Foreclosure Fraud For Dummies, Part 2: What's a Note, Who's a Servicer, and Why They Matter

Oct 12, 2010Mike Konczal

mike-konczal-2-100Mike Konczal defines the key players in the foreclosure fraud mess. **This is Part 2 in a series giving a basic explanation of the current foreclosure fraud crisis.

mike-konczal-2-100Mike Konczal defines the key players in the foreclosure fraud mess. **This is Part 2 in a series giving a basic explanation of the current foreclosure fraud crisis. You can find Part 1 here.

What is the note?

The SEIU has a campaign: Where's the Note? Demand to see your mortgage note. It's worth checking out. But first, what is this note? And why would its existence be important to struggling homeowners, homeowners in foreclosure, and investors in mortgage backed securities?

There's going to be a campaign to convince you that having the note correctly filed and produced isn't that important (see, to start, this WSJ editorial from the weekend). It will argue that this is some sort of useless cover sheet for a TPS form that someone forgot to fill out. That is profoundly incorrect.

Independent of the fraud that was committed on our courts, the current crisis is important because the note is a crucial document for every party to a mortgage. But first, let's define what a mortgage is. A mortgage consists of two documents, a note and a lien:

The note is the IOU; it's the borrower's promise to pay. The mortgage, or the lien, is just the enforcement right to take the property if the note goes unpaid. The note is crucial.

Why does this matter? Three reasons, reasons that even the Wall Street Journal op-ed page needs to take into account. The first is that the note is the evidence of the debt. If it isn't properly in the trust, then there isn't clear evidence of the debt existing.

And it can't be a matter of "let's go find it now!" REMIC law, which governs the securitization, is really specific here.  The securitization can't get new assets after 90 days without a tax penalty, and it can't get defaulted assets at all without a major tax penalty. Most of these notes are way past 90 days and will be in a defaulted state.

This is because these parts of the mortgage-backed security were supposed to be passive entities. They are supposed to take in money through mortgage payments on one end and pay it out to bondholders on the other end -- hence their exemption from lots of taxes. The tradeoff is that they can't be de facto managers of assets, and that's what going to find the notes would require.

For Distressed Homeowners

The second is that it also matters a great deal for homeowners who are distressed. The note lays out the terms of late fees and other penalties. As we will discuss in the section on mortgage servicers, the process of trying to get people who are behind on their payments current instead of driving them into bankruptcy has broken down. But for now, it's clear that mortgage servicers don't have great incentives to get distressed homeowners' records correct.

There's well-documented evidence that extra fees are tacked on to mortgages that have fallen behind, fees that aren't following the terms of the note. This is usually only found out in bankruptcy where there is a lawyer (and multiple parties), not in foreclosure cases. But the terms of the note are necessary for the court if homeowners wants to challenge the servicers' claim of the final due amount.

This will matter a great deal for many homeowners. Small, marginal differences in the total owed could allow for a short sale. It could determine if the homeowner has any equity in their home. And this can only be determined by producing the note.

For Investors, Who Took This Seriously at the Beginning

Last reason: you can tell it's important because all the smartest finance guys in the room thought it was important. Let's look at a Pooling and Service Agreement form from 2006 (PSA) between "GS MORTGAGE SECURITIES CORP., Depositor, and DEUTSCHE BANK NATIONAL TRUST COMPANY, Trustee." (h/t Adam Levitin for this example.) Let's reproduce the chart from part 1 to see the chain between depositors and trustees who oversee the trust:

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So what agreement did they come to when it comes to the proper handling of notes in securitization? Did they think this was no big deal, or that it is something serious? From the PSA (my bold):

(b) In connection with the transfer and assignment of each Mortgage Loan, the Depositor has delivered or caused to be delivered to the Trustee for the benefit of the Certificateholders the following documents or instruments with respect to each Mortgage Loan so assigned:

(i) the original Mortgage Note (except for up to 0.01% of the Mortgage Notes for which there is a lost note affidavit and the copy of the Mortgage Note) bearing all intervening endorsements showing a complete chain of endorsement from the originator to the last endorsee, endorsed "Pay to the order of _____________, without recourse" and signed in the name of the last endorsee...

The Depositor shall use reasonable efforts to cause the Sponsor and the Responsible Party to deliver to the Trustee the applicable recorded document promptly upon receipt from the respective recording office but in no event later than 180 days from the Closing Date....

In the event, with respect to any Mortgage Loan, that such original or copy of any document submitted for recordation to the appropriate public recording office is not so delivered to the Trustee within 180 days of the applicable Original Purchase Date as specified in the Purchase Agreement, the Trustee shall notify the Depositor and the Depositor shall take or cause to be taken such remedial actions under the Purchase Agreement as may be permitted to be taken thereunder, including without limitation, if applicable, the repurchase by the Responsible Party of such Mortgage Loan.

Read that again through to the end and use the chart to follow the chain. If more than 0.01% (!) of mortgage notes weren't properly transferred, the trust can force the sponsor (in this case, Goldman Sachs) to repurchase the bad mortgages.   And this is just one contract for one part of the ~$2.6 trillion dollar mortgage backed securities market.  How's that for systemic risk?  Especially if this is found to be widespread...

Looking at the documents, you see that the smart guys who created these mortgage-backed securities put large poison pills into them to try and prevent the kind of note fraud we are currently experiencing.  They took the policing and legal recourse (and legal ability to cover themselves) very seriously on this issue. So seriously they can force repurchases of this bad debt.

So don't believe anyone who says these are just technicalities; the people who wrote the contract didn't believe they were.

Who is a servicer?

Whenever I hear someone say there wouldn't be a problem with foreclosures if people just paid their mortgages on time, I'm reminded of Alan Grayson's paraphrase of the Republican Health Care Plan: "Don't Get Sick. If You Get Sick, Die Quickly." Yes, the world would be an easier place if people never got sick, or credit risk didn't exist, and people made payments perfectly all the time. But they don't, and we need a system of rules and a process for collecting and presenting evidence in order to kick a family out of their home. And we need a system where this process sets the ground rules that in turn allow for lenders and borrowers coming together and negotiating a situation that is best for both of them.

Because the first rule of mortgage lending is that you don't foreclose.  And the second rule of mortgage lending is that you don't foreclose.  I'll let Lewis Ranieri, who created the mortgage-backed security in the 1980s, tell you: "The cardinal principle in the mortgage crisis is a very old one. You are almost always better off restructuring a loan in a crisis with a borrower than going to a foreclosure. In the past that was never at issue because the loan was always in the hands of someone acting as a fudiciary. The bank, or someone like a bank owned them, and they always exercised their best judgement and their interest. The problem now with the size of securitization and so many loans are not in the hands of a portfolio lender but in a security where structurally nobody is acting as the fiduciary."

In the past you had Jimmy Stewart banks. The mortgages were kept on the bank's books. You had someone who you could go to in order to renegotiate your mortgage. With mortgage-backed securities, the handling of payments and working-out of troubles moved to servicers.  If you are learning about this crisis for the first time, understanding what is broken here is very important.

This is Not a New Problem With Servicing

Let's get some quotes from bankruptcy judges in here:

“Fairbanks, in a shocking display of corporate irresponsibility, repeatedly fabricated the amount of the Debtor’s obligation to it out of thin air.” 53 Maxwell v. Fairbanks Capital Corp. (In re Maxwell), 281 B.R. 101, 114 (Bankr. D. Mass. 2002).

“[T]he poor quality of papers filed by Fleet to support its claim is a sad commentary on the record keeping of a large financial institution. Unfortunately, it is typical of record-keeping products generated by lenders and loan servicers in court proceedings.” In re Wines, 239 B.R. 703, 709 (Bankr. D.N.J. 1999).

“Is it too much to ask a consumer mortgage lender to provide the debtor with a clear and unambiguous statement of the debtor’s default prior to foreclosing on the debtor’s house?” In re Thompson, 350 B.R. 842, 844–45 (Bankr. E.D. Wis. 2006).

(Source.) Notice that consumer rights groups were flagging this as a major problem back in 1999 and 2002 because judges were noticing it was a major problem in their bankruptcy courts. If the late 1990s to 2006 period is a Renaissance period of servicer fraud, then we can contrast it with the period we live in now, the Baroque period of servicer fraud.  Whatever unity there used to be between the forms and functions of the sloppy documentation and outright fraud in the art of servicing have become detached.

The forms of fraud have gone high art: serving documents on people who could never have been served, signing 10,000 affidavits a month, etc. They are all well-covered, and we'll list more later perhaps. Here are some of my favorites from last year, the reading list in Part One has even more. But what I want to focus on is the function of servicer fraud.

What Do Servicers Do?  A Case Study in Bad Design and Worse Incentives

Servicers in a mortgage-backed security have two businesses. The first is transaction processing. This means taking in your mortgage money on one end and walking it over to the crazy tranches and payment waterfalls on the other end. This is clean, efficient, largely automated, requires little discretion and works very well, and implicit in it is that it is most profitable when you can harness economies of scale.

In fact, it's considered a "passive entity", so there are no taxes applied in this passthrough mechanism. If servicers went "active", say by looking for mortgage notes not in the trust 90 days after the fact or mortgage notes that are not in the trust that have defaulted (which is what they'd likely have to do to get out of this foreclosure fraud crisis), they'd face very severe tax penalties.

Their other business is to handle default situations.  In addition to the fixed fee they get for servicing each individual mortgage, they get paid by default fees like late charges. They get to retain most, if not all, of these fees.

So right away they have a disincentive to negotiate to get a mortgage in a good state. They also have a strong incentive to keep a steady stream of fees and charges going to their books, rather than to investors.  So anything that puts servicers in charge of negotiating mortgages, say the Obama's administration's HAMP program, is designed to fail.

Because even without bad incentives, doing good work on modification is costly, time consuming, requires individual expertise and experience and doesn't benefit from automation or economies of scale.  Which is to say it has the opposite structure of their normal business.

And there are additional worries. Many of the servicers work for the largest four banks -- Wells Fargo, Bank of America, Citi, and JP Morgan -- and these four banks have large exposures to junior liens. These are second or third mortgages or home equity lines of credit that would have to be wiped out before the first mortgage can be modified. The four banks have almost half a trillion dollars worth of these exposures and, from the stress test, are valuing them at something like 85 cents on the dollar. Keeping a homeowner struggling to pay the second lien would be more worthwhile to these middlemen banks than getting him or her into a solid first lien to the benefit of the bond investor.

So keep these in mind as you read about the servicers here. There have been worries that they, as a designed institution, were simply not qualified for this job going back a decade. They have massive conflicts with the investors they are supposed to be working for. They profit when homeowners collapse and lose money when they are brought up to a normal payment schedule (made current). And if the instruments don't have the notes necessary to bring standing to carry out the foreclosures, they have to take a massive tax hit in order to take the note into the trust. And there is no regulation in place to handle this.

No Regulator

Because for all the talks of regulatory burden, there is no current federal government agency that regulates the servicers. Not the Federal Reserve. Not the Treasury. This is what happens when the financial industry writes the deregulation. Instead, you have a patchwork of state regulators and attorney generals.  Notice how President Obama has nobody to turn to and tell the press that "So and So is on the case." In theory, the OCC regulates servicers if they are part of a bank or a thrift. This regulation must fall to the new regulatory counsel and the Consumer Financial Protection Bureau to investigate, where it will properly belong.

(The Fair Debt Collections Act, which applies to debt collectors, doesn't apply to servicers. Here's a fun idea for an enterprising staffer: if there is no producible note, are servicers still legally servicers and thus exempt from the Fair Debt Collections Act? Just a thought...)

Is it any wonder that servicers are rushing these foreclosures and making a mockery of the courts and producing systemic risk in the process? There needs to be an investigation of what is being done and why, because this problem is not taking care of itself.

(Special thanks to Katie Porter and Adam Levitin, who you can read at credit slips, as well as Tom Adams and Yves Smith, who you can read at naked capitalism, for in-depth discussions on this material.)

Mike Konczal is a Fellow at the Roosevelt Institute.

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Josh Rosner Goes After the Children Who Ran the Banks

Oct 12, 2010

Sunlight is the best disinfectant, and there is a lot of rot to uncover in the mess that lead to the financial crisis. ND20 contributor Josh Rosner appeared on the new CNN show Parker Spitzer to discuss documents that prove a solid 28% of mortgages in securities didn't even meet investment banks' own underwriting standards. The banks ignored the warnings, ratings agencies turned a blind eye, and the securities got sold to investors, Rosner explains:

Sunlight is the best disinfectant, and there is a lot of rot to uncover in the mess that lead to the financial crisis. ND20 contributor Josh Rosner appeared on the new CNN show Parker Spitzer to discuss documents that prove a solid 28% of mortgages in securities didn't even meet investment banks' own underwriting standards. The banks ignored the warnings, ratings agencies turned a blind eye, and the securities got sold to investors, Rosner explains:

"There's a real problem here and these documents do seem to highlight that the investment banks did have reason to know that these loans didn't even meet their own standards," Rosner explains. Ratings agencies claim they have no obligation to verify information, so "it seems they intentionally avoided collecting this information," he adds. "This is what happens when the children are in charge. We saw the risk management culture of the investment banks disappear, the trading desks really took over this business," he says. Things would have been fine if housing prices kept rising -- but we all know the end to that story.

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So is this fraud? Rosner claims, "I'm not a lawyer. I don't play one on TV." But Eliot Spitzer is -- and he proposes someone should "drop a subpoena on every investment bank saying I want to track this information... see where in the company [the documents] went, who saw them, who knew about them, who had a conversation about them, and what did they do." And if someone saw the documents and pushed these securities anyway? "Boom, charge them right there." Time will tell if anyone else takes the hard line against this behavior.

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Foreclosure Fraud For Dummies, 1: The Chains and the Stakes

Oct 12, 2010Mike Konczal

mike-konczal-2-100All you need to know to follow the trail of wrongdoing.

mike-konczal-2-100All you need to know to follow the trail of wrongdoing.

The current wave of foreclosure fraud and the consequences for the economy are difficult to follow. As such, I'm going to write a few posts to simplify what is going on so you can follow stories as they unfold.  This is very 101 level, and will include a reading list of blog posts and articles at each stage to help provide depth.   (Special thanks to Yves Smith for walking me through much of this.)  Let's make three charts of the chains involved in the process. The first is what is currently going on with foreclosure fraud (click through for a larger image):

As you can see, in judicial review states like Florida the courts require that servicers, or those who administer the bonds that are full of mortgages (securitization, residential mortgage backed securities, RMBS, are all phrases they use), say that they have everything necessary in order to have standing to bring a foreclosure. They need to have the note for a mortgage, which is supposed to be in the trust -- part of the mortgage backed securities -- that they administer.

What is breaking down here? In Florida, a judicial review state, it was found that one person was notarizing documents far faster than anyone reasonably could have. Someone found forged documents necessary for the foreclosure process, like the note. A separate court system was set up to resolve these foreclosures faster, at the expense of allowing serious challenges to the documents. Here's Smith on how kangaroo these courts look up close. Here's WaPo on one individual and the nightmare of trying to challenge an invalid foreclosure. Keep him in mind when you hear about deadbeats and whatnot: the current system is designed to make it difficult for anyone to challenge their case.

Meet the robo-signer who kicked it off here at this WaPo story. I almost feel bad for this patsy; the real battle here is between junior and senior tranche holders, and this doofus could end up in jail in order to keep John Paulson rich. After reading about this guy, I'm asking our elites to take better care of their goons. (Can we get a Financial Patsy Fordism social contract movement going? If you are going to be a patsy for GMAC, you should be paid enough to be able to buy GMAC's services.)

Why would servicers do this? One story would be that the more foreclosures they process, the more fees they get, so there is an incentive to cut as many corners to speed through the process as possible. Hence the term foreclosure mills. You can read more about this from Andy Kroll's excellent work for Mother Jones (start here).

There's another problem though -- what if servicers are behaving this way because the actual notes aren't in the trust? Let's go back to the creation of these instruments.

I take a mortgage out at Joe's Lending, a mortgage originator. A mortgage consists of two parts. The first is the note, or the IOU, which is the borrower's promise to pay. The second is the mortgage, which is the security, or the lien, or the actual interest.

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Joe's lending takes the mortgage note to a sponsor to turn these mortgages into a bond. The sponsor is often an investment bank like (now non-existent) Bear Sterns. Now that investment bank puts an intermediary in between itself and the trust. This intermediary is usually called a depositor, and sometimes there are several of them in the chain.

What's the worry here? Well many of these mortgage originators were fly-by-night shops, shady enterprises that collapsed the moment they hit trouble. And many of them cut corners, and one of the corners they may have cut would have been to send the note to the trust. Specifically, there is worry that many mortgage originators never sent the notes to the depositors. Originators wanted volume to get fees and may not have done all the paperwork correctly. There are a lot of things that have to end up in the trust when I take out a mortgage, things like the note, title insurance, supporting documents. But the note is the most important.

Why is this important? Because the trustees usually sign several certificates saying that they have verified all the documentation in these trusts. Many of these trusts are under New York trust law, which is particularly clear and strict when it comes to these matters. With this in mind, tackle these three posts by Yves Smith (one two three).

So connect the two together, and you can see why we might have a systemic crisis on our hands:

There are roughly $2.6 trillion dollars in mortgage backed securities. The Wall Street Journal starts to explain how this will be a battle between holders of junior and senior tranches of debt. It also exposes the servicers, which include the four largest banks, to extensive legal liabilities by those who bought these securitizations that were signed off as being properly administered and created.

One result is that this has led homeowners to reasonably demand to see the proper documentation before they and their families are put out on the street. Read Ryan Grim and Shahien Nasiripour from June, Who Owns Your Mortgage? "Produce The Note" Movement Helps Stall Foreclosures.

Katie Porter is an expert who has done extensive research into this area and often blogs about it at credit slips. See the blog posts: How to Find the Owner of Your Mortgage and Produce the (Bogus?) Paper. In her research, Porter found that this situation was extensive -- see Misbehavior and Mistake in Bankruptcy Mortgage Claims:

"A majority of mortgage claims are missing one or more of the required pieces of documentation for a bankruptcy claims. Fees and charges on claims often are poorly identified and do not appear to be reasonable. The bankruptcy data reinforce concerns about the overall reliability of the mortgage service industry to charge homeowners only the correct and legal amount of the debt and to comply with applicable consumer protection laws."

By rushing the process, unreasonable and excessive foreclosure fees can get applied to homeowners when there may not even be the proper documentation to have the standing to bring foreclosure at all.

So keep these frameworks in mind when you see the debate unfold in the next weeks. It is a problem of systemic risk, and it is a problem for the currently cratered securitization market. It will need to be addressed, the sooner the better.  But how?

Mike Konczal is a Fellow at the Roosevelt Institute.

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More on the Florida Foreclosure Nightmare

Sep 30, 2010Mike Konczal

mike-konczal-2-100Foreclosure cases are running afoul of the law, and underwater homeowners get shafted. **Tune in to NPR's Marketplace tonight to hear Mike talk with David Brancaccio.

mike-konczal-2-100Foreclosure cases are running afoul of the law, and underwater homeowners get shafted. **Tune in to NPR's Marketplace tonight to hear Mike talk with David Brancaccio.

We just discussed the nightmare situation in Florida, which is likely to spin out nationally. Before I tell you more about what I think about the Florida situation, I'll tell you I was raised by a family in law enforcement, and as such, I tend to think people who are arrested are usually guilty.   And I think that the people who are ending up inside the Florida bankruptcy courts are usually going to be people that shouldn't be in their homes.

It's because of the fact that I and others usually believe this to be true that I think due process and trust in the process of our courts is so incredibly important. It's necessary to force the parties at hand to marshal evidence that they swear is true, and to present it to an impartial judge to render judgment after full consideration. This is America, where everyone gets a chance before the court. If this system breaks, the weak and the innocent are the ones who suffer.

So it's because of this background that I feel sick to my stomach learning of a random sampling of foreclosure cases conducted by the Florida Bar News has just found "that 20 percent or more of the cases set for summary judgment had some procedural or paperwork problems."

Think about that. Twenty percent! It's outrageous, and shouldn't stand in a country that values the rule of law.

Why is this happening? Again, keeping with what I know about the law, the criminals courts would simply shut down if everyone had a jury trial. Hence the crucial role of plea-bargaining. (If you want to see the role plea-bargaining plays, you should read Courtroom 302, one of my favorite books, by Chicago Reader journalist Steve Bogira.) There's a plea-bargaining mechanism to be had in these foreclosure trials: remove the deficiency judgments. People want to be able to hand over their homes, but they don't want to spend the next decade hounded by JP Morgan for every last dollar that can be grabbed out of their paycheck. From the Florida Bar (my bracketed numbering):

Another hitch in clearing cases, he said, is [1] sometimes banks put off getting the final judgment so they don’t have to immediately take possession of the property, which makes the banks liable for property taxes and homeowners’ association fees on homes that may take considerable time to resell...

“If we had everyone defending their foreclosure, we’d never get through this.”

She said an unappreciated problem is [2] that many foreclosed homeowners don’t realize they are still liable for deficiency judgments, which is the difference between what they owed on the mortgage and what the bank gets in a foreclosure auction or a short sale. Those who do understand may fight or try to delay foreclosures, which doesn’t help the courts with the backlog. But it also means that once the foreclosure crisis is over, courts could be hit with a wave of deficiency actions.

Zikakis said of many of her clients, “If they could be relieved of the deficiency, they would hand in the keys immediately.”

Two things. First, in number one, notice that a lot of the backlog is the result of banks not wanting to take over properties. Some estimates place an abandoned property at $20,000 a pop, so a bank leaving three properties abandoned in any given place reasonably costs the municipality a teacher's salary.

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The second is even more important: homeowners are still on the hook for the deficiency judgments. If banks said they wouldn't chase homeowners to the ends of the earth, garnishing their wages and disrupting their earnings, many years after a bum investment decision went south -- if they were able to take at least a share in the downside -- there would be a much, much smaller crisis. But because banks are credibly signaling that they will move Heaven and Earth to get every last penny they can out of those who have already been kicked to the curb, those who are about to be kicked out want to have their say in court.

Having mortgage cramdown would have helped alleviate this, FYI. Sure, courts would have gotten more crowded short-term, but it also would have been clearer in the results. And remember, this isn't about poor people wanting to steal a home from someone;  it's about people wanting to make sure they can negotiate their way out of the housing crash that has left them deeply underwater.  The ramifications of the crisis have left people much worse off than their original bad investment would have.  People are willing to negotiate. Are the banks?

When you go back and read Yves Smith's site about a sample judge, it's clear he's moving people as fast as possible into a situation of not wanting to fight, either for their homes or for the their negotiated values. Those who are falsely being evicted or those who have a credible case to fight are being lost in the shuffle. Meanwhile, banks realized that they could cash out big by rushing as much as possible through foreclosure, but that doesn't give homeowners a fair shake, or cause a reasonable negotiation to occur. And that is simply not just.

Start watching this (Naked Capitalism is the clearinghouse of info). The ratings agencies are being put in motion and they are always late to the news. JP Morgan has just fessed up to worries, arguably slowing the foreclosures in the country to a standstill. It's going to get much worse before it gets better.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Why We Should be Mad as Hell About Florida's Foreclosures

Sep 29, 2010Mike Konczal

mike-konczal-2-100We could be giving underwater homeowners a chance. Instead, we're kicking people out of their homes without due process.

mike-konczal-2-100We could be giving underwater homeowners a chance. Instead, we're kicking people out of their homes without due process.

Given that the IMF and others believe a large part of the "structural unemployment" in our country is related to the struggling housing market and underwater/barely-hanging on homeowners, what is to be done? One choice is to allow for options like lien-stripping in bankruptcy courts, resetting mortgages by zip code, etc. Another option is for courts to accelerate foreclosures by ignoring due process, proper documentation and legal process in order to kick people out of their homes and preserve the value of senior tranches of RMBS while giving mortgage servicers a nice kickback.

What option do you think our country is taking?

We should all be very concerned about the foreclosure situation in Florida. If you are a homeowner or potential homeowner, you should find it offensive that people's property rights are being violated in such a flagrant way. If you are an investor, either as "bond vigilante" or someone with a generic 401(k), you should be worried that servicers have gone rogue and the incentive structure to maximize value instead of fees associated with foreclosures has broken down.

And if you care about basic Western liberalism -- the classical kind, with a Lockean understanding of freedom to own property along with freedoms of speech and religion -- you should be pissed off. This is a clear-cut instance of the rich and powerful decimating other people's property rights, rights that are supposed to protect the weak from the strong, in order to preserve their wealth and autonomy. Unless you think property rights are mere placeholders for whatever the financial sector demands, this should be resisted. This should be viewed as a problem an order of magnitude larger than Kelo v. City of New London.

The short problem is that banks are foreclosing without showing clear ownership of the property. In addition, "foreclosure mills" are processing 100,000s of foreclosures a month without doing any of the actual due diligence or legal legwork required for the state to justify the taking of property and putting people on the street. Even worse, many are faking documentation and committing other fraud in the process. The government is allowing this to happen both by not having courts block it from going forward, but also through purchasing the services of these mills. As Barney Frank noted: "Why is Fannie Mae using lawyers that are accused of regularly engaging in fraud to kick people out of their homes?"

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And the worst part is the lack of conversation about this. Thanks to Yves Smith at naked capitalism for following this story from the get-go; her blog has become the place for anyone interested in this topic (that link is a catch-up post). The rest of the media is starting to catch up to where she was weeks ago.  Here's the Washington Post with the story of an individual caught in one of these nets and ProPublica on GMAC's "robo-signers" who sign off on foreclosures without knowing anything about them.

Also Dean Baker just wrote a good summary of the situation for the Guardian:

As a number of news reports have shown in recent weeks, banks have been carrying through foreclosures at a breakneck pace and freely ignoring the legal niceties required under the law, such as demonstrating clear ownership to the property being foreclosed.

The problem is that when mortgages got sliced and diced into various mortgage-backed securities, it became difficult to follow who actually held the title to the home. Often the bank that was servicing the mortgage did not actually have the title and may not even know where the title is. As a result, if a homeowner stopped paying their mortgage, the servicer may not be able to prove they actually have a claim to the property.

If the servicer followed the law on carrying through foreclosures then it would have to go through a costly and time-consuming process of getting its paperwork in order and ensuring that it actually did have possession of the title before going to a judge and getting a judgment that would allow them to take possession of the property. Instead, banks got in the habit of skirting the proper procedures and filling in forms inaccurately and improperly in order to take possession of properties.

And the situation in Florida is worse than most assume. The specially-created courts see it as their purpose to clear out the foreclosures, as Yves Smith covers here (must read). The most obvious takeaway is that homeowners aren't being given the chance to have their documents properly viewed, have the challenges and proper legal hurdles to putting someone on the street vetted by the courts, and instead are being bribed with an additional month of house time if they don't ask too many questions.

And the biggest fear is that the fraud uncovered at GMAC is the tip of the iceberg for what is going on nationwide.   Keep your eye on this situation.

Mike Konczal is a Fellow at the Roosevelt Institute.

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The New Deal Meets 'The Wire'

Sep 10, 2010

What does Wall Street have to do with "The Wire"? Roosevelt Institute Senior Fellow Tom Ferguson took to the streets of Baltimore with the Real News Network to explain. There, boarded-up buildings and screaming police sirens demonstrate what happens when communities are left on the hook for bankers' bets turned sour. Ferguson explains how "collateral damage" accumulated when unaffordable loans that were pushed on the people of Baltimore collapsed and brought down the price of houses around them. He points out that without a steady tax base, no one will make loans to the city, which, like many others, is desperate for funds. "It's really a Catch-22," says Ferguson.

What the people of "The Wire" really need are New Deal programs, he proposes. The administration should "move vigorously to put people back to work. You should have seen cranes and construction stuff everywhere. Obama should have revived the CCC and other programs to get us back to full employment -- because that's the only real panacea to get us out of crisis", he says.

And where is Wall Street now? "The invisible hand is just waving goodbye," quips Ferguson. Watch the full interview:

What does Wall Street have to do with "The Wire"? Roosevelt Institute Senior Fellow Tom Ferguson took to the streets of Baltimore with the Real News Network to explain. There, boarded-up buildings and screaming police sirens demonstrate what happens when communities are left on the hook for bankers' bets turned sour. Ferguson explains how "collateral damage" accumulated when unaffordable loans that were pushed on the people of Baltimore collapsed and brought down the price of houses around them. He points out that without a steady tax base, no one will make loans to the city, which, like many others, is desperate for funds. "It's really a Catch-22," says Ferguson.

What the people of "The Wire" really need are New Deal programs, he proposes. The administration should "move vigorously to put people back to work. You should have seen cranes and construction stuff everywhere," he says. Obama should have revived the CCC and other programs to get us back to full employment -- because as he points out, that's the only real panacea to get us out of crisis.

And where is Wall Street now? "The invisible hand is just waving goodbye," quips Ferguson. Watch the full interview:

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Surprise, Surprise! Ben Bernanke Discovers the 'Paradox of Thrift' (Sort Of)

Aug 31, 2010Marshall Auerback

marshall-auerback-100 When consumers are trying to save, the government must step in to create growth.  That's going to require smart and imaginative fiscal policy.

marshall-auerback-100 When consumers are trying to save, the government must step in to create growth.  That's going to require smart and imaginative fiscal policy.

That “central bankers alone cannot solve the world’s economic problems” was the most extraordinary concession to come out of the mouth of Federal Reserve Chairman Ben Bernanke during last Friday’s speech at the Jackson Hole Economic Symposium.

Of course, he’s right, but, rather than acknowledging that fiscal policy is the most effective counter-stabilisation tool available to national governments, Bernanke still trumpets the idea that monetary policy is the only game in town. Despite huge efforts by the Fed to stimulate the private sector via “quantitative easing” and a veritable alphabet soup of lending programs over the past year and a half, consumers remain reluctant to spend, banks remain reluctant to lend, and businesses are hoarding corporate cash rather than reinvesting. The problem is that “unconventional monetary policy measures" have had no impact because all the central bank is doing is changing the term structure of assets on its balance sheet, rather than generating additional spending power in the economy. This is understandable, given the economic backdrop: in a time of over-indebted households and weak aggregate demand, workers are simply losing their jobs, remaining unemployed and loath to spend.

In short, we have what Keynes once described as the “paradox of thrift” in action. Any individual can increase his/her savings by reducing spending on consumption goods. So long as this decision does not affect one’s income—and there is no reason to assume that it would—she ends up with less consumption and more saving. My friend, Randy Wray, gives a good illustration of this phenomenon:

The example I always use involves Mary who usually eats a hamburger at Macdonald’s every day. She decides to forego one hamburger per week, to accumulate savings. Of course, so long as she sticks to her plan, she will add to her savings (and financial wealth) every week. The question is this: what if everyone did the same thing as Mary—would the reduction of the consumption of hamburgers raise aggregate (national) saving (and financial wealth)?

The answer is that it will not. Why not? Because Macdonald’s will not sell as many hamburgers, it will begin to lay-off workers and reduce its orders for bread, meat, catsup, pickles, and so on.

All those workers who lose their jobs will have lower incomes, and will have to reduce their own saving. You can use the notion of the multiplier to show that this process comes to a stop when the lower saving by all those who lost their jobs equals the higher saving of all those who cut their hamburger consumption. At the aggregate level, there is no accumulation of savings (financial wealth).

Of course that is a simple and even silly example. But the underlying explanation is that when we look at the individual’s increase of saving, we can safely ignore any macro effects because they are so small that they have only an infinitely small impact on the economy as a whole.

But if everyone tries to increase saving, we cannot ignore the effects of lower spending on the economy as a whole.

One of Chairman Bernanke’s persistent blind spots in his inability to recognize this basic “fallacy of composition." The President of the European Central Bank, Jean-Claude Trichet, suffers from the same cognitive defect as evidenced by his call to deal promptly with “fiscal imbalances” as “an important precondition for sustaining a durable recovery."

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The non-government sector’s newfound love of thrift is precisely what everybody keeps urging in order to create the foundations of a sustainable economic recovery, but both Bernanke and Trichet fail to realize that if private households and businesses desire a surplus then the government sector has to target a deficit for growth to be maintained. This inability to understand basic sectoral balances leads to the fraudulent idea that the government is “running out of money." It is not. The only shortfall that exists today is political will and imagination. The US government refuses to fill a greater proportion of aggregate demand with public spending or additional tax cuts and so exacerbates the private sector’s uncertainty and its corresponding desire for a higher ex ante savings rate.

For decades, governments have been pressured to run tight fiscal positions which have entrenched persistently high unemployment rates so that the inflation genie would not break out of the bottle. But the evidence continues to mount that the policy of simply keeping interest rates down is a variable instrument with diffuse impacts that creates as many losers as winners. For every borrower who benefits, there is a pensioner, starved of income from the government’s financial assets. In the meantime, unemployment, by any honest measure, remains in double digits.

Ben Bernanke is right: central banks can’t do all of the heavy lifting here. Real recovery is going to require government initiative via fiscal policy, starting with job creation by government. And we will need direct job creation, with government paying the wages and benefits for up to 12 million new jobs. Announce a Job Guarantee program, a national payroll tax holiday, and a per capita revenue sharing program with the states. In regard to our housing crisis, we need massive loan modifications to make mortgages truly affordable for the length of the loan. We also need large scale employment programs that restore households’ capacity to pay; we need to deal with the over-supply of homes and to help people to stay in their houses; and we need swift and cheap bankruptcy procedures that provide a fresh start to the people who cannot afford to keep their houses. Given that the government effectively is the main instrument behind housing finance today, it is in a position to simplify the foreclosure process and stand ready to buy the homes of distressed mortgagors at the lesser of current market value or the value of the mortgage. It can allow the homeowner to lease the home at a fair market rental price, with an option to buy it back after two years at the then-prevailing market rate. This would not only help to deal with the excess supply of homes (and so put a floor under home prices), but also would help to restructure the finances of households while allowing them to remain in their homes.

Taken in sum, all of these measures will allow households to go about the business of actually repairing their balance sheets. Not only do they make economic sense, but they would be politically popular as well, because they are designed to serve the vast majority of Americans who don’t work on Wall Street. Expanding fiscal policy further will provide further support to private saving while continuing to expand aggregate demand and employment growth.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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Time to Bring Back the Home Owners Loan Corporation?

Aug 31, 2010David B. Woolner

The New Deal's mortgage relief program offers an effective alternative to the Obama administration's failed strategy.

The New Deal's mortgage relief program offers an effective alternative to the Obama administration's failed strategy.

Continued high unemployment is unfortunately not the only bad piece of economic news that the nation has had to face this summer. It now appears as if the level of home foreclosures will continue at an alarming pace, with many economists now predicting that the number of Americans likely to lose their homes in 2010 will exceed one million -- a figure that would surpass the more than 900,000 homes lost to foreclosure in 2009.

With so many homes at risk, the current housing crisis certainly rivals that which struck the nation in the wake of the 1929 crash, when the housing industry all but collapsed. Indeed by the end of 1933, housing starts had fallen to one tenth of pre-1929 levels, and the number of urban homes that were either in delinquency or in foreclosure was running at a staggering fifty per cent.

The New Deal response to this crisis was immediate and effective. In June of 1933, FDR signed the Homeowners Refinancing Act, which established the Home Owners Loan Corporation (HOLC), a new federal agency whose chief purpose was to refinance existing home mortgages that were in default and at risk of foreclosure. The HOLC also assisted mortgage lenders by providing them with additional capital and by refinancing problematic loans. By the close of 1935, when the program had come to an end, the HOLC had refinanced approximately twenty per cent of all the urban mortgages in the United States -- over one million homes -- and had lent out roughly $3.5 billon (an estimated $750 billion in today's dollars).

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Equally important, the HOLC's strategy of buying out existing mortgages and replacing them with new ones based, not on the typical short-term mortgage agreement of the time (usually a non-amortized loan of seven to ten years terminating with a balloon payment), but rather on the far more affordable amortized mortgage of between twenty-five and thirty years, would eventually become standard practice and help revolutionize the mortgage industry. The HOLC obtained its financing by borrowing from the Treasury and from capital markets, and by the time it had closed its books in the early 1950s, it had turned a small profit.

Given the relatively poor showing to date of the Obama administration's Making Home Affordable Program -- a voluntary effort that pays lenders to modify bad loans -- and the growing fear among some economists that a continuation of the mortgage crisis may drag the US back into recession, perhaps it is time to consider a more direct federal response to the crisis along the lines of a new HOLC. Today's mortgage market is of course much more complex than that of the 1930s, but the essential problem -- keeping struggling families in their homes -- is the same. A new HOLC might be a far more effective and efficient means of providing relief to the millions of Americans in danger of losing their piece of the American dream. It would also help stabilize our fragile economy and might even prevent us from slipping back into a recession. For all of these reasons, providing direct federal assistance to struggling home owners is not just good social policy, it is also sound economic policy that, from the perspective of those families who are but weeks away from losing their most precious financial asset, cannot be implemented soon enough.

David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute.

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Housing and Bubbles

Aug 20, 2010Joe Costello

skyline-150Where is the real estate wreck heading?

skyline-150Where is the real estate wreck heading?

Well, there was a meeting in DC this and the Treasury Secretary, Wall Street, banks, and MBS bondholders all agreed something should be done with Fannie and Freddie, as long as no one, except maybe homeowners, incurred any losses. Fannie and Freddie represent a lot that's wrong with our government. It became a bipartisan cesspool of corruption, jobbery and incompetence over the past decade, for which every public revelation only led to expressions of surprise by DC officialdom. Most recently Fannie and Freddie became dumping grounds for the worst of the real estate dreck, and that's saying something.

Fannie and Freddie played a role in the housing bubble. The last couple months the housing market, let's leave out the commercial market which is worse, has stalled. All the Fed and Treasury blowing couldn't reflate the bubble, and prices will continue their slow movement down for a very long time. Remember the NASDAQ ten years on is at 40% of its bubble peak, while Japanese real estate, 20 years on, is just over 20% of its peak value, so that leaves at lot downward room for US housing, depending on how big you think the bubble was.

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Most interesting of course is how all the thinking remains quite bubbly. Bill Gross of PIMCo came out and warned last week that without any gov guarantee PIMCO would quit the mortgage market. Mr. Gross' fund sits on $36 billion in MBS, so he has a definite interest. Even more bubbly was Mr. Gross' suggestion yesterday that the US government back refinance of all mortgages currently paying over five percent:

Massive refinancing of the nearly 60% of mortgages backed by the government that are one full percentage point above today's 4.5% mortgage rates would provide quick stimulus "as well as a potential lift of 5-10% in terms of housing prices," he said.

I suppose a chunk of that is now held by PIMCO and the implicit government guarantee would then be explicit, or better you could just get it off your books, plus free money right? I guess that's win-win-win. I didn't hear any idea on what would be done with the 25% of the people underwater in their mortgages. It will be a long long time before real estate in this country heads up, bet on it.

Joe Costello was communications director for Jerry Brown’s 1992 presidential campaign and was a senior adviser for Howard Dean’s effort in 2004.

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On Elizabeth Warren, Financial Literacy and Complexity

Aug 5, 2010

The GOP will have a hard time blasting someone who works for financial literacy and against complex products.

The recommendations for Warren keep coming in: The New York Times makes the best case on her credentials, but there are other cases to be made. Matt Yglesias writes that it would rally the base. Noam Scheiber does the math and finds Warren can likely be confirmed.

The GOP will have a hard time blasting someone who works for financial literacy and against complex products.


The recommendations for Warren keep coming in: The New York Times makes the best case on her credentials, but there are other cases to be made. Matt Yglesias writes that it would rally the base. Noam Scheiber does the math and finds Warren can likely be confirmed.

Also 141 academics signed a petition supporting Warren. Notably, the Roosevelt Institute's Make Markets Be Markets conference contributors Michael Greenberger and Richard Carnell signed it. Warren presented the Consumer Financial Protection Bureau at our conference earlier this year in the video above, and it it is difficult to think of a more successful champion for the project.

Some people like Karl Smith aren't convinced: "Is there anyone who disputes that Elizabeth Warren has signaled that she will be a crusader on behalf of consumers; that she views consumers as having gotten a raw deal from the financial system and that she intends to do what she can to change that?...My ideal vision of the government is as an institution that is a fair and neutral arbiter of disputes. One that ensures that fraud, deception, bullying and coercion don't go on." His commenters caught the fact that he's contradicting himself there, and that fighting fraud, deception, bullying and coercion necessitate a role that speaks on behalf of consumers in the same way a lawyer fights for a client.

But let's unpack Warren's writings, as I read them. Others may have a different interpretation. I think there are two main threads in what I've read of Warren's popular work that are relevant, and that is her approach to consumer financial literacy and her arguments about complexity.

Consumer Financial Literacy as a buffer against Shocks

If you look at the final financial reform bill you get this in there:

(d) OFFICE OF FINANCIAL EDUCATION.- (1) ESTABLISHMENT.-The Director shall establish an Office of Financial Education, which shall be responsible for developing and implementing initiatives intended to educate and empower consumers to make better informed financial decisions.

There's growing scholarly evidence that a lack of financial literacy was a contributor to the financial crisis. My suspicion is as people continue to investigate we'll find is that a lack of financial literacy made people vulnerable to fraud.

So it's worth noting that Dr. Phil has endorsed Warren for her efforts, both on her show and in general, at increasing financial literacy. I know Karl Smith really wants to find a proto-Marxist seething with the desire to destroy Wall Street buried here somewhere, but practically speaking Warren does stuff like this: Conducting a Financial Fire Drill. "1. Can your family survive without one income?...2. Can you downshift your fixed expenses?...3. What is your emergency back-up plan?"

And as for blaming Wall Street for everything, that's not what she writes to consumers. If you read her book All Your Worth, she writes about mental traps that keep people in debt like this:

Finger-Pointing....The trap is in the hidden message: You are telling yourself that you are off the hook. The financial problems you face are someone else's doing, and therefore it's all out of your hands. You are telling yourself there's nothing you can do. And if there is nothing you can do, then you have a free pass to sit on your duff....The truth is that there will always be a reason why you can't balance your money....Move past the blame because it isn't helpful. In fact, it is worse than not helpful; it is downright destructive....Because there is always something you can do. (p. 59-61)

I like the idea of economists, Wall Street, libertarians and bank-friendly democrats terrified by the idea of a person who uses the word "duff", but it's important to think of how much this doesn't sync with where a lot of thinking is. This is an idea that debt could be a trap for consumers, that business models have evolved to make their biggest profits, not by getting repaid, but by keeping people underwater for as long as possible and that customers need to be wary. This goes against both the economic notion of a consumer as a fully-informed consumption smoothing robot and the idea that the financialization of our lives doesn't come with a dark side.

And I'll over-read the other part, the idea that the middle class is facing a new type of economic vulnerability. This one is centered around the rising costs of the bundle of middle class stability goods like transportation, child rearing and health care, and all the cheap stuff you can get at the mall doesn't substitute for that. This calls for a re-commitment to stability and economic security for families that, frankly, centrist aren't willing to fight for. I think this is what is scary to elites, that the system we've built isn't working for a lot of Americans, though it's common sense for most of us out there. Warren advises consumers to be extra conscious of this as they set up their budgets, spending and households, urging people to take responsibility and think like a risk manager.

Complexity

The other theme is complexity. In the video above, Warren talks about the evolving complexity of credit cards contracts. I'm not sure if people like Smith are concerned about this. If the idea that the financial sector is putting on complexity without adding real value comes across as dangerously radical, then there are a lot of respectable dangerous radicals out there.

Rick Bookstaber, Senior Policy Adviser at the SEC, who has also worked at Bridgewater Associates, ran the Quantitative Equity Fund at FrontPoint Partners and was in charge of risk management at Moore Capital Management, thinks that a lot of the complexity in the derivatives market isn't adding much value, and writes about a flight to simplicity in derivatives.

Kevin Warsh, a member of the Board of Governors of the Federal Reserve System to the New York Association for Business Economics, says that "Asset quality and funding sources for financial firms must be more understandable and readily comparable among peers. Stakeholders can then make better informed judgments of potential risks and rewards." Which is the same exact thing Warren says about consumer financial products like mortgages and credit cards.

American Enterprise Institute Fellow Alex Pollack created a one-page mortgage. (Warren's talk used a two-page mortgage, so Pollack must be twice the radical Warren is.)

More disclosure doesn't always help. This area is where the CFPB could, in theory, make the most difference. Warren likes to quote an AARP poll that asked if people want a two page credit card agreement, no tricks, no traps. 96 percent of Americans said, "That's what I want." 91 percent: "That's what I strongly want."

(If you are the type of person hyperventilating at the idea that a perfect market should have provided this by now, I'd recommend checking out Shrouded Attributes and Information Suppression in Competitive Markets by Gabaix and Laibson.)

Politics

I'm not much of a political analyst, but I'd note that I think Republicans would have a hard time going hard against her. I'm not sure if the Republicans could opposed her as a block. Shahien Nasiripour reports about the waffling inside the Republican camp already.

A nomination battle in which the GOP is blasts Elizabeth Warren is going to hurt them with women voters, voters they are looking to test out strategies to reach. For a GOP looking to bring on women voters who like Sarah Palin, the idea of them yelling "who cares about a fee that is only $30?" or "$1,000 in medical costs? That's chump change!" at Warren would probably not work that well with women voters who fight to make sure the budget lasts the whole month.

And remember the Credit Card Bill of early last year passed the Senate 95-to-5. This was May, 2009, so we were already into GOP Waterloo territory on the Obama domestic agenda. That's a lot of votes for the Senate; I think Republicans can't quite defend this part of the financial sector in the same way that they work to get expanded derivatives loopholes.

And the GOP managed to make the financial bill much weaker and then voted against it anyway. And it's not going to cost them anything that they did this. So turning up the heat with this nomination battle has to look good for voters.

Mike Konczal is a Fellow at the Roosevelt Institute.

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