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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 stability.

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.

Fannie 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.

You'd 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 risk taking.

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.


Foul Ball?

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 homes. 

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.

There is 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?

Federal 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.

State 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 founder.

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.

Property 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 best.

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.

Scale:  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?

Another 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 Neighborworks, 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 quickly.


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