How Banks and Servicers Play Hide the Ball

Jan 21, 2011Thomas A. Cox

home-foreclosure-documentForeclosure industry lawyers use every trick in the bag to block the revelation of important documents.**This is the second part of a three-part series.

home-foreclosure-documentForeclosure industry lawyers use every trick in the bag to block the revelation of important documents.**This is the second part of a three-part series. Read part 1 here.

Logic suggests that in foreclosure, the homeowner should be able to know who owns his loan. In the rare circumstance where the homeowner wants to pay off the loan rather than lose his or her house, he needs to know who is entitled to receive that payment so that the wrong party is not paid and so that he is protected against any other party ever claiming a right to payment. Where a homeowner cannot actually pay off his loan, he still has a real interest in knowing who claims ownership of it because only that party can respond to requests to work out a rational loan modification.

Logic does not control the foreclosure industry's practices.

Variation Number 1: MERS hides the ball

In the first variation of this tactic, homeowners must face a massive concealment scheme set up in 1995 by the foreclosure industry in the form of Mortgage Electronic Registration Systems, Inc. ("MERS"). Before MERS came along, every mortgage was recorded in a registry of deeds for the county where a mortgaged home is located. When that mortgage was assigned, it was recorded in the registry. Thus, if a homeowner ever had any doubt as to who owned his mortgage, he had only to check his nearby registry to find that information. MERS unilaterally changed the rules of the game (with no permission sought from state legislatures). Under the new regime, while an original mortgage is still filed in the local registry of deeds, subsequent assignments of that mortgage are not recorded there. Instead, information about them is simply entered into the MERS electronic recording system. Any homeowner can check the records of his local registry of deeds, but no homeowner is permitted to access MERS. Thus, it took away a sure way to identify the owners of mortgage loans.

After an outcry against MERS over its concealment of the identity of mortgage owners in its inaccessible system, it claims to have met those complaints by setting up a web site where homeowners can look up this information. The problem is, the website will not reveal the name of the owner of any mortgage unless the owner voluntarily allows MERS to disclose that information. My experience with look-ups on the website is that it repeatedly reports that the owner of the mortgage has not voluntarily agreed to disclose its identity.

Even when a mortgage owner does  allow its identity to be disclosed, there is a high likelihood that the information will be inaccurate. I am working on a case right now involving a Deutsche Bank trust created in 2006. Deutsche Bank claims that it has owned my client's loan since 2006, but until July of 2009 the loan originator, not Deutsche Bank, was shown on the MERS system as the owner.

Use of the MERS website to look up mortgage ownership information is basically a waste of time for homeowners and their lawyers. I am working on another case right now where there were major errors at the inception of the loan that give our client the right to rescind it under the Truth in Lending Act. We know that the lender is out of business and that some other entity owns the loan, but we do not know who that is. The MERS website does not disclose the identity of the owner of this loan. Under TILA, the rescission letter must be sent to the owner, so we have to file a request with the servicer for that information. Experience tells us that the servicer may or may not respond and that if it does, the response may or may not be accurate. In any event, a lot of lawyer time will be wasted in seeking out information as to the identity of the owner of the loan, information that should be (and in pre-MERS days was) immediately available.

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Variation Number 2: Fannie and Freddie hide the ball

Fannie Mae and Freddie Mac are also major players in the concealment game. In their agreements with the major loan servicers, they require that the servicers foreclose in their own names. In judicial foreclosure states, such as Maine, where I work, we see this repeatedly even though Maine law permits only the real owners of to be the foreclosing parties. To further this subterfuge, Fannie and Freddie will actually endorse and deliver mortgage notes to the servicers to hold temporarily while the servicers foreclose under the guise of being the true owners. The same problem arises here as with the MERS concealment game -- if we, as lawyers representing homeowners, do not know who the true owner is, we do not have the ability to properly represent our clients as we try to resolve that loan.

I have been unable to determine any legal benefit of this subterfuge to Fannie and Freddie. Rather, I suspect that this game relates to political issues. Fannie and Freddie do not want to let the country, our political leadership, and the regulatory agencies see just how tremendous their roles are in the current waive of foreclosures. I suspect that they fear the public and political backlash that might develop if the true scope of their roles in the foreclosure process were revealed.

The problems created by the concealment game are real. I ran into this problem a couple of months ago in a foreclosure action brought by GMAC Mortgage, LLC. Maine law requires the foreclosing plaintiff to file a certification showing that it owns the loan and including proof of that ownership in the form of note endorsements and mortgage assignments. In this case, there was a "Certification of Mortgagee" signed by none other that GMAC's notorious "limited signing officer" Jeffrey Stephan. He certified directly that GMAC Mortgage owned the loan in issue. I attended a mediation session with my client on this case, devoting about five hours of legal time to the effort, while my client took a day off from his hourly pay job to attend. It turned out that Fannie Mae owns this loan. Thus, my client and I went into the mediation without knowing that only Fannie Mae HAMP loan modification programs would be up for negotiation. Because of GMAC's participation in the concealment game, my time and that of my client were wasted, as was the time of the court appointed mediator.

The practical effect of all of this obfuscation is that the foreclosure defense process becomes unduly expensive for homeowners paying for representation, and the very limited resources of legal services and volunteer lawyers are wasted on searches for basic loan ownership information that should never have been hidden in the first place. By playing this game on such a massive scale, the foreclosure industry depletes the resources that the opposition might use in productive tasks, such as pursing loan modifications.

Variation Number 3: obstructing homeowners' discovery efforts

As foreclosure defense lawyers, we know hide the ball variations 1 and 2 well, so we try to compensate by pursing appropriate pre-trial discovery to dig out the true identity of the owners of the loans. Without fail, every single request for the production of documents that we file is met by massive and frivolous objections by counsel representing foreclosure plaintiffs. Even a simple demand for producing the original note and all endorsements is met by an objection that the request is "overly broad" and "unduly burdensome," even though the original note must be produced at trial if the plaintiff is to prevail.

When we ask for information as to the existence of endorsements to the note, we are met with an objection stating that the information is "irrelevant." The servicers and their lawyers know that judges hate pre-trial discovery disputes and are not likely to impose sanctions for their abusive conduct. Servicers seem willing to take the few sanctions orders that we do obtain knowing that, it the vast majority of cases, their obstructive tactics will go unpunished.

When we demand that the servicers produce the pooling and servicing agreements that evidence their claimed right to act on behalf of the loan owners, they refuse to do so, claiming that the agreements are confidential trade secrets. They make this claim even though copies of these agreements appear on the SEC Edgar website as public records. When confronted with this reality, they fall back on their claims that the documents are irrelevant or that it is unduly burdensome to produce them.

This kind of conduct should be sufficient for a court to simply dismiss the foreclosure outright, but our rules and case law do not allow for such dismissals until the violations become even more egregious. Foreclosure industry lawyers know and take advantage of that fact.

Thomas Cox is a retired bank lawyer in Portland, Maine who serves as the Volunteer Program Coordinator for the Maine Attorney’s Saving Homes (MASH) program. He represents homeowners in foreclosure and assists and consults with other volunteer lawyers in providing pro bono legal services to these Maine homeowners.

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Homeowners Get Screwed, Lawyers Get Played, Banks Make Profit: Where's the Outrage?

Jan 20, 2011Thomas A. Cox

house-in-hands-150The foreclosure industry is playing the system while homeowners suffer. **Stay tuned for the rest of this three-part series.

house-in-hands-150The foreclosure industry is playing the system while homeowners suffer. **Stay tuned for the rest of this three-part series.

Two recent reports, read together, should spark outrage in the country at large and among our political leadership. But no one seems to care anymore. JPMorgan Chase, the country's third largest mortgage lender, confessed that it has overcharged over 4,000 active duty troops on their mortgages and improperly foreclosed upon 14 military families. Only three days before that, reports came out that JPMorgan had just experienced a 47% jump in profits for the previous quarter and 2010 profits reached a record level of $17.4 billion.

The story of the violations of the Servicemembers Civil Relief Act was forced into the open by a Marine fighter pilot. He kept all of his payments current, but due solely to the fault of JPMorgan Chase, his mortgage was placed into default status. His wife reports collection calls (sometimes three a day) coming on Saturdays, Sundays, holidays and even at 3:00 in the morning. It took over two years and the hiring of a lawyer to get JPMorgan to back off and finally admit that he had fully paid his mortgage obligations on time. Certainly no member of the military should have to endure this kind of treatment. But, beyond this, no American homeowner should have to endure those kinds of collection tactics from America's second largest bank. Where is the outrage over these kinds of heavy-handed and abusive tactics?

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The Foreclosure Game

The situation described above fits within a pattern of abuse of American homeowners by JPMorgan Chase and the other major loan servicers that I have experienced in my work as a lawyer representing homeowners in foreclosure. They treat the foreclosure process like a game, seeking to win at any cost without regard to the harm inflicted upon homeowners. Strategic decisions are made, odds of specific outcomes are calculated and bets based upon those odds are placed. Ways to skirt the rules are studied and ignored when referees (judges) are not watching, weak opponents are trampled, cheap shots are taken at opposing parties, and major efforts are made to wear out the opposition as the game winds on. Since the foreclosure industry's pockets are deep, it is more than willing to outspend the opposition to gain an upper hand when it will help win the game.

Lawyers who have the experience and knowledge required to represent homeowners in foreclosure cases are in very short supply. The work does not pay well, if at all, it is very time consuming, and the level of knowledge necessary to do the work well is very high. I have been focusing on this work on a full-time basis for almost three years now. To be competent, I have to be familiar with the Truth in Lending Act ("TILA") and its related Regulation Z, the Homeowner Equity Protection Act ("HOEPA"), the Real Estate Settlement Procedures Act ("RESPA"), the Maine Consumer Credit Code, the Maine Unfair Trade Practices Act, the United States Bankruptcy Code, the Maine Civil Action Foreclosure Statute, the Maine and Federal Rules of Civil Procedure, the constantly changing HAMP loan modification guidelines, and the separate and distinct guidelines of Fannie, Freddie, FHA, VA, and Rural Development, each of which has its own variations on HAMP. In addition, I have to keep current on developing foreclosure case law all over the country on a daily basis. The number of us willing and able do this work is extremely limited when measured against the needs of homeowners for legal assistance -- I hear that fewer than 5% of homeowners looking for legal help are able to obtain it.

Perhaps the largest frustration for me in this work is to experience on a daily basis the games that the servicers play in the foreclosure process. I am constantly frustrated by how much of my time is spent in dealing with the servicers' antics, thus reducing the number of homeowners that I and my colleagues are able to help. What will follow is a two-part explanation of the game playing that we experience in our dealings with the mortgage loan servicers and their lawyers.

Thomas Cox is a retired bank lawyer in Portland, Maine who serves as the Volunteer Program Coordinator for the Maine Attorney’s Saving Homes (MASH) program. He represents homeowners in foreclosure and assists and consults with other volunteer lawyers in providing pro bono legal services to these Maine homeowners.

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Obama's Economic Team: Focused on the Wrong Symptoms

Jan 19, 2011Mike Konczal

A reliance on supply-side theory, in both the White House and the media, keeps us from addressing our real economic problems.

Peter Baker has a 6,500-word piece in the upcoming Sunday New York Times MagazineThe White House Looks For Work, about Obama's economic team and the quest to create jobs. He says:

A reliance on supply-side theory, in both the White House and the media, keeps us from addressing our real economic problems.

Peter Baker has a 6,500-word piece in the upcoming Sunday New York Times MagazineThe White House Looks For Work, about Obama's economic team and the quest to create jobs. He says:

I went to see Geithner one evening in late December in his high-ceilinged office at the end of the third floor in the Treasury Building...All the second-guessing, he said, missed the point. “Everybody now has these cool ideas -- why didn’t we do it in this way, why didn’t we do it bigger, why didn’t we have a different mix,” he said, thinking about the stimulus. “All of that is marginal.” What was important, he said, were speed and force. As for nationalizing or liquidating the banks, he said, “They both would have been catastrophic.”

Marcy Wheeler points out that the words "foreclosure", "housing" or "HAMP" don't come up in the piece at all. How telling is that? We just had a housing bubble collapse, and the signature post-collapse stories are about the fraudulent ways the securities were made in the first place, the obvious flaws in the servicing models, and the record numbers of foreclosures during the entirety of Obama's first term in office.

There are obvious problems of spillovers: cascading housing price depreciation, lack of mobility, abandoned properties and the effects on neighborhoods, etc. There's also the greater issue that households are in a balance sheet recession, where they are saddled with worthless housing debt that will keep the housing market depressed. As foreclosure spins out of control, housing values plummet further, putting households further underwater, decreasing consumer spending, etc.

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Atif Mian and Amir Sufi have recently written an economic letter for the Federal Reserve Bank of San Francisco, Consumers and the Economy, Part II: Household Debt and the Weak U.S. Recovery:. They find:

Overall, the county evidence strongly suggests that credit demand is weak because of an overleveraged household sector. This view is supported by survey evidence that the main worry of businesses is sales, not financing. The October 2010 National Federation of Independent Business survey (Dunkelberg and Wade 2010) shows that almost no small businesses viewed credit availability as their primary problem. In fact, the NFIB has reported that weak sales were the top problem facing small businesses throughout the recession. Weak consumer demand also helps explain the enormous cash balances currently held by U.S. corporations (see Lahart 2010). These results have important policy implications. If the main problems facing businesses relate to depressed consumer demand due to a household sector weighed down by debt, investment tax subsidies and lower interest rates may have a limited effect on business investment and employment growth.

The evidence is more consistent with the view that problems related to household balance sheets and house prices are the primary culprits of the weak economic recovery.

I'm going to write more about this later, but it's amazing how our opinion leaders are locked into the "supply-side" logic, even when dealing with our current recession. The article spends a lot of time on the Chamber of Commerce, Obama dealing with business leaders, and how to get business confidence back. It doesn't mention that the number one self-reported problem facing small businesses, by a mile, is poor sales. The article is really stuck on the idea that the problem must be the deficit, or the "populist" tone Obama has taken with Wall Street, or the financial reform bill, not depressed consumer spending.

Embedded in that assumption is the notion that the only thing that would hold back a full employment economy is government action. Deregulate enough, and supply will create its own demand. It's too bad that doesn't describe our situation.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Mike Konczal on Countdown: Beware Foreclosure Solutions that Bailout the Banks

Jan 18, 2011

Want some good news? Don't look to the housing market. Roosevelt Institute Fellow Mike Konczal went on Countdown to explain to guest host Chris Hayes the dangers our economy still faces from the foreclosure crisis:

Visit for breaking news, world news, and news about the economy

Want some good news? Don't look to the housing market. Roosevelt Institute Fellow Mike Konczal went on Countdown to explain to guest host Chris Hayes the dangers our economy still faces from the foreclosure crisis:

Visit for breaking news, world news, and news about the economy

Homes are being repossessed so quickly that there's no one to buy them, and Mike points out that they're being put into a "phantom zone" on banks' balance sheets. This is likely going to decimate housing prices further, putting homeowners more underwater. It's also going to ravage state and municipality budget sheets, which means "they're going to lay off teachers to help cover for these losses," Mike says. That's like fighting a fire with lighter fluid.

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People have long been hoping this problem will just disappear, so it's good to see someone doing something about it, Mike says -- Third Way has written an open letter to Congress urging action. But it's not the solution we need. "It leaves Wall Street still in the diver's seat," he says. "The way that [banks] deal with debt, called the servicing industry, is completely unregulated, has huge conflicts of interest where Wall Street profits when people go into foreclosure, and both investors and borrowers lose." He adds, "It's very important to think of this as a bank bailout."

But not all is hopeless. We do have a solution just waiting to be used -- our bankruptcy courts, which can modify loans and tackle the problem. "Bankruptcy courts are one of our best institutions in the country and an institution uniquely situated to handle foreclosures," Mike says.

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Debt, Housing and Currency: Cautiously Optimistic for 2011

Jan 14, 2011Edward Harrison

the-economy-200Some signs are looking up, but there are still plenty of landmines in the economy.

the-economy-200Some signs are looking up, but there are still plenty of landmines in the economy.

It's high time I laid my cards on the table about 2011. So, here it is: I am cautiously optimistic about the US and global economy for 2011. Let me explain both pieces of the puzzle -- the cautious part and the optimistic part -- below. I'll start with the positive first.


Double dip recessions are not the norm; they are the exception. Why? Here's how I put it in September:

Recoveries by definition start from a point of diminished output because recessions are periods of diminishing output. So output in the initial period of any recovery is always lower. That's how the math works -- and also why I continue to stress that this is a technical recovery.

But, the important part to remember is how the business cycle works and how the recency effect creates self-reinforcing declines or recoveries in output.

Increases in income lead to increases in retail sales which lead to increases in output and inventories which lead to more jobs and thus a further increase in income. This is a virtuous circle that defines the upward path of a business cycle.

So, you really need to see powerful secular forces to overcome this self-reinforcing dynamic. Once a technical recovery begins, we should expect it to continue and blossom into a full-blown cyclical recovery. Obviously, I am talking about the medium-term, not the long-term here. But the point is that we have been in recovery for over one-and-a-half years in the US. Odds are that this will continue for some time to come (through 2011 at least).

I see the jobs picture as encouraging. Employment is lagging, as it has in the last two recoveries. So the recovery looks particularly weak. Moreover, there seems to be a skew toward the upper income strata. This makes the technical recovery appear even more sluggish. But clearly, the jobs picture is improving.

What are US jobless claims telling us about recovery? They are averaging about 410,000, down from almost 470,000 a year ago. And since employment is a lagging indicator, we should expect claims to drop even further as GDP has been growing.

Across the board, the economic indicators show a modest but improving economic picture: industrial production, capacity utilization, personal income, retail sales. And I expect this to continue through at least the first half of 2011, probably through the whole year.


I am cautious about this outlook because I still believe the US is in a cyclical upturn within a larger depression. The concept that the structural problems of excessive household indebtedness and an over-reliance on financial services and housing can be solved by money printing and fiscal stimulus leaves me cold. My thesis is that these remedies mask problems only due to the cyclical upturn. If the recovery is not used to whittle the problem away, the next recession will be as bad or worse than the last.

That said, policy makers have done a pretty good job of avoiding egregious policy errors so far. I think that gives us enough oomph to get over the hump so the cyclical agents like inventories and cyclical hiring can do their magic. But, here are my lingering concerns.

1. Europe: the sovereign debt crisis refuses to go away. The European periphery is hurting but the crisis has infected the core via Belgium and Italy. I expect the crisis to get worse before decisive action is taken because that's how politicians usually respond. There are three options for the euro zone: monetisation, default, or break-up. The question is whether this -- in and of itself -- deals a fatal blow to recovery in Europe, infecting the global economy. If you had asked me this question early last year, I would have said yes. Today, one year more into a cyclical recovery, it is less clear.

2. US states and municipalities: Meredith Whitney has put this crisis front and center. My take is similar to the one on Europe: The question is whether this -- in and of itself -- deals a fatal blow to recovery in the US, infecting the global economy. Here, I have always felt that the budget issues would only become dire in a cyclical downturn as declining asset prices created public sector pension losses. In an upturn, tax revenue increases, as do accounting gains from asset prices. Costs for supporting the unemployed decrease. To the degree that there are budget problems, the situation is very pro-cyclical -- meaning you have what MBAs call a high degree of operating leverage on municipal and state income statements. Leverage works to magnify cyclical ups and downs. That means that, while I agree with Whitney's alarm on munis, I do not think this is a 2011 event.

3. Housing: House price declines have resumed in the UK and the US. They never stopped in Ireland and Spain. The housing double dip is in progress. Complicating matters, clearly, fraud was a big issue not only in the origination of mortgage loans in the US but also in packaging and foreclosure. There is a real possibility that a systemic legal problem develops on that front in 2011. I don't know how this problem will be resolved. At this point, I see it as the biggest near-term risk for the US in 2011.

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4. Currency Wars: a lot of good is done simply by having economic growth. It takes a lot of political heat off politicians. The currency wars are really a political event because they are caused by a lack of aggregate demand. When the pie shrinks, individual countries feel obliged to implement beggar-thy-neighbour policies to maintain their standards of living by taking a larger share of the pie. The developed economies have felt this ‘pie shrinkage' most acutely. So it is they who are driving the so-called currency wars forward. The emerging markets are merely reacting in kind. I say "First the rate reductions, then money printing, then the currency war, then the tariffs, then..." hopefully economic recovery. But, as with the other problems, unless recovery is used to solve the issue of external imbalances created by our jury-rigged monetary system, the so-called Bretton Woods II, then tensions will return worse than before when a recession hits. Only after a full-blown crisis will the underlying issues be addressed. So, wait for the next crisis for reform of the monetary system.

5. UPDATE: Added this paragraph -- Commodity price Inflation: There is a real threat to recovery from commodity price inflation. We have already begun to see signs of food price riots, food price controls and the like in emerging markets. Additionally, Brent crude is at 27-month highs, closing in on $100 a barrel. Just think back to 2008; this type of commodity price inflation was toxic and sowed the seeds of its own demand destruction.


I may write what I think this means for stocks or bonds in another post. But the quick data dump is that profit margins are cyclically high while P/E ratios are above their long-term levels. If firms staff up, we could see a modest rise in stocks due to an increase in aggregate demand, despite these two factors. Personally, I tend to like large cap value and I think that's the right call for this environment because, while I am optimistic, I am cautious. On bonds, I have been saying for four months that they showed a poor risk/reward skew at these levels. Moreover, duration changes are pretty large when yields are low. That means you can sustain heavy losses if yields tick up. There is no reason to be a hero by moving out the curve and getting long duration. Nor is there any reason to load up on risk, especially in munis and sovereign debt. That is still my view. But US sovereign debt is a lot more attractive today than it was four months ago.

On the economic front, I moved away from a multi-year recovery baseline because of the prospect of policy errors. We avoided those errors in 2010. With the technical recovery poised to become a full-blown cyclical recovery, I think it's time to move back to the multi-year recovery baseline. Let me repeat my oft quoted phrase about the secular leveraging in the developed economies:

The problem I have with the recent history of growth in the United States, the United Kingdom, Spain and Ireland in particular is that the growth was underpinned by high debt accumulation and low savings. As debt is a mechanism through which we pull demand forward, the debt and consumption has meant we have been growing today at the expense of future growth.

Low quality growth can go on for a long time

This dynamic can continue for a very, very long time. In the United States, by virtue of America's possession of the world's reserve currency, an increase in aggregate debt levels has been successfully financed for well over twenty-five years. Mind you, there have been a number of landmines along the way. But, time and again, these pitfalls have been avoided through asymmetric monetary policy and counter-cyclical fiscal expansion.

So, poor quality growth can continue for very long indeed. And it is this fact which allows the narrative of easy money and over-consumption to gain sway.

The boy who cried wolf

A soothsayer who counsels against this type of economic policy, but who warns of impending collapse, will surely be seen as the boy who cries wolf. Think back to 2001 or 2002. Did we not witness then the same spectacle whereby the bears and doomsayers were let out of their holes to warn of impending doom from reckless economic policy? By 2004, unless these individuals changed their tune, they were long forgotten or even laughed at -- only to resurface in 2007 and 2008 with their new tales of woe. Knowing this shapes the psychology of economic forecasting is why missing the turn is disastrous for one's career. Efforts to avoid missing the turn are also part of a very large pro-cyclical psychological force underpinning a cyclical bull market.

The fact is: low quality growth does not lead to immediate economic calamity. It can continue through many business cycles. Even today, it is wholly conceivable that we could experience a multi-year economic expansion on the back of renewed monetary and fiscal expansion.

Marc Faber: "Don't underestimate the power of printing money"

You will recall that I wrote a post at the depths of the market implosion highlighting a phrase by Marc Faber, "Don't underestimate the power of printing money." This quote has stuck with me as asset markets have soared in the intervening time. What Faber was alluding to was the fact that printing money works. It does goose the economy as intended and it can induce a cyclical recovery.

Nevertheless, the recovery is likely to be of poor quality due to significant malinvestment. Debt levels will rise and capital investment will be directed toward riskier enterprises. Look at what's happening in China. Are you telling me stimulus is not working? It most certainly is.

In the west, stimulus is also working. It is designed to stop people from hoarding cash and to consume. It is also designed to get people out of savings accounts and into riskier asset classes. It is doing just that.

But, remember, the developed world has a lot of problems to work through. The origins of the next crisis are already apparent -- and they have nothing to do with cyclical upturns and everything to do with a secular trend of rising indebtedness, now in both the public and private sectors in developed economies. If the developed economies use this cyclical upturn wisely to reduce household debt levels, to increase private sector savings, to clean up the balance sheets of weak banks, and to cautiously normalize fiscal and monetary policy, we will be in a much better position to counteract economic weakness when the next downturn hits.

Edward Harrison blogs at, where this  piece originally appeared.

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Detroit: An American Ghetto Where a House Costs Less Than a Car

Jan 12, 2011Bryce Covert

What used to be a symbol of middle class prosperity now lies in ruins.

Detroit's history tells the story of the rise of manufacturing and economic prowess in the US. It is the story of the American middle class, built on the back of a booming industrial sector. But today it's become an omen of the struggles for middle- and lower-class Americans and the manufacturing jobs they once relied on. And the city itself is turning into a ghetto.

What used to be a symbol of middle class prosperity now lies in ruins.

Detroit's history tells the story of the rise of manufacturing and economic prowess in the US. It is the story of the American middle class, built on the back of a booming industrial sector. But today it's become an omen of the struggles for middle- and lower-class Americans and the manufacturing jobs they once relied on. And the city itself is turning into a ghetto.

Convenient to transportation on rivers and rail, Detroit became a hub of industry as far back as the late 1800s, leading to a nouveau riche class of wealthy industrialists. But its real claim to fame would come when Henry Ford piggybacked on the city's established carriage trade and built his first car manufacturing plant in 1899. Ford was the epitome of an American self-made man -- the son of an immigrant farmer who left to apprentice with a machinist and go on to become an engineer and an industrialist. Soon after Ford's plant opened up, GM, Chrysler and American Motors would follow suit, and the city quickly became the world's car capital. The booming automobile industry sucked in labor, and the city's ranks swelled from 265,000 in 1900 to over 1.5 million in 1930. With the workers -- who came from the South as well as Europe -- came labor disputes and the rise of union activism. It became the fourth largest city in the country. This period was the city's gilded age, during which skyscrapers, mansions, and historic buildings all cropped up, as well as apartment buildings aimed at middle class workers from the factories. This was the American Dream.

Now look at the city today: it is literally falling apart. It has shed roughly 1 million residents since the 1950s, and as the 2010 census showed Michigan was the only state to lose population, some analysts estimated that it would also show a drop to 150,000 people living in Detroit, down from 951,000 in 2000. The median price of a home sold in Detroit in 2008 was $7,500 -- less than the price of a car -- and the proportion of vacant homes to occupied ones almost tripled since 1999 to 28%. The city's unemployment rate just fell, but from a dismal 13.3% to a still-pretty-dismal 12%. Median household income dropped nearly 25% to $28,730 between 1999-2008. The auto crisis allowed the big car companies to force two-tier payment systems in GM and Chrysler plants and labor's influence is taking a huge blow in the recession. And those beautiful buildings built with booming auto profits lie in shambles, which look straight off the set of a post-apocalyptic movie. (I highly recommend clicking through and taking in these devastating, striking photos.)

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Living in this city is tantamount to living in a lawless state. Just ask Johnette Barham, who stuck it out through more than 10 burglaries and break-ins before her place and most of what she owned were torched. "I was constantly being targeted in a way I couldn't predict, in a way that couldn't be controlled by the police," she told the WSJ. The empty houses that surround her can no longer act as a buffer against crime, and she and many other middle-class people are fleeing the city in droves. Wealthy neighborhoods have resorted to hiring private security firms to police their streets. Why? The Detroit Police Department is down about 700 officers, according to Warren Evans, who was appointed police chief in July 2009. There's no one he can send to take care of crimes like petty theft when they're working round the clock to bring down homicide rates.

It's not just the police force that's feeling the pain from budget cuts. As fires raged through the city in September, which destroyed 85 homes and structures, the level of damage was directly connected to cutbacks. They've led to 8-12 fire company "brown outs" each day, meaning the companies are temporarily unavailable to fight fires, and one of the decommissioned stations was reported to be closest to a neighborhood that went up in flames. The city's public school system is considering a GM-style restructuring to deal with its $327 million deficit and avoid bankruptcy. As Mayor Dave Bing grapples with the city's $300 million budget gap, he's looking to cut services in the emptier parts of town in an effort to shrink the city, which means many areas will be left without basic services such as water and sewage. On top of the cuts at the city and state level, cuts at the federal level also imperil Detroit's economy -- take Defense Secretary Robert Gates' recent announcement to cut the defense budget, which will mean layoffs in Michigan defense companies. Not to mention that just Friday Ben Bernanke said the Federal Reserve won't be helping out any state or local governments saddled with debt. All of these trends are likely to continue or worsen as the recession drags on and cutting budgets and services is in vogue.

And while Detroit's troubles are gruesome, it's not the only city in America that's falling to shambles. Take Baltimore. Roosevelt Institute Senior Fellow Tom Ferguson recently took to the city's streets to explain how it's caught in a housing Catch-22. When cheap loans pushed on the population went sour, they brought down many communities' housing prices, and now without a steady tax base no one is interested in making loans to a city that is desperate for funds. It's no wonder Ferguson tells this story outside boarded up houses.

And it's no wonder that images of Detroit ended up on a blog called Ghetto America. Once our pride and joy, Detroit now reminds us of how far off track our economy has gone and how downtrodden the middle class is. As Roosevelt Institute Senior Fellow Rob Johnson said to me:

Detroit is the canary in the coalmine of America's harsh, unbridled economic adjustment. It can happen anywhere with a violence and swiftness that is only tolerated by suppressing these horrid images and neglecting the human consequences. Such an unnecessary loss of grand creations.

Bryce Covert is Assistant Editor at New Deal 2.0.

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Strategic Default: Elites Freak Out Over Imaginary Problem

Jan 12, 2011Mike Konczal

mike-konczal-2-100Even when economically irrational, most homeowners are still trying to do the right thing.

Remember this guy? David Walker of the Peterson Institute gets nostalgic about debtors prisons for strategic defaulters:

mike-konczal-2-100Even when economically irrational, most homeowners are still trying to do the right thing.

Remember this guy? David Walker of the Peterson Institute gets nostalgic about debtors prisons for strategic defaulters:

There is a norm asymmetry being ruthlessly exploited between how people and businesses view debt.  Strategic default is not a phenomenon that appears in any empirical data, but it is a boogeyman that needs to be ruthlessly pounded on before people realize that bankruptcy is something they pay for in their mortgages and is their ultimate safeguard against abusive practices. It's telling to watch financial elites freak out about the prospect of waves of strategic defaults, even as they fail to happen. It exposes what really worries them about the state of the economy and where they may not have control.

A Multi-Year Foreclosure Pipeline Slowdown Slows Down More

Cardiff Garcia has a post outlining the economic impact of the foreclosure slowdown. This dated graph shows that the foreclosure slowdown has been happening for a while now:

(Source.) The foreclosure slowdown is some mix of book valuation statistical junking (the banks don't want to mark down the property and take the loss, and perhaps of the neighboring properties), pipeline limitations, and a collapse of the new, 'thin' servicing model used by the largest banks. This slowdown will likely increase as the result of servicing fraud, and the record keeping errors and irresponsible practices for assembling mortgage-backed securities come to light in the courts.

Garcia points us to recent remarks by Joseph S. Tracy, Executive Vice President of the Federal Reserve Bank of New York, at the Connecticut Business and Industry Association/MetroHartford Alliance Economic Summit and Outlook. Tracy has a specific worry about the foreclosure slowdown (my bold):

The combination of declining house prices and increasing delays in the foreclosure process will put upward pressure on default rates as well as losses on defaulted mortgages. CoreLogic estimates that in the third quarter of 2010 there were 10.8 million borrowers in negative equity where the balance on the mortgage exceeds the current value of the property... This increases the risk that these borrowers will default on their mortgages either out of necessity -- say as the result of a job loss -- or out of choice, which is called strategic default as borrowers determine that there is little economic advantage to keep paying the mortgage. Longer delays in the foreclosure process further increase the incentive for a borrower to strategically default by extending the period of time that they can live “rent free” in the house. In addition, declining house prices increase the expected losses on those mortgages that do default.

We should be worried about slowdowns in the foreclosure process because it will encourage people to default on their mortgages when they could otherwise afford to pay. It isn't that it exposes the fact that the primary prestige industry in the United States over the past decade was a boiler room sham operation. But people may start to really look at their debt obligations like businessmen.

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Talk about a dog that didn't bark in 2010. The funny part about this rhetorical crackdown is that there's been no wave of strategic default people can point to. Homeowners really value their promises and are doing anything they can to try and do right by them, and the industry is using that leverage over them anyway they can.

There's Been No Wave of Strategic Defaults

You'll sometimes hear the figure that a third of defaults are strategic. That number comes a survey conducted by Luigi Guiso, Paola Sapienza and Luigi Zingales. They asked random people if they'd strategically default if their home was X% underwater, took their answers, and projected them onto the actual defaults and how underwater they were. There was no actual look at household budgets in creating this number. I'm a fan of Zingales' writing, but this is simply not useful in the debate. There's nothing here.

An Experian study from June 2010 found that strategic defaults peaked in the fourth quarter of 2008. What's a strategic default? "The research follows on an earlier report by Experian and Oliver Wyman that first aimed to quantify the share of mortgage defaults that are 'strategic,'" the study says. "Strategic defaulters are defined as those who miss six straight mortgage payments without missing multiple payments on auto loans and other consumer debts for the six months after they first fell behind on mortgage payments." I don’t see that as a good working definition of strategic default. From their model, a strategic defaulter is someone who misses six straight months of mortgage payments without missing multiple payments on auto loans and other consumer debts. It is fairly easy to keep consumer debt “current” by negatively amortizing it or making the bare minimum payments. What is a legitimate default here? One where the person can’t make any payments on any of their bills.

All this definition means is that someone has enough money to pay their car payment and the minimum on their credit card but not enough money to pay their mortgage payment. The mortgage payment is going to be bigger than each of the other two, and there is no benefit to paying part of the mortgage payment, as it doesn’t keep it current. The definition you want to use is whether or not someone has enough income to make all their payments, not how they allocate payments.

It's interesting that one of the few datapoints that find current (as opposed to 2008) strategic defaults, by CoreLogic, find them happening disproportionately among the rich, whose views on obligations probably mirror MBA and corporate logic more than community norms.

Borrowers Will Pay "A Substantial Premium"

Anyone actually looking at the data would conclude, in the words of the Federal Reserve Board: “The fact that many borrowers continue paying a substantial premium over market rents to keep their homes challenges traditional models of hyper-informed borrowers.” People take their obligations seriously, they (irrationally, in an economic sense) value their communities, neighbors and promises, and they work desperately to try and make good on them.

You can see this in the testimony of David Lowman, Chief Executive Officer, JPMorgan Chase Home Lending, at a House committee: "In fact, almost 64% of borrowers who are 30-59 days delinquent on a first lien serviced by Chase are current on their second lien. It is only at liquidation or property disposition that first lien investors have priority." So what you see is a lot of people, over half of them, who have stopped paying their first mortgage trying to make some sort of payment. If people were economically informed, financially literate and strategic they'd refuse to pay the second (especially if they can't pay the first). But they want to be paying something.

Consider it from a debt point of view. The (back-end) DTI ratio of someone applying for HAMP is 77.5% and 61.3% after modification. Think about that. Here's someone who spends 77.5% of their income servicing debt payments. To put that in perspective, this person will work until around October 10th before they see the first dollar that doesn't go to a creditor.

Instead of ditching this form of debt peonage, defaulting, going underground, etc., they are fighting to get into and through a program that will make it so they still spend the majority of their productive labor to pay off rentiers. Strategic default isn't a binary on-or-off switch. It is fine if people put the large majority of their productive labor towards debt payments.  And that's what we see from people in the HAMP program.

With that in mind, it's almost shocking to see how little strategic default is going on. Wouldn't it be great to have a system that met people trying to do the right thing halfway?

Mike Konczal is a Fellow at the Roosevelt Institute. You can follow him on Twitter at

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FDR's Second Bill of Rights: 'Necessitous Men are not Free Men'

Jan 11, 2011Harvey J. Kaye

fdrmain-150FDR envisioned a new definition of freedom and well-being -- one that we ought to remember.

fdrmain-150FDR envisioned a new definition of freedom and well-being -- one that we ought to remember.

On January 11, 1944 -- with American workers going "All Out!" on the home front and American soldiers, airmen, and seamen fighting European fascism and Japanese imperialism globally -- President Franklin Delano Roosevelt delivered his annual message to Congress on the State of the Union. In that speech, he reaffirmed his determination to pursue the Four Freedoms -- "Freedom of Speech, Freedom of worship, Freedom from want, Freedom from fear" -- both in the United States and abroad. He also articulated those freedoms anew, especially freedom from want and fear, in the form of an Economic Bill of Rights for all Americans.

Roosevelt knew full well that Congress, dominated by a conservative coalition of Republicans and Dixie Democrats, would never endorse it. And yet, based on polls commissioned by his administration, he had good reason to believe that most of his fellow citizens would support it. He also had reason to imagine that it would lead not only to victory in the upcoming November elections, but also to renewed efforts to extend and deepen freedom, equality, and democracy in a peacetime America.

Suffering from the flu and unable to go up to Capitol Hill to speak in person, the president sent the text of his message to Congress at midday and then presented it to the American people in a radio broadcast from the White House that evening. As ill as he was, he spoke vigorously and his remarks were reminiscent of a younger FDR.

He began by discussing his recent meetings with Churchill and Stalin at Tehran and the need to translate the wartime alliance into a permanent system of international security, and he then turned to the subject of the home front. To speed victory, but "maintain a fair and stable economy at home," FDR recommended five legislative measures to Congress, the first four clearly targeting corporate greed, the fifth evidently challenging labor. Specifically, he called on Congress to pass a "realistic" revenue act to increase taxes on profits; maintain the law allowing government to renegotiate war contracts to "prevent exorbitant profits and assure fair prices;" approve a law enabling government to more effectively control food prices; renew the Economic Stabilization Act; and enact "a national service law -- which, for the duration of the war, will prevent strikes, and... make available for war production or for any other essential services every able-bodied adult in this Nation."

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The president then looked ahead. Hoping to be heard on every front, he told Congress and the nation that, "It is our duty now to begin to lay the plans and determine the strategy for the winning of a lasting peace and the establishment of an American standard of living higher than ever before known." And in favor of that, he proposed the recognition and adoption of a Second Bill of Rights.

He said: "This Republic had its beginning, and grew to its present strength, under the protection of certain inalienable political rights... They were our rights to life and liberty. As our Nation has grown in size and stature, however -- as our industrial economy expanded -- these political rights proved inadequate to assure us equality in the pursuit of happiness." But, he continued: "We have come to a clear realization of the fact that true individual freedom cannot exist without economic security and independence. ‘Necessitous men are not free men.'" And evoking Jefferson and Lincoln, Roosevelt contended that, "In our day these economic truths have become accepted as self-evident," and, "We have accepted, so to speak, a second Bill of Rights under which a new basis of security and prosperity can be established for all regardless of station, race, or creed." This Second Bill of Rights included, he proffered:

The right to a useful and remunerative job in the industries or shops or farms or mines of the Nation;
The right to earn enough to provide adequate food and clothing and recreation;
The right of every farmer to raise and sell his products at a return which will give him and his family a decent living;
The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad;
The right of every family to a decent home;
The right to adequate medical care and the opportunity to achieve and enjoy good health;
The right to adequate protection from the economic fears of old age, sickness, accident, and unemployment;
The right to a good education.

In sum, he stated, "All of these rights spell security. And after this war is won we must be prepared to move forward, in the implementation of these rights, to new goals of human happiness and well-being."

The vision and aspirations articulated by FDR and fought for by those whom we have come to call the Greatest Generation continue to resonate in American hearts and minds. It is up to liberals, progressives, and radicals to encourage their fellow Americans -- starting with Obama and the Democrats -- to pursue them.

Harvey J. Kaye is the Rosenberg Professor of Democracy and Justice Studies at the University of Wisconsin-Green Bay and the author of Thomas Paine and the Promise of America. He is currently writing The Four Freedoms and the Promise of America. Follow Harvey on Twitter:

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Something Rotten in the State of the US Economy

Jan 4, 2011

While the markets start out the new year optimistically and we cross our fingers for a good jobs report this week, will 2011 really bring recovery? The good news may be hiding some fundamental flaws that haven't been addressed. Roosevelt Institute Senior Fellow Jeff Madrick spoke with GRITtv before the end of the year about what we can expect, and got straight to the point: "This economy has a lot to overcome to get back to what it used to be and what it used to be wasn't good enough."

More GRITtv

While the markets start out the new year optimistically and we cross our fingers for a good jobs report this week, will 2011 really bring recovery? The good news may be hiding some fundamental flaws that haven't been addressed. Roosevelt Institute Senior Fellow Jeff Madrick spoke with GRITtv before the end of the year about what we can expect, and got straight to the point: "This economy has a lot to overcome to get back to what it used to be and what it used to be wasn't good enough."

More GRITtv

It's not just enough to go back to the way things were -- they weren't so great. "The foundations of the economy have not been good for 30 years," he says. "We've neglected education, we've neglected infrastructure, we've neglected energy investments... we've neglected early education. But wages have basically stagnated for 30 to 40 years." And a living standard that stays the same or decreases is "ahistorical" and "not the American experience," he points out. The American Dream is about the ability to increase wealth, but we lost that some time ago.

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But simply growing out way out of this problem isn't the solution either, he warns. "I do think growth is an important component of the way America dealt with its problems, but only in conjunction with social programs that made sure that wealth was shared," he says. We've neglected to develop those programs that make sure everyone has a fair chance. "We're not going to correct these problems... until we recognize we've got to allow government to get bigger, better managed, and raise tax revenue to support government," he concludes. And he's not the only one calling for a shift in our thinking about the economy. Check out Senior Fellows Rob Johnson and Tom Ferguson's new paper on the roots and cures for our raging deficit hysteria, as well as Joseph Stiglitz's alternative deficit reduction plan that will boost economic growth now.

Meanwhile, Roosevelt Institute Fellow Mike Konczal warned of another problem threatening the system before the holidays: foreclosure fraud. At a New America Foundation event, he explained that our current system of creating mortgages and mortgage-backed securities is relatively new and this is the first time it's really being put to the test. "And we find that it's failing," he concludes. The ways the system is set up "push toward foreclosure and push toward the speeding up of foreclosure," he says. But "foreclosures are lose-lose-lose events." An investor loses whatever money the homeowner could have put toward the house. The community sees its property values go down. And the homeowner loses his house, not to mention his social standing.

The problem, Mike adds, is that there doesn't seem to be a quick fix. "It's not clear that banks have a silver bullet to make this go away," he says. And legislators don't either. But the good news is that state attorneys general are finally being called into action to investigate, and that "does show a real promise for a real new opening and possibility for change in this crisis." Click here for the full video of his presentation.

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2011 Will Bring More De facto Decriminalization of Elite Financial Fraud

Dec 28, 2010Bill Black

What’s coming in 2011?  We asked thought leaders to share their perspectives on the biggest challenges for the year ahead, along with the changes they’d like to see and the hopes they cherish. Our very own Bill Black takes a hard look at the criminal justice system -- and how financial fraudsters are beating it.

What’s coming in 2011?  We asked thought leaders to share their perspectives on the biggest challenges for the year ahead, along with the changes they’d like to see and the hopes they cherish. Our very own Bill Black takes a hard look at the criminal justice system -- and how financial fraudsters are beating it.

The role of the criminal justice system with regard to financial fraud by elite bankers in 2011 is likely to reprise its role last decade -- de facto decriminalization. The Galleon investigation of insider trading at hedge funds will take much of the FBI's and the Department of Justice's (DOJ) focus.

The state attorneys general investigations of foreclosure fraud do focus on the major players such as the Bank of America (BoA), but they are unlikely to lead to criminal liability for any senior bank officials. It is most likely that they will lead to financial settlements that include new funding for loan modifications.

The FBI and the DOJ remain unlikely to prosecute the elite bank officers that ran the enormous "accounting control frauds" that drove the financial crisis. While over 1000 elites were convicted of felonies arising from the savings and loan (S&L) debacle, there are no convictions of controlling officers of the large nonprime lenders. The only indictment of controlling officers of a far smaller nonprime lender arose not from an investigation of the nonprime loans but rather from the lender's alleged efforts to defraud the federal government's TARP bailout program.

What has gone so catastrophically wrong with DOJ, and why has it continued so long? The fundamental flaw is that DOJ's senior leadership cannot conceive of elite bankers as criminals. On Huffington Post, David Heath writes:

Benjamin Wagner, a U.S. Attorney who is actively prosecuting mortgage fraud cases in Sacramento, Calif., points out that banks lose money when a loan turns out to be fraudulent. An investor in loans who documents fraud can force a bank to buy the loan back. But convincing a jury that executives intended to make fraudulent loans, and thus should be held criminally responsible, may be too difficult of a hurdle for prosecutors. 'It doesn't make any sense to me that they would be deliberately defrauding themselves,' Wagner said."

Mr. Wagner is confused by his own pronouns: "It doesn't make any sense to me that they would be deliberately defrauding themselves." This direct quotation needs to be read in conjunction with the author's description of his position: "banks lose money" when loans "turn out to be fraudulent." Wagner was responding to a question about control fraud -- frauds led by the person controlling the seemingly legitimate entity who uses it as a "weapon." The relevant "they" is the person looting the bank -- the CEO. The word "themselves" refers not to the CEO, but rather to the bank. The CEO is not looting the CEO; he is looting the bank's creditors and shareholders. Two titles capture this well known fraud dynamic. The Nobel laureate in economics, George Akerlof, and Paul Romer co-authored Looting: the Economic Underworld of Bankruptcy for Profit in 1993 and I wrote The Best Way to Rob a Bank is to Own One (2005). The CEO becomes wealthy by looting the bank. He uses accounting as his ammunition because, to quote Akerlof & Romer, it is "a sure thing." The firm fails (or in the modern era, is bailed out), but the CEO walks away wealthy.

Here is the four-part recipe for maximizing fraudulent accounting income in the short-term:

1. Grow extremely rapidly
2. By making bad loans at high yields
3. While employing extreme leverage, and
4. Providing only minimal loss reserves

A bank that follows this recipe is mathematically guaranteed to report record income in the near term. The first two ingredients in the recipe are linked. A bank in a reasonably competitive, mature market such as home mortgage lending cannot decide to grow extremely rapidly by making good loans. A bank can, however, guarantee its ability to grow rapidly -- and charge a premium yield -- if it lends to the tens of millions of people who cannot afford to own a home. Equally importantly, if many lenders follow the same recipe they will cause a financial bubble to hyper-inflate. Financial bubbles extend the lives of accounting control frauds by making it simple to refinance loans to those who cannot afford to purchase the asset. The longer that delinquencies and defaults can be delayed the more the CEO can loot the bank.

Note that the same recipe that maximizes short-term fictional income in the near term maximizes real losses in the longer term. Mr. Wagner is unable to understand that accounting control fraud represents the ultimate "agency" problem -- the unfaithful agent (the CEO) enriches himself at the expense of the principals he is supposed to serve and the firm's creditors. Agency problems are well known to white-collar criminologists, economists, lawyers that practice corporate, securities, or criminal law, and financial regulators. Yes, accounting control fraud causes the bank to suffer huge losses. The loans don't "turn out to be fraudulent" -- they are fraudulent when made. The recognition of the losses is delayed when an epidemic of accounting control fraud hyper-inflates a bubble, but the bubble will increase the ultimate losses. Sacramento, California is one of the epicenters of the mortgage fraud that drove the financial crisis, so Mr. Wagner's lack of understanding of fraud mechanisms is particularly harmful.

Financial regulators are essential to prevent this kind of error by senior prosecutors. The regulators have to serve as the Sherpas for the criminal justice system to succeed against epidemics of control fraud. The FBI cannot have hundreds of agents expert in many hundreds of industries. The regulators have to do the heavy investigative lifting. They have the expertise and greater staff resources. The regulators also have to serve as the guides. Their criminal referrals have to provide the roadmaps that allow the FBI to conduct successful investigations. The regulators played this role successfully at key times during the S&L debacle, filing thousands of criminal referrals that led to over 1000 priority felony convictions. During the current crisis the OCC and the OTS - combined - made zero criminal referrals. None of the federal regulatory agencies appear to have enforced the regulatory mandate that federally insured depositories file criminal referrals - and noncompliance with that requirement was and is the norm. There is no indication that the FBI has demanded that the regulators enforce their rules.

Absent guidance and support from the regulators, the FBI turned to the worst conceivable source of guidance and support - the trade association of the "perps" -- the Mortgage Bankers Association (MBA). The MBA, predictably, defined its members as the victims of mortgage fraud. The MBA invented a nonsensical definition of mortgage fraud which made accounting control fraud impossible. All fraud supposedly fell into one of two categories: "fraud for housing" or "fraud for profit." The MBA members are, in fact, victims of accounting control fraud. The mortgage banks, however, do not set MBA policy. The CEOs of the mortgage banks determine MBA policy and they are not about to tell the FBI that they are the primary source of the epidemic of mortgage fraud. Similarly, they are not about to make criminal referrals, which might cause the FBI to investigate why some lenders made loans that were overwhelmingly fraudulent. MBA members virtually never made criminal referrals even though they made millions of fraudulent loans. Why don't the victims make criminal referrals and help the FBI protect them from the frauds?

Why did an industry, home mortgage lending, which had traditionally been able to keep losses from all sources to roughly one percent suddenly begin to suffer 80-100 percent fraud incidence on "liar's" loans? Why would an honest mortgage lender make "liar's" loans knowing that doing so would produce intense "adverse selection" and a "negative expected value"? They would not do so. They were not mandated to do so by federal regulation or law. They were not encouraged to do so by federal regulation or law. They did so because their CEOs decided they would do so in order to maximize fictional income and real bonuses. The CEOs increased the number of liar's loans they made after they were warned by the FBI that there was an "epidemic" of mortgage fraud and the FBI predicted it would cause an "economic crisis" were it not contained. The CEOs increased their liar's loans after the MBA's own anti-fraud experts stated that they deserved the name "liar's" loans because they were pervasively fraudulent and after those experts said that "liar's" loans were "an open invitation to fraudsters." The industry's formal euphemisms for liar's loans were "alt-a" and "stated income" loans. None of this makes sense for honest CEOs.

The federal regulators have not made any public study of liar's loans. The FDIC and OTS' joint data system on mortgages is an anti-study -- it uses a categorization system that ignores whether the loans were underwritten. This makes the data base useless for studying loans made without full underwriting -- the loans that were overwhelmingly fraudulent and drove the crisis. Credit Suisse reported that mortgage loans without full underwriting constituted 49% of all new originations in 2006. If that percentage is even in the ballpark it indicates that that there were millions of fraudulent loans originated in 2005-2007. It is appalling that the regulators are not studying the facts necessary to understand the crisis and hold the perpetrator accountable.

Fortunately, the state attorneys general have studied these mechanisms and they have found that it was the lenders and their agents that overwhelmingly (1) prompted the false loan application data and (2) coerced appraisers to inflate market values. An honest lender would never engage in either practice or permit its agents to do so. The federal regulators, however, have spent their passion trying to preempt state efforts to protect borrowers. The federal regulators took no effective action in response to the State AGs' findings.

The combined effect of these private sector, regulatory, and criminal justice failures has created a set of intellectual blinders that have caused DOJ to mischaracterize the nature of mortgage fraud. Attorney General Mukasey famously dismissed the epidemic of mortgage fraud as "white-collar street crime." He did so in the context of refusing to establish a national task force against mortgage fraud. A national task force is essential in this crisis because of the national lending scope of many of the worst accounting control frauds. Attorney General Holder has maintained Mukasey's passive approach to the elite frauds that drove the crisis.

The U.S. needs to take three major steps to be effective against the epidemic of accounting control fraud. First, DOJ needs to realize that it is dealing with accounting control fraud. That task is not terribly difficult. The criminology, economics, and regulatory literature -- as well as the data on fraud and analytics are all readily available. The FBI must end its "partnership" with the MBA.

Second, the regulators need new leadership picked for a track record of success as vigorous regulators and a willingness to hold elites accountable regardless of their political allies. The regulators need to make assisting prosecutions, and bringing civil and enforcement actions, against the senior officers that led the control frauds their top priority. The regulators need to make detailed criminal referrals, enforce vigorously the regulatory mandate that insured depositories file criminal referrals, and prioritize banks that made large numbers of nonprime loans but few criminal referrals. The regulators need to work with DOJ to prioritize the cases. In the S&L debacle we used a formal process to create our "Top 100" priority cases. The regulators need to investigate rigorously every large nonprime lending specialist by creating a comprehensive national data base. We have unique opportunities given the massive holding of nonprime paper by the Fed and Fannie and Freddie to create a reliable data base and use it to conduct reliable studies and investigations.

Third, the regulators and the DOJ need to partner with the SEC and the state AGs to share data (where appropriate under Grand Jury rule 6e). The federal regulators need to end their unholy war against state regulatory efforts and the SEC needs to end its disdain for the state AGs. The SEC needs to clean up accounting and the Big Four audit firms. The bank control frauds' "weapon of choice" is accounting. The Big Four audit firms consistently gave clean opinions to even the most egregious frauds. Provisions for losses (ALLL) fell to farcical levels. Losses were not recognized. Clear evidence of endemic fraud was ignored.

What are the prospects for these three vital changes occurring in 2011? They are poor. There is no evidence that any of the three changes is in process. The new House committee chairs have championed even weaker regulation and have not championed the prosecution of Wall Street elites.

The media, however, has begun to pick up our warnings about the failure of the criminal justice response to the epidemic of fraud. Prominent economists, particularly Joseph Stiglitz and Alan Greenspan, have joined Akerlof, Romer, Galbraith,Wray, and Prasch in emphasizing the key role that elite fraud played in driving this crisis. Even Andrew Ross Sorkin, generally seen as an apologist for the Street's elites, has decried the lack of prosecutions.

Our best bet is to continue to win the scholarly disputes and to continue to push media representatives to take fraud seriously. If the media demands for prosecution of the elite banking frauds expand there is a chance to create a bipartisan coalition in Congress and the administration supporting prosecutions. In the S&L debacle, Representative Annunzio was one of the leading opponents of reregulation and leading supporters of Charles Keating. After we brought several hundred successful prosecutions he began wearing a huge button: "Jail the S&L Crooks!" Bringing many hundreds of enforcement actions, civil suits, and prosecutions causes huge changes in the way a crisis is perceived. It makes tens of thousands of documents detailing the frauds public. It generates thousands of national and local news stories discussing the nature of the frauds and how wealthy the senior officers became through the frauds. All of this increases the saliency of fraud and increases demands for serious reforms, adequate resources for the regulators and criminal justice bodies, and makes clear that elite fraud poses a severe danger. Collectively, this creates the political space for real reform, vigorous regulators, and real prosecutors.

Bill Black is a NewDeal2.0 braintruster, an associate professor of economics and law at the University of Missouri-Kansas City, a white-collar criminologist, a former senior financial regulator, and the author of The Best Way to Rob a Bank is to Own One.

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