain why they didn’t produce it before.

Yves again. And given that they presented that little assignment with a date after the bankruptcy was filed….that would seem to say that any cleaned up paper trail was fraudulent.

Of course, presumably everyone in foreclosure land will get smarter and at least post date their documents more carefully. But maybe not.

And we have an even more interesting set of possibilities. Say servicers and MERS fail to clean up their act, and more judges start throwing out foreclosures. Kansas Supreme Court Judge Rosen didn’t just say he didn’t see an acceptable paper trail; elements of his ruling were a much more fundamental attack on MERS. If more judges start challenging MERS’s legitimacy, that could strike at the heart of foreclosures in securitizations. In other words, a few more of these rulings may accomplish what the folks in DC have been unwilling and unable to do: force banks to negotiate. The problem, of course, is the impact will be very inconsistent. Some jurisdictions and judges will no doubt be more sympathetic to this line of argument than others.

Stay tuned, this looks certain to get even more interesting.

By Jonathan Mintz, the Commissioner of the New York City Department of Consumer Affairs, and Richard H. Neiman, the Superintendent of Banks for the State of New York:

For over a year, most of us have agreed that reform of our financial regulatory system is essential to our future financial stability and economic growth. Yet further consensus has been difficult to achieve.

With House committee debate and markup of Congress’s reform bills underway we, a bank regulator and a consumer protection official write to unify two perspectives that have created more conflict than necessary in this debate. We reject the myth, as many have unfortunately framed it, that consumer protection and prudent bank regulation are in conflict. Risky or deceptive financial products hurt the economy as a whole as much as they hurt the consumer. The public deserves — and our economy requires — that we concentrate on a strengthened system of financial oversight that demands clear, fair, and prudent banking and lending products and practices.

More important than the discourse over whether it would be better to combine or separate bank regulatory and consumer protection agencies is the idea that we first collectively agree that the solution must leverage and strengthen the resources of both disciplines. The New York State Banking Department (NYSBD) is the oldest bank regulatory agency in the nation, regulating state-licensed and state-chartered financial entities. New York City’s Department of Consumer Affairs (DCA) is the first municipal consumer protection agency in the nation, enforcing a fair and vibrant consumer marketplace. Through our cooperation in developing consumer products and financial education programs, we have experienced firsthand the benefits of combining our perspectives and offer three observations based on that experience.

First, smart consumer protections enhance choice and encourage a more competitive and more stable marketplace. Consumer protection at its core is about a clear offer that can be meaningfully accepted; it is a red herring to suggest that consumer protection leads to limitations on consumer choice. Excessive latitude toward overly complex, aggressive and deceptive marketing created a robust but short-term recipe for profit, but sacrificed sustained profitability, a stable customer base and ultimately the entire economy. And it decimated millions of individual families’ financial stability, primarily those least able to afford having their modest resources plundered.

Second, while expanding financial literacy is critical, it is insufficient alone to protect consumers. Deceptive practices must be banned and truly effective disclosures for complex products must be required. The vast bulk of consumers who avoid mainstream banking do so because of well-founded fears of unexpected and destabilizing fees and hidden product features, not a lack of education. Overdraft protection plan fees are the prime example. The Federal Deposit Insurance Corporation reports that overdraft fees on debit transactions-which average $27 on overdrafts averaging just $20-represents a staggering annual percentage rate of 3,540 percent. According to a recent Moebs Study, bank revenues from these fees may total $38.5 billion this year alone. Credit products offer more of the same: hidden disclosures, costly fees and imposed surprises. In addition to prohibiting unacceptably unsafe financial products and services, we need to empower consumers to distinguish between safe and potentially dangerous products, for their benefit and the stability of our economic system.

Third, we therefore propose the development of a nationally recognized rating system that would clearly communicate product safety and complexity. With advice from diverse stakeholders, this rating function would be enforced across the spectrum of banking regulators. These product ratings would aid consumers in selecting suitable products, and would provide a useful tool for evaluating Community Reinvestment Act (CRA) compliance in a qualitative way, reforming the program’s stifling “check-the-box” mentality which fails to bring meaningful banking services to many communities.

For example, simple and transparent products would be appropriate for many consumers and could receive green light safety ratings. Product features that add complexity or riskiness for those with lower incomes could be given a yellow light designation. And products with features that are inherently dangerous or expensive to the majority of such consumers could be labeled with a red warning, alerting consumers to high risk. Think of skiing. Who would ever venture down a mountain without first knowing if the trail was rated for beginners or was a double black diamond, for experts only?

Approaches such as this ratings system wouldn’t constrain financial institutions to anything other than free market competition, while at the same time empowering consumers to choose the most appropriate financial products and services for their individual needs. If this idea can unite these two regulators, perhaps it can unite the two sides of the debate as well.

Posted courtesy New Deal 2.0.

One of the horrorshows that has been moving along in the background is the disaster of the funding of a sewer project in Birmingham, Alabama, which looks pretty likely to produce the biggest municipal bankruptcy since Orange County back in the mid 1990s.

Orange County did have one Robert Citron to blame for its woes. By all accounts (Frank Partnoy in Infectious Greed is particularly good here) Citron was WAAAY over his head, and not the brightest bulb to begin with.

The South has an even more combustible mix: a proud history of political corruption, plus even less-than-normally finance savvy bunch of officials (if such a thing is possible). There is a very good piece up at Bloomberg, so you can do some one-stop shopping and catch up on this sorry saga. A quick overview:

Jefferson County, Alabama,…anchored by Birmingham, is staring at what one local politician calls financial “Armageddon.”

The spectacle — a tax struck down, about 1,000 county employees furloughed, a politician indicted over $3 billion in sewer debt that may lead to the largest municipal bankruptcy in history — has elbowed its way up the ladder of county lore….

One target of their anger is Larry P. Langford, who was the county commission’s president in 2003 and 2004 and is now mayor of Birmingham. The 61-year-old Democrat goes on trial today, charged in a November 2008 federal indictment with taking cash, Rolex watches and designer clothes in exchange for helping to steer $7.1 million in fees to an Alabama investment banker as the county refinanced its sewer debt….

Under Langford’s stewardship, the county bet on interest- rate swaps, agreements that a representative of New York-based JPMorgan Chase & Co. told commissioners could reduce their interest costs. Instead, the swaps — covering more than $5 billion in all — blew up during the credit crisis after ratings for the county’s bond insurers fell…

Thousands of public borrowers across the U.S. chose a similar strategy, and many are now paying billions of dollars to escape the contracts….Even Harvard University, the world’s richest academic institution with an endowment of $26 billion, fell for Wall Street’s financing in the dark: It paid $497.6 million to investment banks during the fiscal year ended June 30 because it chose to cancel $1.1 billion of interest-rate swaps.

Yves here. I am clearly an old fart. Jefferson County had floating rate and switched to supposedly cheaper fixed rate debt. Remarkably (and insanely) they had a massive maturity mismatch, funding a lot of the program…in auction rate securities! The rest was in floating rate debt dependent on credit enhancement (apparently for the swap) that got whacked in monoline downgrades:

In 2003 and 2004, with Langford as president, the commission plunged into interest-rate swaps with JPMorgan, Bear Stearns Cos., Bank of America Corp. and Lehman Brothers Holdings Inc. Over time, the county, whose fiscal 2010 operating budget is $808.6 million, entered swaps on more than $5 billion in bonds.

Langford said in 2005 that the swaps would save $214 million — an assumption based on the county and its bond insurers maintaining their credit ratings…

The county later hired financial adviser James White of Birmingham-based Porter, White & Co., who estimated that the commission’s cost for the swaps, $120.2 million, was as much as $100 million too high, based on prevailing rates.

Then, in 2007-08, credit ratings for bond insurers that backed the variable-rate bonds plummeted to junk status because of unrelated losses in mortgage-backed securities. The reduction in credit quality killed demand for the bonds they insured.

Banks were forced to buy the securities, kicking in contract provisions that accelerated to four years from 40 the county’s payment schedule on more than $800 million of the debt. The insurers’ fall also affected more than $2 billion in auction-rate securities in late 2007 as bidders’ interest evaporated.

Some of the county’s variable rates more than tripled, to as high as 10 percent. Meanwhile, the bank payments it received were decreasing. In March 2009, when JPMorgan canceled its swap agreements, a county filing said they were worth more than $650 million to the bank, which has agreed to waive termination fees under negotiations on how to restructure the county’s debt.

Worse, the local authorities don’t bother with bids, which sets them up to be fleeced:

Less than 15 percent of $391 billion in new debt offerings were sold last year on the basis of public bidding — down from 83 percent of new sales in 1970. Most issues are now negotiated, meaning borrowing costs are set in private bargaining sessions.

In Jefferson County, the resulting opacity was a gateway to corruption, according to documents filed in Langford’s case. The Securities & Exchange Commission began probing the county’s swaps in 2004; the Federal Bureau of Investigation started inquiring later. In June 2007, SEC investigators deposed Langford in Miami about whether he used the sewer-debt refinancings to pay off political friends.

And that’s just the bond issues, so the transparency of swaps has to be even worse.

Readers may recall that this sorry drama has been going on for well over a year. So why hasn’t the county filed for bankruptcy, or prepared a filing and gotten into a stare-down with the swaps counterparties to negotiate a settlement? Get a load of this:

Carns and Commissioner Bobby Humphryes, both Republicans, say they reluctantly favor bankruptcy, in part to prevent the appointment of a receiver who might seek increases. “We need a cram-down on the debt,” says Carns, adding that the county can afford to service less than half the obligations, about $1.4 billion worth. A bankruptcy court would have authority to reduce the amount owed.

Democrat Shelia Smoot, along with Democrat William Bell and commission President Collins, opposes filing voluntarily.

“It would be detrimental to our community for the next 50 years,” she says.

Yves here. The last statement is utter hogwash. The idea that not filing for BK is a good idea is as big a bill of goods as the original swaps deals.

The county is nuclear waste NOW due to the unsupportable debt burden. By contrast, lenders are happy to fund post bankruptcy companies, and municipalities even more. They have decent cash flows and have delevered! They might well look like a much better credit than the average municipal borrower post bankruptcy.

The reluctance to file for bankruptcy suggests there is even more dirty laundry the local officials do not want aired.

The story is very well done, and you will find it here.

By George Washington of Washington’s Blog.

William K. Black – professor of economics and law, and the senior regulator during the S & L crisis – says that that the government’s entire strategy now – as during the S&L crisis – is to cover up how bad things are (”the entire strategy is to keep people from getting the facts”).

Indeed, as I have previously documented, 7 out of the 8 giant, money center banks went bankrupt in the 1980’s during the “Latin American Crisis”, and the government’s response was to cover up their insolvency.

Black also says:

There has been no honest examination of the crisis because it would embarrass C.E.O.s and politicians . . .

Instead, the Treasury and the Fed are urging us not to examine the crisis and to believe that all will soon be well.

PhD economist Dean Baker made a similar point, lambasting the Federal Reserve for blowing the bubble, and pointing out that those who caused the disaster are trying to shift the focus as fast as they can:

The current craze in DC policy circles is to create a “systematic risk regulator” to make sure that the country never experiences another economic crisis like the current one. This push is part of a cover-up of what really went wrong and does absolutely nothing to address the underlying problem that led to this financial and economic collapse.

Baker also says:

“Instead of striving to uncover the truth, [Congress] may seek to conceal it” and tell banksters they’re free to steal again.

Economist Thomas Palley says that Wall Street also has a vested interest in covering up how bad things are:

That rosy scenario thinking has returned to Wall Street should be no surprise. Wall Street profits from rising asset prices on which it charges a management fee, from deal-making on which it earns advisory fees, and from encouraging retail investors to buy stock, which boosts transaction fees. Such earnings are far larger when stock markets are rising, which explains Wall Street’s genetic propensity to pump the economy.

The media has largely parroted what the White House and Wall Street were saying. As a Pew Research Center study on the coverage of the crisis found:

The gravest economic crisis since the Great Depression has been covered in the media largely from the top down, told primarily from the perspective of the Obama Administration and big business, and reflected the voices and ideas of people in institutions more than those of everyday Americans…

Citizens may be the primary victims of the downturn, but they have not been not the primary actors in the media depiction of it.

A PEJ content analysis of media coverage of the economy during the first half of 2009 also found that the mainstream press focused on a relatively small number of major story lines, mostly generating from two cities, the country’s political and financial capitals.

A companion analysis of a broader array of media using new “meme tracker” technology developed at Cornell University finds that phrases and ideas that reverberated most in the coverage came early on, mostly from government, particularly from the president and the chairman of the Federal Reserve…

• Three storylines have dominated: efforts to help revive the banking sector, the battle over the stimulus package and the struggles of the U.S. auto industry. Together they accounted for nearly 40% of the economic coverage from February 1 through August 31. Other topics related to the crisis have been covered much less. As an example, all the reporting of retail sales, food prices, the impact of the crisis on Social Security and Medicare, its effect on education and the implications for health care combined accounted for just over 2% of all the economic coverage.

• Actions by government officials and business leaders drove much of the coverage. The White House and federal agencies alone initiated nearly a third (32%) of economic stories studied through July 3. Business triggered another 21%. About a quarter of the stories (23%) was initiated by the press itself and did not rely on an external news trigger. Ordinary citizens and union workers combined to act as the catalyst for only 2% of the stories about the economy.

• Fully 76% of the datelines on economic stories studied during the first five months of the Obama presidency were New York (44%) or metro Washington D.C. (32%). Only about one-fifth (21%) of the stories originated in any other city in the U.S., and about a quarter of those emanated from two other major media centers: Atlanta and Los Angeles.

As I have previously reported, concentration in the mainstream media (along with a number of other dynamics) has severely undermined the credibility of the media.

Why Should We Care?

Why should we care if there has been a cover up?

Well, initially, if there has been activity which is harmful to the economy and may lead to another financial crisis, wouldn’t we want to know about it, so that we prevent it from happening again?

The answer is obviously yes.

But if the government, Wall Street, and the media are all in cover-up mode, then independent auditors, financial analysts and economists cannot shine a light into financial practices to find out what really went wrong.

In addition, if we don’t know what’s really going on, we can’t gauge whether the government’s economic policies are working. For example, Time Magazine called Tim Geithner a “con man” and the stress tests a “confidence game” because those tests were so inaccurate.

William Black said:

How do you think we did the stress tests? Like doing a stress test on an airplane wing, but you don’t actually have airplane wing. And don’t know what airplane wing is made out of. It’s a farce.

I agree.

Without accurate information, we will not know if we’re heading in the right or the wrong direction.

Fraud

One of the foremost experts on structured finance and derivatives – Janet Tavakoli – says that rampant fraud and Ponzi schemes caused the financial crisis.

University of Texas economics professor James K. Galbraith agrees:

You had fraud in the origination of the mortgages, fraud in the underwriting, fraud in the ratings agencies.

Congress woman Marcy Kaptur says that there was rampant fraud leading up to the crash (see this and this).

According to economist Max Wolff:

The securitization process worked by “packag(ing), sell(ing), repack(aging) and resell(ing) mortages making what was a small housing bubble, a gigantic (one) and making what became an American financial problem very much a global” one by selling mortgage bundles worldwide “without full disclosure of the lack of underlying assets or risks.”

Buyers accepted them on good faith, failed in their due diligence, and rating agencies were negligent, even criminal, in overvaluing and endorsing junk assets that they knew were high-risk or toxic. “The whole process was corrupt at its core.”

William Black says that massive fraud by is what caused the economic crisis. Specifically, he says that companies, auditors, rating agencies and regulators all committed fraud which helped blow the bubble and sowed the seeds of the inevitable crash. And see this.

Indeed, as I have previously noted, the giant ratings agencies have a culture of covering up improper ratings (and they essentially took bribes for giving higher ratings).

Black also notes:

• Everyone involved knew that the CDOs which packaged subprime loans were not AAA credit-worthy (which means that they are completely risk-free). He also said that the exotic instruments (CDOs, CDS, etc.) which spun the mortgages into more and more abstract investments were intentionally created to defraud investors

• The government knew about mortgage fraud a long time ago. For example, the FBI warned of an “epidemic” of mortgage fraud in 2004. However, the FBI, DOJ and other government agencies then stood down and did nothing. See this and this

• “Accounting is the weapon of choice in the financial sphere”, with the top executives involved in these fraudulent schemes vacuuming out huge profits for themselves and select insiders, and having auditors rubber stamp what’s being done

• In November 2007, one rating agency – Fitch’s – dared to take a look at some loan files. Fitch concluded that there was the appearance of fraud in nearly every file reviewed

Black and economist Simon Johnson also state that the banks committed fraud by making loans to people that they knew would default, to make huge profits during the boom, knowing that the taxpayers would bail them out when things went bust.

See also this, this and this.

The Economy Won’t Recover Until We Prosecute

So there was a little fraud, no big deal, right?

Wouldn’t looking backwards at fraudulent conduct be distracting for the people, the government, and the economy? Shouldn’t we look forward so we can recover?

No.

Specifically, the Wharton School of Business has written an essay stating that restoring trust is the key to recovery, and that trust cannot be restored until wrongdoers are held accountable.

The Wharton paper states:

The public will need to “hold the perpetrators of the economic disaster responsible and take what actions they can to prevent them from harming the economy again.” In addition, the public will have to see proof that government and business leaders can behave responsibly before they will trust them again…

For more on the importance of trust in the economy, see this.

The stakes are high. As Pam Martens, who worked on Wall Street for 21 years, writes:

The massive losses by big Wall Street firms, now topping those of the Great Depression in relative terms, have yet to be adequately explained. Wall Street power players are obfuscating and Congress is too embarrassed or frightened to ask, preferring to just throw money at the problem and hope it goes away. But as job losses and foreclosures mount and pensions and 401(k)s shrink, public policy measures to address the economic stresses require a full set of unembellished facts…

It was four years after the crash of 1929 before the major titans of Wall Street were forced to give testimony under oath to Congress and the full magnitude of the fraud emerged. That delay may well have contributed to the depth and duration of the Great Depression. The modern-day Wall Street corruption hearings in Congress … must now resume in earnest and with sworn testimony if we are to escape a similar fate.

A fair bit of ink has been spilled on the idea that what is often called “innovation” in financial services is a fancy way of saying “extortion racket.” I was cheered when Paul Volcker put the ATM on his list of banking innovations and seemed unable to come up with anything worthwhile since then. Similarly, Martin Mayer described innovation in banking as using new technology to do that which was forbidden under the old technology.

A related bit of NewSpeak is “efficiency.” Businessmen will often argue that certain measures should be undertaken because they are more efficient. That is code for “because everything will go faster/more smoothly, we will make more money.”

Now why does this idea deserve critical scrutiny? Well, for instance, disclosure, ranging from product labels to SEC filings, is inefficient. Anything that helps public safety is inefficient. Democracy is inefficient.

Moreover, if you put on your systems design hat, too much efficiency is a VERY bad thing. A highly efficient system, as Richard Bookstaber reminded us in his A Demon of Our Own Design, suffers from “tight coupling,” which means that activities propagate through the system so rapidly that they cannot be interrupted. That in turn means it is very easy for processes to amplify and spin out of control. Systems designers give safety and stability top priority, and efficiency second.

And now we have “efficiency” possibly turning the Consumer Financial Protection Agency legislation into a Trojan horse to gut state oversight of banking. It was the states, not the Feds, that went after a host of abuses, starting with dot com stock touting to auction rate securities to dubious mortgage lending practices.

The row started when Representative Melissa Bean of Illinois, who sits on the House Financial Services Committee, added an amendment to the draft bill (which could come to a vote today, call your rep!) that would bar states from having measures tougher than the Federal standards. As Huffington Post noted (hat tip reader Barbara):

Bean is the co-chair of the pro-business New Democrat Coalition’s financial services task forced and vies for the title of Wall Street’s favorite Democrat. Bean and other New Dems are tussling with committee progressives over federal preemption. If Bean’s measure carries, states would not be allowed to enforce consumer protection laws on national banks that are stronger than those at the federal level. All banks would need to do, then, is water down regulation at the top, rather than in each state legislature.

Lisa Madigan, the Illinois Attorney General, is not taking this lying down and has fired off this salvo to Bean:

Federal regulators have maintained that national banks did not play a significant role in precipitating the crisis. That claim does not comport with the facts. The Center for Public Integrity found that 21 of the 25 largest subprime lenders during the lead-up to the crisis were financed by large banks….In contrast, in the run-up to the current crisis, many state attorneys general (including my Office) aggressively prosecuted the bad actors in the industry within our reach….

Federal laws have frequently stymied state reform efforts. These laws preempted states from regulating certain risky loan terms and features, such as prepayment penalties and negative amortization, regardless of whether a state-chartered or federally licensed entity makes the loan. It was precisely these types of features that led to widespread abuses….State attorneys general saw abuses of the prepayment penalties, which often locked borrowers into unaffordable subprime mortgages. Yet federal preemption barred states from enacting tougher laws to address these abuses, even as applied to those entities that we regulate.

National banks and thrifts claim that allowing states to enact tougher laws when necessary – as the CFPA Act would – will result in too great a burden on the system. That argument is disingenuous. Many of these lenders are multi-national companies that currently have to comply with a vast array of varying rules both inside and outside our nation’s borders. In fact, as demonstrated by the swollen docket of our nation’s foreclosure courts, national banks seem to have no problem complying with the varying state and local laws governing the foreclosure process.

And of course, the real point of this exercise is obvious. It is is much more “efficient” for banks to assert their control over the country at the Federal level, where they have already made impressive inroads, than to have to also deal with rearguard efforts from pesky and persistent state officials.

This is starting to get interesting, although it is far from conclusive.

Massachusetts Land Court judge Keith Long reaffirmed a 2009 ruling (Ibanez) that invalidated foreclosures on two properties because the lenders did not hold clear title to them at the time of the foreclosure sale. Now this decision is still subject to appeal, and Richard Vetstein of the Massachusetts Law Blog (hat tip reader Barbara W) thinks the Massachusetts Supreme Judicial Court might hear the case directly, given the potential significance of the ruling.

I am still gobsmacked that this issue is even in dispute. Who has ownership is the foundation of commercial as well as property law, and it permeates our life in ways most people do not recognize. The reason you get a receipt at the grocery store is that it is evidence that the title of the goods transferred from the store to you. The idea that banks were too lazy to do a decent job of keeping on top of title instruments, when that was the SOLE basis for their ownership interest in the collateral underlying their loans, is equally stunning. I have seen all sorts of deals in other areas founder (water rights is a biggie) because investors were unable to “perfect” certain rights they sought. This is a well established area of law, but the banks couldn’t be bothered to spend the money and time to do things correctly. And now they think they can simply assert, “Yeah, we really do own this stuff” and get away with it it is brazen. If you lost a $1000 bill or a bearer bond, no one would take “yeah I really do own this stuff” claims seriously either.

From Ralph Vetstein:

When mortgages are packaged to Wall Street investors, the ownership of a mortgage loan may be divided and freely transferred numerous times on the lenders’ books. But the documentation (i.e., the assignments) actually on file at the Registry of Deeds often lags far behind….

Despite the lender’s attempt to convince him otherwise, Judge Long came out (again) in favor of consumers:

The issues in this case are not merely problems with paperwork or a matter of dotting i’s and crossing t’s. Instead, they lie at the heart of the protections given to homeowners and borrowers by the Massachusetts legislature. To accept the plaintiffs’ arguments is to allow them to take someone’s home without any demonstrable right to do so, based upon the assumption that they ultimately will be able to show that they have that right and the further assumption that potential bidders will be undeterred by the lack of a demonstrable legal foundation for the sale and will nonetheless bid full value in the expectation that that foundation will ultimately be produced, even if it takes a year or more. The law recognizes the troubling nature of these assumptions, the harm caused if those assumptions prove erroneous, and commands otherwise.

Judge Long also had some choice words for lenders:

[T]he problem the [lenders] face (the present title defect) is entirely of their own making as a result of their failure to comply with the statute and the directives in their own securitization documents… What the plaintiffs truly seek is a change in the foreclosure sale statute (G.L. c. 244, § 14), which can only come from the legislature.