Initial Award of Frederic Mishkin Iceland Prize for Intellectual Integrity: Calomiris, Higgins, and Mason Paper on Mortgage Settlement

It seems more than a bit peculiar that, per American Banker, financial services industry participants have paid for three academics to issue a lengthy paper attacking a leaked draft settlement between state attorneys general and mortgage servicers. We have pointed out in multiple posts that the state AGs bargaining position is weak due to the lack of investigations. If the banks don’t like the terms, they can tell the AGs to see them in court.

But far more interesting is how embarrassingly bad this paper, “The Economics of the Proposed Mortgage Servicer Settlement,” by Charles Calomiris, Eric Higgins, and Joe Mason, is, yet how the economics discipline continues to tolerate special-interest-group- favoring PR masquerading as research.

In real academic disciplines, investigators and professors who serve big corporate funders have their output viewed with appropriate skepticism, and if they do so often enough, their reputation takes a permanent hit. Scientists who went into the employ of tobacco companies could anticipate they’d never leave that backwater. Even the great unwashed public knows that drug company funded research isn’t what it is cracked up to be.

But in the never-never realm of reality denial within the Beltway, as long as you can get a PhD or better to grace the latest offering from the Ministry of Truth, it gives useful cover to Congresscritters and other message amplifiers who will spout whatever big donor nonsense they are being asked to endorse this week.

The Academy Award winning documentary Inside Job depicted how the fish has rotted from the head in the economics academy, using former Harvard dean Larry Summers, former Fed vice chairman Frederic Mishkin and Columbia Business School dean Glenn Hubbard as object lessons.

Despite our publication of Academic Choice theory, which provides more formal support for the Inside Job observations, we’ve seen perilous little in the way of a change in attitudes from within the academy. So to make a wee additional contribution on this front, we are inaugurating the Frederic Mishkin Iceland Prize and making Calomiris, Higgins, and Mason its initial recipients based on their remarkable work as exemplified in this paper.

First and foremost is that this article goes well beyond the normal boundaries of shilldom, which is generally confined to cherry picking of data and artful framing. There are multiple, gross distortions, which call into question either the writers’ honesty or their knowledge of the basics in the mortgage servicing arena. But that level of inaccuracy is necessary to create the simulacrum their patrons desire, that of a parallel universe in which servicers are virtuous, borrowers are scheming, and the rule of law operates only for the benefit of corporate interests.

Another one of its distinctive contributions is the multiple layering of what mere mortals would call “stupid”. For instance, this paper cites earlier work on strategic default and mortgage mods that is analytically dubious. So it creates a steaming edifice of garbage but via its extensive citations, it hews to the form of normal academic output, making it look legitimate to those who don’t know the terrain.

Let’s look at the paper in some detail. It is so wrongheaded in so many places that a detailed shred would tax the patience of readers. So for the most part, I’ll stick to broader issues.

Attack on principal mods based on inaccurate and misleading reporting of history. The main reason for this paper being issued is most likely to be to demonize the notion of principal mods generally rather than the 50 state AG settlement proposal since any deal would be negotiated and completely voluntary (note that the paper’s depicting them as “government mandated” is one of its many distortions).

First, it charges that principal mods don’t work. Any honest appraisal can’t possibly conclude that, since in every local/regional market housing downturn prior to 1995, mortgage mods to borrowers with viable income was standard practice by banks. Moreover, Wilbur Ross, who has also recently engaged in deep principal mods, reported results far better than that of shallower payment mods, and Chris Flowers is rumored to have developed a template for principal mods based on his experience with IndyMac. So the article argues from irrelevant examples to do so, such as HAMP, which was a five year payment reduction program. Saying HAMP failed to work is like saying aspirin failed to cure pneumonia and therefore there is no point in prescribing antibiotics.

But we get sanctimonious nonsense like this:

Moreover, the settlement assumes, without any apparent evidentiary basis, that there should have been more modifications than have been made thus far. We are not aware of any disclosure or discussion of any criterion by which advocates of the settlement have reached that conclusion, nor a statistical analysis in support of that view.

Given that they fail to offer anything remotely approaching that standard of proof for their position, it’s more than a tad disingenuous for them to then use the unverifiable claim that they know of no evidence to mean that there is no counterevidence of the sort we cited above. As Tom Adams translated by e-mail:

Other than thousands of forged documents, false fees and charges, collapsed law firms, plummeting home prices, abandoned communities, and insolvent lenders and builders, we are not aware of any evidence that foreclosure is not a better route to fixing the housing problem, said Mason.

The most important reason that mods have failed to date is servicers have every reason to make them fail. Servicers earn fees related to various activities in foreclosure. They don’t get any compensation to do mods. They can execute foreclosures in a very streamlined (indeed, overly streamlined, as the number of abuses attests) manner. Mods, by contrast, are costly. They are tantamount to underwriting a new loan and have good odds of not working if not done on bespoke or partially bespoke basis (initial screening out to eliminate obvious non-candidates, with more individualized evaluation of the balance). The servicers have never invested to build the infrastructure to do it correctly. And for that reason, servicers have also falsely claimed that the pooling and servicing agreements don’t permit them to do mods, when that is true only for a subset of deals. So their past failures were predictable and in no way constitute proof that the principal mods don’t work.

Complete whitewashing of servicer actions and incentives. Reading Calomiris et al., you’d never have the foggiest idea that servicers engaged in robosiging and forgeries, pyramiding/junk fee created foreclosures, and cheating investors via fee double-dipping (as with broker price opinions) and improperly using principal repayments from current borrowers to reimburse themselves for principal and interest advances on delinquent borrowers, along with all too frequent operational incompetence.

The paper has the gall to insinuate that the proposed settlement, which we attacked because for the most part all it does is call for the servicers to obey existing statutes (why do we need to negotiate with them to do that?) could undermine the rule of law. Yet it ignores the elephant in the room, that banks have bolstered their income in this line of business with institutionalized fraud. So to argue that that the reduced returns the banks would experience by finally cleaning up their act represents some sort of broader social harm is utterly backwards. By the same logic, we should allow, and maybe even incentivize drug dealing, child prostitution, and counterfeiting since they are all GDP enhancing. As Adam Levitin writes:

The AG settlement would make servicers comply with existing law in judicial foreclosure states. In other words, it would make servicers give mortgagors what they had bargained for–adherence to judicial foreclosure rules….

Finally, back to that 20-45bp number. The calculation of this figure is really pretty silly and not a serious academic exercise. It’s a guess. It’s also a very unfair figure to pin on the settlement. If the residential private-label MBS market is to get restarted, mortgage servicing will have to be radically reformed. There’s no doubt that going forward servicing will cost more. Servicers massively underpriced relative to the costs of performing their contracts. This has nothing to do with the AG settlement proposal. The real question is whether the AG settlement proposal will add costs to mortgage servicing above and beyond the costs that will be imposed by the market. It’s far from clear whether there are any given how skittish private-label MBS investors are (and rightfully so).

I would have thought that rule of law was priceless; that without it markets could not function, homo homini lupus and all that. But apparently, rule of law is not even worth a lousy 20bps.

Yet the paper attempts a finesse via a false claim that struck yours truly and Mike Konczal, that servicers have a fiduciary duty to investors and therefore, by Panglossian extension, must already be behaving correctly.

Earth to base: servicers are NOT fiduciaries. They have only contractual obligations to investors. And even the “trustees” which are parties distinct from the servicers, are not the sort of trustees with broad discretion to handle the affairs of widows and orphans and are thus held to a fiduciary’s standard of care. Konczal cites a post by Adam Levitin:

A securitization trustee is not a general purpose fiduciary; it is a corporate trustee with very narrow duties defined by contract, and entitled to rely on information supplied by the servicer. So we’ve got a case of feral financial institutions, a sort of servicers run wild, with both homeowners and MBS investors bearing the costs of unnecessary foreclosures, all because servicers misjudged the housing market and didn’t charge enough to cover the costs of properly performing their contractual duties.

Distorted macroeconomic analysis. This part is stunningly bad. Conceptually, they argue for the Mellonite position that foreclosures need to happen for the markets to clear. Funny, that’s the reverse of the position that the government has taken at every turn with the banks, where overt and covert bailouts (like the Fed’s super low interest rates) and extend and pretend are the order of the day. So by that logic, Calomiris and his co-consipriators should also be in favor of wiping out second mortgages on seriously upside-down borrowers, which would require the four biggest banks to be recapitalized.

First, they ignore the fact that we have so much inventory overhang that dumping more homes into foreclosure is simply going to lead them to sit vacant and unsold. Banks do a terrible job of securing and maintaining them; they too often wind up being vandalized, stripped for copper, or simply get musty and moldy. Indeed, that’s one of the big reasons for foreclosure times becoming so protracted: banks are keeping borrowers in homes because they remain on the hook for property taxes, plus they take care of home maintenance. So the actions of the banks themselves to date contradict the argument made in the paper.

Second, normal creditor behavior in every other lending product is to prefer a restructuring whenever possible to liquidation because it maximizes value. So why should mortgages be different? That alone means that having the only way to deal with delinquency be to foreclose results in unnecessary foreclosures. The fact that investors suffer losses of anywhere from 50% to over 70% on a foreclosure also means they’d be happy to take a writedown to a borrower with adequate income rather than proceed inexorably to a foreclosure.

The authors contend that banks now use NPV analysis to decide whether to offer a mod. That’s false (Felix Salmon simply hooted at how ridiculous this claim was). While HAMP required the use of NPV analysis for participating servicers, it was otherwise used only for comparing a short sale to a foreclosure, and then only by servicers like Litton which were more serious about handling delinquent borrowers than the bulk of the industry.

Felix also jumped on a stunning misrepresentation in the paper:

As for the authors’ attempts to quantify the costs of the settlement, they use numbers in the CFPB report uncovered by Shahien Nasiripour which says that “effective special servicing of delinquent loans would have cost 75 bps/yr more than the actual costs incurred” — except the way they put it is very different:

The CFPB recently estimated that five servicers avoided $24 billion in costs between 2007 and 2010, yielding a 75 basis-point reduction in interest rates.

Er no, the CFPB nowhere says or even hints that there was any kind of reduction in interest rates as a result of the banks’ broken servicing operations. (And it wasn’t five servicers, it was nine.)

This bit of dishonesty is the basis for their argument that the cost of lending will rise. And note how gross a misrepresentation this is. Not only do they say that the 75 basis points applied to market interest rates, when in fact it was servicing fees, but they further tried to apply a figure that related only to distressed mortgages to the entire mortgage market. This is in other words is a distortion on multiple axes.

The article also astonishingly ignores second order effects of unnecessary foreclosures: sales at distressed prices, the high odds of overshoot of housing prices to the downside, clogging of the courtrooms, and perhaps most important, increased legal challenges to foreclosures Do they really want more borrowers chipping away at the foundations of the mortgage industrial complex? Major investors have examined chain of title issues and the impact of major rulings like Ibanez in this area. Many think the problems are serious and have been loath to take action themselves against the originators and trustees because doing so has the potential to create a new financial crisis. In other words, Calomiris, Higgins and Mason should be more careful about what they wish for.

Other data/factual distortions. There are SO many things that are just plain wrong that one wonders how the authors can assert expertise with a straight face. To pick just a few:

Option ARMs. The paper focuses on an alleged wave of Option ARM resets in 2011. The argument is muddied, but the assertion is that these borrowers can’t be saved but will chew up mod capacity. That analysis relies on a Jan 2010 study by Laurie Goodman. It was an outlier at the time, since it assumed a high default rate, plus a payment shock that assumed increases in LIBOR The LIBOR increases have not materialized.

And they also fail to quantify how many Option ARM resets there will be. Guess what? Not many. Of the original balances, half have defaulted, and 25% has paid down. Calculated Risk, who is normally relentless on this beat, wrote two post in early 2010 on how the feared 2011 resets were not going to amount to much, and has not even bothered returning to the topic since then.

Bank equity discussion. This is rich (p 13):

….the effects of transferring resources from banks to borrowers could reduce lending and hamper short term economic growth and employment (as bank equity capital is the basis on which the supply of lending is based.

I guess the authors have not heard of securitization. But a 1999 Calomiris paper seems to exhibit a passing acquaintance with it, since he mentions, “But lenders realize that the securitization that provides their funding base…”. The bigger issue is that the relatively paltry sums that the writers get so exercised about is not going to impair bank capital in any meaningful way, and banks have reserves piled up at the Fed, which confirms that they have boatloads of unused lending capacity.

South African consumer credit reference. There are a lot of lower level howlers, like the one mentioned above. Another is the fact that the authors are so desperate to prove that borrowers behave badly that they cite a study of South African consumer finance study as a basis for arguing about the danger of encouraging strategic defaults. This is so apples and oranges as to be offensive. Consumer finance in South Africa, which does not have our credit reporting system, is not at all comparable to the US. The negative consequences of defaulting on consumer credit and on housing debt in the US are much higher, thanks to our extensive and speedy credit reporting, which is widely used in job screening. And that’s before we get to the considerable emotional attachment to primary residences.

I have to wonder whether the sponsors of this study had to shop to get such a bending-over-backwards-to-be-favorable report, as issuers often did with rating agencies, or whether the authors’ willingness to accede to the propaganda needs of the banks is so well established that it was an easy decision. And like rating agencies, these economists bear no costs of their bogus, irresponsible, client-pleasing analysis. As Outis Philalithopoulos observed:

….an economist has an incentive to propound theories that CEOs and financial institutions find attractive. Even if adoption of these theories leads to substantial public costs, these costs will not be shouldered by the economist personally.

So naming and shaming will have to do until the discipline decided to do a better job of policing its members.

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  1. Eleanor

    How did Iceland end in the name of this prize? Granted the Icelandic bankers were crooked, but that doesn’t make them different from other bankers. The Icelandic people have been struggling to recover and doing some things I admire, such as voting down the Icesave deal. They changed their government, took over and reorganized the banks and arrested at least some of the bankers. This is a lot more than the US has done. I vote for the American Prize for Abject and Dishonest Thought.

    1. craazyman

      you need to do your homework before weighing in on such matters.

      Mr. Mishkin wrote an excellent textbook on Money, Banking and Financial Markets, which I purchased at a used book sale in Greensboro, NC for $5.

      It was the 1995 edition, but it was still very informative and Mr. Mishkin did an excellent job explaining the threats that adverse selection and moral hazard pose to the healthy functioning of credit markets.

      When your main industry is fishing and you get into banking to make a little extra money on the side, all sorts of things can happen.

      I think Mr. Mishkin updated his book and so I’d recommend it highly. I’m willing to forgive him for Iceland, but I am a believer in the Lord — both the Angry God of the Old Testament and the Loving God of the New Testament.

      Sincerely yours,
      Professor D.T. Tremens, Esquire, GED
      Chairman, Department of Crosscultural Analysis
      University of Magonia
      13 Rue d’Absinthe
      Paris, France

        1. craazyman


          I just read a really funny story about a whore yesterday. concerning a work by the author Norman Mclean of “River Runs Through It Fame”. But it’s off topic.

          I have no problem with whores, personally. As long as they stick to the healing arts. LOL. It’s not a sin.

          YOu are being way to harsh on Mr. Mishkin’s book. Truly, he did a good job. I hate to see a guy get beaten up beyond reason. He deserves a few punches, but not a decapitation. LOL.

    2. Yves Smith Post author

      You can’t be bothered to go through the post, it appears. The information was there.

  2. bmeisen

    President of elite business school arrested.

    Jahns was later released. He is suspected of steering state funds to an outside organization in which he has a substantial stake.

    EBS was – may still be – in the process of establishing a law faculty. There are indications that it was modelled after the law and economics programs described by Yves in Econned. In doing so EBS was relying heavily on funding provided by the State of Hessen.

  3. readerOfTeaLeaves

    Well, the Frederic Mishkin Iceland Prizecertainly has a ring to it. It looks as if this ‘worthy’ nominee covers the categories for shilldom, cherry picking data, distorting information, and whitewashing in a fashion that even Glenn Hubbard would approve.

    Excellent prize title.

    1. psychohistorian

      Unfortunately, Mishkin knows no shame. Nor do many of those sort of folks.

      But it will make us feel better for seeing these folks called for the pathetic examples of humanity they are.

  4. Anonymous II

    Concerning the paper, it seems it doesn’t even touch
    or barely mentions the legals issues, and the role of
    the courts in dispensing justice: If (as a hypothetical)
    the state AGs had no credible legal case, why would the
    lenders, the banks, even bother to arrange or agree
    in principle (or consider) a proposed out-of-court
    settlement? The shallowness and myopia of the paper
    boggles the mind.

  5. Diogenes

    Wonderful that you have created this prize. That CV revision was disgusting and should be remembered. Always.

  6. Jim Haygood

    ‘Far more interesting is … how the economics discipline continues to tolerate special-interest-group- favoring PR masquerading as research. In real academic disciplines, investigators and professors who serve big corporate funders have their output viewed with appropriate skepticism, and if they do so often enough, their reputation takes a permanent hit.’

    Bestowing on economics the dignity of a ‘discipline,’ in light of the bill of particulars presented in the essay, is quite charitable.

    At least any crackpot notions of economics being a ‘science’ have been laughed out of the intellectual arena, as the Federal Reserve’s high-wire bicycle-riding pyramid-of-clowns act bets the farm with the planetary economy without a safety net. Their pre-show self-medication for acrophobia is laughing gas (what, me worry?).

    In all likelihood, the mortgage industry found Calomiris, Higgins and Mason in the Adult Encounters section of Craigslist, advertising themselves as ‘hot, brainy gigolos, suprisingly affordable.’

  7. Huck

    I did a quick Google search of the paper’s authors. They seem to have ties to the FDIC in some fashion via the CFR or various conferences. Calomiris was head of Greater Atlantic Bank (failed). Mason’s academic chair is funded by the Louisiana Bankers Association. And the paper itself is funded by the financial services industry. Awesome.

  8. Jesse

    Calomiris is at Columbia Business School (in addition to the American Enterprise Institute).

    Glenn Hubbard, is the Dean of the Graduate School of Business at Columbia. Hubbard was also one of the economists stepping all over himself in the documentary Inside Job.

    Some of the business schools have particularly bad reputations amongst their colleagues in other schools, most notably the sciences such as mathematics and engineering.

    If I ever saw a discipline crying out for a code of ethics it is the economics profession, in particular the academic side of it. Disclosure and transparency would go a long way.

  9. monday1929

    At the risk of redundancy or a slap on the wrist from Yves, Mishkin is famous for listing a paper titled “Instability in Icelands Financial System” on his CV. The actual title of his paper, for which he was paid by the banks (IMF?), was “Stability in Icelands Financial System”.
    When challenged, the Prostitute stated it was an editing error.

  10. Paul Tioxon

    I believe that Yves has left some money on the table in re the Mishkin Icelandic Awards. Here is the big concept. The Economics Channel, a new cable offering that will ride the crest of interest in budget battles, unemployment figure deconstruction and scream fests as unions are de certified on a state by state basis. The crowning jewel will be a gala award ceremony/variety TV show production with a cavalcade of stars. I see a lot of cross over potential with rap stars who are heading into billionaire status representing the ghetto dreamers in a better tomorrow. Imagine, Beyonce and Brooksley Born, paired as emcess. Not enough star power, okay, how about Garth Brooks reprising live from Club Fed, the classic Johnny Cash Live from San Quentin with an exclusive Bernie Madoff interview, where he reveals names, times and places of unspeakable financial debauchery, that will send people to jail, place shotguns in mouths and maybe bring down ONE TOO BIG TO FAIL INVESTMENT HOUSE!!! You see where I am going with this. It will be huge, trust me, I know what I am talking about, I have here a Comcast Foundation / Wharton Report on the Impact of cable channels and award shows on political opinion shifting with Pew Foundation Poll results that incontrovertibly true.

          1. ScottS

            The only problem is that reality is rapidly outpacing satire in the production of irony. There is a serious current account deficit of irony in satire.

  11. William Wilson

    While a little off topic, Judd Bagley’s video summaries:

    and his story about a network of market miscreants that includes disreputable financial analysts, prominent journalists, some of America’s best-known hedge fund managers, associates of the Mafia, and Michael Milken, the famous criminal from the 1980s:

    provide excellent examples of the strategies routinely employed by hedge fund managers who appear to be both accomplished media manipulators and, rather frequently, associated with mobsters, Mafia members, etc. What you might have suspected about the absence of SEC regulation is affirmed in these reports.

  12. Jim

    Yves comment that “the Academy Award winning documenatry “Inside Job” depicted how the fish rotted from the head in the economics academy using former Harvard Dean Larry Summers, former Fed vice-chairmen Frederick Mishkin and Columbia Business School dean Glen Hubbard as object lessons” also raises the broader issue of the role of the intellectual/professional academic in modern systems of domination(i.e. a mass society of primarily disempowered individuals).

    Those of us(like myself) who see the potentiality of a more democratic populism as a possible way out of this crisis also assume an active citizenry.

    Yet we exist in a situation in which, among other groups, intellectuals/professional academics of all political stripes are anxious to use their cultural capital (i.e. knowledge) in the service of Big Capital/Finance or Big State and thus directly or indirectly contribute to the disempowerment of average citizens.

    Doesn’t it seem necessary, therefore, that populists at least reconsider the original model of federalism as part of a future political vision/program.

    Such a model of refederalization would seem to offer at least the possibility of reactivating local communites and, in turn, offering intellectual/professionals more organic roots that might serve to contain their recruitment by the national managerial elites( with their own priorites and interests) who now run our country.

  13. Jimbo

    Yves, your publication cited in today’s Dealbook newsletter….Nothing Like a Couple PhD’s Working for You The nexus of special interests and top economists is back in action, with a new report by Columbia professor Charles Calomiris assailing the settlement reached between state attorneys general and mortgage servicers. Yves Smith has awarded Mr. Calomiris and his co-authors the Frederic Mishkin Iceland Prize for intellectual integrity….

  14. Sy Krass

    Jim Haygood, that stuff is priceless! LOL! We need more sarcastic truth telling wit like that!

  15. Sy Krass

    …although the Congress and we the people are just as much to blame for this massive debt as is the fed.

  16. Brad

    If this were an article on antidepressants, funded by industry, I’d suspect the article was ghostwritten.

  17. A

    Any reader of this post who is a member of the press corps or in other media should call the Press Offices of the famous professors’ schools and ask for their press release on their school’s professor receiving the coveted Frederic Mishkin Iceland Prize for their remarkable work.
    And if the press officer didn’t hear about it, ask them to inquire and then send you the resulting press release.
    Ask if their answer is on the record, and publish it here.

    (Or at least call/e-mail the student newspapers of these schools, pointing the budding journalists there to a possible scoop).

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