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When Hell Freezes Over
March 16, 2008
The big financial news this week is that the Iron Curtain that was
supposed to separate the well disciplined Masters of the Universe in
private market investment banks from the girly-men of finance at Freddie
Mac and Fannie Mae has turned out to be nothing more substantial than
tissue paper. The Fed joined in a shotgun marriage with JP Morgan Chase
to staunch a run on Bear Stearns.
Can you spell "too big to fail?"
For years now, the members of FM Policy Focus,
which includes JP Morgan Chase, and other financial sages, have been
beating their breasts over the "moral hazard" created by Fannie and
Freddie's special charters and implicit federal guarantee. As late as
last year, Fed officials and OFHEO, the safety and soundness regulator
of the two companies, were calling Fannie and Freddie a systemic risk to
the financial system. Investors, they argued, lulled into a stupid
trance by the charters, would buy their debt without regard to its
risks. The firms could thereby borrow money recklessly and expand to
such a degree that their leveraged positions would threaten the system's
The corollary to this argument was that private sector
firms could not rely on such back up and therefore were more soundly
capitalized and their debt more carefully scrutinized.
Ooops. It seems that hell has indeed frozen over.
and Freddie may pose greater risks to the system than we yet realize.
God knows their economic and accounting losses have been a surprise.
But while the Fed was sleeping, Wall Street and money center banks went on a credit binge that actually is
threatening the financial system. When one of them got to the brink of
insolvency as nervous investors called for their cash, who but the Fed
stepped in to save them?
There can be no doubt that Fannie and
Freddie's special charters put them in a special position with the
government. Their debt typically trades above Treasuries, but below
comparable commercial paper, reflecting the market's higher degree of
confidence in its provenance. They have their own two special
regulators and currently are operating under a 30 percent surcharge
against their mandatory minimum capital. They are suffering
unprecedented accounting and economic losses. But no one has suggested
that they now need, or are likely to need any time soon, a cash infusion
from the government to weather this storm.
But over on Wall
Street, these swaggering hypocrites are only too happy to call the
government's bluff. And the Fed, which was wasting its time clucking
over the GSEs when they should have been reining in the Street, is
putting the government right in the middle of a bailout.
think the folks at FM Policy Focus would be screaming bloody murder over
this crude violation of the private sector's credo of "eat lunch, or be
lunch." But when push comes to shove, they were never really concerned
about systemic risk. They were just concerned over how to keep the
GSEs from limiting their own voracious appetites for market share and
I don't know if the Fed's bailout ultimately is a good thing or a bad thing. Today's New York Times Business section has a trenchant piece by Gretchen Morgenstern that
raises lots of issues. What's more important to me is the complete
breakdown of the fiction that Wall Street -- and probably the big money
center banks -- are not as threatening to the financial system as the
GSE's, or as likely to be bailed out if they threaten to fail.
January 30, 2008
Maybe it's just me, but I thought there was some karmic convergence
when in the same week Countrywide collapsed into the arms of Bank of
America and former Sen. George Mitchell testified in Congress on the
doping scandal in major league baseball.
Both events grew out of
the same unnerving ability to rationalize anything to get to the top of
the game or stay there. In baseball, world class athletes succumbed to
whatever would get them the next homerun or a higher RBI number on their
Topps baseball card. In mortgage lending, former Countrywide CEO
Angelo Mozilo pleaded that he and his firm had no choice but to dive
headfirst into the toxic lagoon of subprime to keep up with the
competition and secure their long cherished goal of being the number one
mortgage lender in America.
Greed, hubris and ambition are the common drivers. What a disheartening spectacle.
But in baseball, at least, you can argue that it's always been the same. Doping is a time honored tradition. After all, it was baseball legend Leo Durocher who is credited with dryly noting that "nice guys finish last." (What he actually said was "The nice guys are all over there. In seventh place.") In the mortgage business, everyone should have known better. What kind of world are we living in where the federal banking regulators feel compelled to issue regulations that require banks to follow this simple rule: do not make a loan to someone that you know they cannot repay? Isn't this the basic, bedrock principle of banking?
Apparently not. In spite of many people warning investors, bankers and even rating agencies that the market was badly mispricing risk, brokers, bankers and investors ignored the signs and piled on. Banking regulators finally adopted that rule and some others to rein in these drunken sailors. But too late for millions of American borrowers and the communities in which they live.
The ball players caught up in the scandals are all exceptional athletes and competitors. They reached the highest levels of their sport on talent and drive. But reaching even higher was too great a temptation. So, too, with Angelo Mozilo. His career in building the Countrywide powerhouse, in helping millions to buy homes and access mortgage credit, and in supporting public efforts to increase access established his reputation. What a shame that what most people will remember now is the ruins left for homeowners, shareholders, employees and communities from the mortgage industry's own "doping" scandal.
Be Where the Ball is Going to Be
December 08, 2007
This week's announcement of an industry-wide agreement on
subprime loan forebearance is a step forward. But no one, including
those who hammered out the deal, thinks it is a solution to the looming
foreclosure crisis. Tens of thousands already have lost their homes;
the plan specifically limits its forebearance to a small segment of
those affected; and the ability of servicers and lenders to modify
individual loans with any real success is very limited. In short, many,
many more families are going to face foreclosure and the loss of their
Housing advocates, funders and government should
be focusing much more attention right now on "where the ball is going to
be," rather than on where it is today. And where the ball is heading
is to a tidal wave of abandoned homes, particularly concentrated in
minority and low and moderate income neighborhoods.
At the NTIC conference here in Chicago Thursday morning, a group of panelists including Martin Eakes from Self Help Credit Union
and John Rokakis from the Cuyahoga, OH County Treasurer's Office,
shared updates on the scale of this crisis. According to Rokakis,
Cleveland has more than 10,000 foreclosed homes already. The
surrounding suburbs, including upper tier places like Shaker Heights,
are also seeing large numbers of homes being foreclosed and abandoned.
Eakes shared information from a Woodstock Institute
study showing the multiplier effect of foreclosures on neighboring
property values. The impact on neighborhood values, he said, is roughly
the same as for the specific home, meaning that every foreclosed home
is likely to cause twice as much damage as it immediately seems,
including property tax revenue losses and home value devaluations.
Rokakis pointed out that this study drew on data from neighborhoods that
were relatively stable to begin with. In cities like Cleveland, that
have suffered decades of population loss and weak housing markets, he
said the impacts are even more severe.
Anyone who lived
through the FHA foreclosure waves following the Section 235
homeownership subsidy scandals has seen this movie before. The
difference today is that many of these neighborhoods have spent the
intervening 35 years coming back from that wave of devastation. Thanks
to irresponsible lending, outright fraud and avaricious real estate
players, much of this progress is now threatened.
an urgent need to jump start programs to take control of these
properties and steward them through the next five to ten years. The
earlier in the process this can be done, the more effective the
intervention can be. What are the likely ways to do this?
action: there are good historical models for how massive real estate
dislocations can be managed. One is the Homeownership Loan Corporation
(HOLC) that was established during the New Deal to take wholesale
control of the millions of foreclosed homes caused by the Depression and
the liquidity crisis that nearly destroyed the banking industry.
Another is the Resolution Trust Corporation (RTC) that stepped into the
S&L crisis of the late 1980's. In both cases, government agencies
swept up huge inventories of assets on which borrowers had defaulted and
reorganized them in a systematic fashion. Congress could create a
similar agency today, fund it through bonds and authorize it to buy up
loans and properties. Such an agency could then act to sort through the
various groups of borrowers and manage them in the most suitable ways.
To the extent that sales of these assets couldn't finance the full cost
of the bonds, a likely situation, Wall St. securitizers who financed
this mess could be made to pay the difference, as surviving S&L's
were required to do through the Federal Home Loan Banks' RefCorp bond
obligations for the RTC. Such a solution would require swift,
bipartisan support, new bonding authority, and a quick start up with a
willing administration behind it. Chances of this happening any time
soon given the current situation in Washington, DC - next to none.
action: Rokakis this morning described efforts underway to create and
fund a land bank in Cleveland to take possession of foreclosed
properties and manage them. He predicted that a very high percentage of
the properties would eventually be demolished. The land could later be
sold for further development or to neighbors who could tend it. What's
needed for this to work is quick governmental action and lots of
money. Chances of this happening on a wide scale - moderate, and the
results will be patchy as some states and localities step up and others
Private action: foundations, government and
nonprofits could work together to create capacity to take possession of
foreclosed or delinquent properties and manage them either as rentals or
to re-sell them to new owners. Given the realities of the current
housing market, it's likely that many of these properties would have to
be rented out in the near to medium term. The goal would be to preserve
the homes and to offer affordable housing to displaced homeowners and
others who need it. Eventually the goal would be to sell the properties
to responsible owners. There are some nonprofits that could do this
now, but they would be very limited in scale. Simply put, most housing
nonprofits have developed an expertise in building and developing
housing, but very few have developed expertise and capacity to acquire
and manage single family homes for any length of time. Enterprise Community Partners and some other groups have worked with HUD through its "Asset Control Area"
program to buy FHA-foreclosed properties at a steep discount, repair
them and then re-sell them to qualified owner occupants. The Enterprise
effort in South Central LA has been successful, but it relied on a
network of real estate agents in the community to do the actual work,
does not rent the homes during the interim and was not trying to sell
huge numbers of homes into a falling market with newly tightened credit
requirements for new borrowers.
While federal action is
unlikely, actions by state and local governments and community
development groups like Enterprise, Neighborworks America and others can
be mobilized relatively quickly. The obstacles to success, however,
are sobering and require careful review before programs are launched.
management: very few nonprofits have significant capacity to manage
rental real estate, and fewer still have it in managing scattered site,
single family properties. As one professional with experience in this
noted, "sending people out to 20 properties at 3 am to check on plumbing
the first time it freezes, or to repair burst pipes, is no picnic."
Mercy Housing, Inc. has a robust property management arm, but its
expertise is in multifamily buildings. It's possible that they and
others with multifamily experience could be brought in to do scattered
site management. But it's not clear the capacity exists on the scale
necessary in the short time frame we're facing. There may be private
management firms that could scale up quickly and do this work, but the
history of such firms operating in these neighborhoods is uneven at
Program management capacity: just as servicers are
not set up to handle the huge amount of work facing them, neither are
non-profits set up to handle property acquisition, management and sale
on the scale likely to be necessary. If funders and government simply
adopt new programs with nonprofits tasked to do this work, it had better
contain millions in operating expenses to pay for the work and a
flexible attitude about government contracting requirements. If not,
sensible nonprofits will demur, and the others will fail.
the scope of the foreclosure wave crashing over neighborhoods is truly
immense. While it is concentrated most heavily in a few areas, it's a
national problem is scale and scope. There are no organizations today
with reach into all the communities being affected to make a credible
case for being able to handle the work. Coalitions of national, state
and local organizations may be able to put together a workable effort.
But it will require an extraordinary level of cooperation.
A New Alternative?
alternative altogether would be to create a purpose-built organization
devoted solely to this problem. It would have to be generously funded,
well staffed and supported by all the national intermediaries who it
would help serve and depend upon. It would have to be able and willing
to work with private sector actors like Fannie Mae, Freddie Mac, loan
servicers and lenders, as well as private contractors, real estate
professionals, counselors, and property managers. Its mandate would be
to acquire large numbers of properties, secure and manage them over some
period of time until local markets stabilize and they can be re-sold to
owner occupants. Some of the properties should be passed to others as
quickly as possible. This could include intermediaries like Enterprise
or the land bank in Cleveland, or others that could be formed for the
purpose. The advantage of having a single purpose entity to manage this
is that it would enable servicers and lenders to deal with one entity
in disposing of properties, enable buyers to get standard and dependable
terms to take blocks of property down from the new organization, and
make it possible to adopt scaled solutions across jurisdictions. In
another time Congress would create a "Neighborhood Recovery
Administration" as Cal Bradford suggested this afternoon at the NTIC
conference. But that seems like a highly unlikely possibility under the
current situation. But if Fannie Mae, Freddie Mac, Countrywide and
other major players wanted to, they could come up with the budget and
even business planning expertise to help launch a new effort fairly