Are the .01% Capitalists?

Dec 22, 2011Bruce Judson

money-question-150The super-rich might not be so outraged by accusations that they haven't earned their money fairly if they didn't know it was true.

money-question-150The super-rich might not be so outraged by accusations that they haven't earned their money fairly if they didn't know it was true.

Thanks to the Occupy movement, the extreme inequality in America has become a focus of the national dialogue. Recently, several of the super-rich have stepped forward to defend their place in society. Leon Cooperman, the billionaire founder of  Omega Advisors, a hedge fund sponsor and previously a senior official at Goldman Sachs, wrote a much publicized letter to President Obama, while Bloomberg News reported that Jamie Dimon, the CEO of JPMorgan Chase & Co, used a question at an investor conference as an opportunity to say that "Acting like everyone who's been successful is bad and because you're rich you're bad, I don't understand it."

For me, the question is not why there seems to be an outpouring of criticism and anger at the rich but whether it's justified. My answer is straightforward: Many of today's super-rich, particularly in the financial sector, have achieved their wealth in ways that are fundamentally anti-capitalist. As a consequence, people are justifiably wondering whether we have an economy that operates on the principles of capitalism or of oligarchy.

A central tenet of capitalism is that those who create the greatest wealth for society should receive the highest compensation. This is the ideal that has for generations motivated Americans and led to the admiration, indeed often veneration, of the rich. These wealthiest members of our society are seen as the people that have helped make us all somewhat better off.  As a result, they deserve their rewards.

What the Occupy movement and others are questioning is whether making us all better off is, in fact, what has made people "rich" and "successful" (Mr. Dimon's words) in the current era. Are the rich and successful the creators of wealth and jobs for all of us, or are they the predators and moochers (Ayn Rand's term in Atlas Shrugged), the reverse Robin Hoods who succeed by finding ways to redistribute wealth upwards?

To me, it's also notable that the most virulent complaints of the 1% seem to come from those in the financial sector. As I talk with wealthy Internet titans, I hear almost universal praise for our societal focus on income inequality. In essence, the complaints emanating from our financial titans have the ring of Shakespeare's famous phrase in Hamlet, "the lady doth protest too much, methinks."

Let's examine the ways in which many of today's highest income Americans, originating in the financial sector, are reverse Robin Hoods rather than wealth creators:

First, as I have written in earlier articles, the financial sector now operates outside all of the disciplines that are inherent in capitalism, from accountability for terrible business decisions to the enforcement of fair bargains to retribution for malfeasance. On the contrary, Bloomberg News recently disclosed massive secret Federal Reserve support for failing banks. This has led to an emerging consensus that the financial sector is socially useless or acutally destroys our overall societal wealth. Nobel Laureate Paul Krugman wrote in his New York Times column that:

[A]fter the debacle of the past two years, there's broad agreement -- I'm tempted to say, agreement on the part of almost everyone not on the financial industry's payroll -- with Mr. Turner's assertion that a lot of what Wall Street and the City [London's stock exchange] do is "socially useless."

In addition, it seems almost undeniable that, in the absence of the excessive anti-capitalist activities of the financial sector over the past decade, our entire society would now be wealthier. I wonder whether many of the "rich" and "successful" who have emerged in this arena would have achieved this wealth if they had been forced to compete on a level, fair playing field governed by the disciplines and rules of actual capitalism.

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Second, finance is an intermediary good. It is not an end in itself, but a means of greasing the wheels to make the economy run better. In a capitalist system the purpose of finance is to help limit risk (for example, by allowing a farmer to hedge against price drops in grain) or efficiently allocate investment capital in support of the long-term growth of new enterprises. According to AR Magazine, the top 25 hedge fund executives earned $22 billion in 2010. In addition, a recent report indicated that, despite the recession, Wall Street was on track for a record year in bonuses, while the financial sector now accounts for 29 percent of all U.S. corporate profits. Since the Census Bureau just reported one in every two Americans is poor or low income, this suggests some kind of massive disconnect between the operating purpose of the financial services sector and the wealth it is accumulating for itself versus the benefits is it creating for our larger economy.

Third, in a capitalist economy, all zero-sum activities which have a winner and loser with no growth in societal value,  are, at best worthless. Yet the majority of hedge funds, Wall Street traders, quants (the people who created sophisticated trading models), and issuers of so-called naked Credit Default Swaps all make money largely through zero-sum activities or high-speed trading (which now accounts for an estimated 75 percent of all equity trading in the U.S.), none of which are oriented toward creating value for society. This suggests, as David Cay Johnston pointed out in a recent column, that the entire business associated with so-called naked Credit Default Swaps is zero-sum gambling and should be illegal. At minimum, it has no value in a capitalist economy.

Moreover, the marginal societal benefits of hedge fund activities, if they exist, are almost certainly offset by the other costs they impose on our society. They create the potential for systematic risk to the overall economy, while hedge funds and other high-paying Wall Street activities also lead to the terrible allocation of talent in our nation. An important share of the nation's top talent is now gravitating to high-paying finance activities, engaged in determining new arbitrage strategies rather than creating the businesses that will create the next generation of jobs and real wealth the country so desperately needs.

In short, I would deem the billions of dollars in bonuses and earnings from hedge fund activity, several large lines of business, and high-speed trading on Wall Street to be antithetical to the capitalism that has helped to make America great. I recognize that I am undoubtedly painting with too broad a brush, but the fundamental point remains.

Finally, many of the rich are not playing by the same rules as the rest of Americans, and in our democracy people resent this basic unfairness. Hedge funds and private equity firms have used their political influence to ensure that the carried interest rule -- which allows a large portion of their earnings to be taxed at 15 percent as opposed to ordinary income rates -- remains in place.

So this brings me back to my original question: Are there a sizable number of the "rich" and "successful," particularly among the most notable members in the financial services sector, who don't meet even the most basic definitions of practicing capitalists?

If so, then perhaps the emerging dialogue over wealth in America is justified and represents an important examination of whether the country's economy has strayed from a core value in the capitalist ideal. Is the vitriol we are now hearing really fear that soon crony capitalism, socialism for the rich, and corporatism will no longer guide national policy?

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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Why Isn't the SEC Cracking Down Harder on Banks?

Dec 15, 2011Bruce Judson

money-justice-scalesBetween underfunding and the perpetual revolving door, it's clear that the SEC isn't helping the system function well.

money-justice-scalesBetween underfunding and the perpetual revolving door, it's clear that the SEC isn't helping the system function well.

In an earlier column, I wrote about the intersection of equal justice under the law and capitalism. The idea of fair bargain is central to a capitalist economy: Both the buyer and seller in any transaction must believe they fully understand the nature of the good being bought or sold (i.e. no fraud is involved). Since no one is omniscient, the remedy for bargains that the buyer or seller believes are unfair is legal enforcement. At the same time, both parties to the transaction must believe wrongdoing by either party will be enforced with equal vigor.

At the time, I referenced the SEC case against Citigroup and criticized the relatively small fine the SEC had imposed, suggesting it was evidence of a broader problem related to meaningful enforcement of the laws by the agency. As background, SEC settlements must be ratified by the court, and a central aspect of these SEC settlements is that defendants "neither admit nor deny the allegations." Rarely does the court fail to endorse an agreement proposed by the SEC, since it's the prosecuting party. Since then, the Citigroup case has received considerable attention, as U.S. District Judge Jed S. Rakoff rejected the proposed settlement, calling it "neither reasonable, nor fair, nor adequate, nor in the public interest."  He both criticized the typical SEC "neither admit nor deny" form of settlement and called the SEC negotiated fine "pocket change" for Citigroup. Today, The Wall Street Journal indicated that the SEC enforcement division is expected to recommend to SEC commissioners that the Judge's decision be appealed.

These recent events beg a deeper look at the system of SEC enforcement. Why has the SEC apparently pursued such minimal settlements? The answers are surprising in that they reflect a wide discrepancy of views.

I found three very different explanations. But they all suggest that we have a broken system that must be fixed so that capitalism can operate properly.

First, the SEC enforcement division is underfunded and therefore lacks the resources to pursue a large number of complex trials. Critics say this reflects a deliberate effort by Congress, influenced by large financial institutions, to prevent punishment for malfeasance.  If true, this suggests yet another example of how our largest financial institutions  are preventing actual capitalism from functioning, often in ways that are not obvious.

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Second, without the no admission of guilt clause, defendants would open themselves up to a stream of well-funded plaintiff actions based on admitted guilt and even risk bankruptcy. In essence, the proponents of this explanation suggest SEC fines are considered a cost of doing business, but if injured customers have an adequate chance of redress then the punishment will more closely relate to the injuries caused by the illegal actions involved and this worries the banks. Judge Rakoff's opinion sharply criticized the settlement in this regard, indicating it "depriv[ed] the pubic of ever knowing the truth in a matter of obvious public importance."

Third, it can be explained by the revolving door, where former SEC enforcement officials are "going to work for the very same firms they used to police." Top SEC enforcement officials represent some the clearest examples of people who move out of government to high paying jobs in the private sector. This has a chilling effect on the efficacy of SEC efforts related to the largest, most powerful institutions. If true, we need to find a fair system that will both attract talent to the SEC but prevent this phenomenon.

There are several implications to these different explanations for what is clearly a broken system. Without the deterrent effect of the credible threat of law enforcement, the financial services industry will continue its malfeasance. The additional deterrent effect of successful private lawsuits based on a pre-existing admission of guilt is lost when the SEC uses the no admission of guilt standard. This raises a central question: Is the SEC's role in our society to punish and deter malfeasance, or is it to help victims more easily recover losses resulting from misconduct? If it is the latter, then finding the actual truth of guilt or innocence would serve a strong societal interest.

Additionally, the knowledge that the SEC always settles suits will inevitably start to enter into the thinking of potential bad actors. Here again the deterrent effect is minimized. It becomes easy to imagine bad actors discussing an issue and saying, "What's the worst that could happen? We will settle with the SEC for far less than we will make on this deal and the details will never become public." Meanwhile, malfeasance by the financial sector has caused millions of people to suffer.

There are solutions to these problems. The Obama administration must insist on far more extensive funding for SEC enforcement. Then we need to remember the famous words of Justice Brandeis, who said, "We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can't have both." Perhaps, as recently discussed by The New York Times, it's time to reconsider the maximum size and concentration of power in our financial institutions, which seem to consistently interfere with the fair operation of capitalism.

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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Bruce Judson on the Societal Dangers of Income Inequality

Dec 8, 2011Bryce Covert

money-justice-scalesI got the chance to talk with Bruce Judson, who has been writing the "Restoring Capitalism" column and whose comprehensive plan for reversing the rise in economic inequality will be published as an e-book

money-justice-scalesI got the chance to talk with Bruce Judson, who has been writing the "Restoring Capitalism" column and whose comprehensive plan for reversing the rise in economic inequality will be published as an e-book, Making Capitalism Work for the 99%: A Manifesto, this week. We talked about his work before the financial crisis that examined the startling rise of income inequality in the U.S., how it can lead to social unrest and instability, and what course we must take to correct these trends.

Bryce Covert: You talked about the societal dangers of growing income inequality in your 2009 book It Could Happen Here before it was on the national agenda. What made you pay attention to the trend?

Bruce Judson: I started discussing the book with Harper Collins in 2007. At that time, a number of prominent people were also very concerned about it, including Paul Krugman, Robert Reich, Elizabeth Warren, and Roosevelt Institute Chief Economist Joseph Stiglitz. They all said it was dangerous for our democracy. But I kept wondering why. What happens next? So I started my own research.

In the book, I took a historic perspective on what happens when extreme inequality arises in a society. It describes a series of steps, or a narrative, for how growing economic inequality can ultimately lead a democracy to implode. The book argued that if economic inequality in America continued unchecked, it would lead to a dysfunctional economy, even greater political polarization, ultimately political paralysis, anger and mistrust throughout the society, protests, and eventually reform or some type of political instability.

Sadly, each of the stages of misery seems to be happening like dominoes falling. And I am convinced the Occupy movement reflects the coalescing of the deep and unfortunate anger that pervades our society as a result.

BC: What historical trends stood out as most similar to our situation?

BJ: I was terrified by the similarities between our society and the era of the Great Depression. As a nation, we were moving toward levels of economic inequality we had not seen since the financial crash of the late 1920s. My reading of history, of events surrounding the New Deal era and the Depression, is that excess inequality tended to be associated with high speculation and a lack of appropriate constraints on the financial industry.

In essence, I came to believe growing economic inequality was intimately linked to economic catastrophe, which would be so great that it would tear our social fabric.

BC: Why is inequality so destabilizing and dangerous?

BJ: There are very few things in America that are taboo. But one thing we never, ever talk about is the potential for political instability in the U.S. We're taught as children that we had one great revolution. We take the stability of our democracy for granted.

But economic inequality is very dangerous, and the reason is that in our society wealth and power go together. As wealth becomes substantial, it starts to use its political power to ensure its hegemony and mucks up the important, competitive elements that make capitalism work. Over time, what was formally a vibrant economy with efficient markets becomes an inefficient, dysfunctional one.

Here's a recent example. The New York Times wrote that Wall Street does not want a transparent market for swaps and that Washington politicians were listening to its demands. The reason for the opposition is that, in effect, traders make more money by keeping "prices in the shadows." A transparent market means that you have the equivalent of a stock exchange, where all participants can see the prices of recent trades. That's all it means.

It's hard for me to see how this would even be a serious discussion if the financial industry did not have political influence. Is there any public interest in a market that is opaque, rather than transparent?

BC: What does inequality mean for the middle class, which is the foundation of our country's economy?

BJ: Early America lacked the class barriers then prevalent in Europe: Everyone mixed with each other. This led the more fortunate to have empathy and a visceral understanding for the problems of the less fortunate. As economic inequality has increased, we see far less mixing among people at different income levels. Now everyone has less of a sense that they are part of one large community and that we have a responsibility to each other.

Political theorists, going back to Aristotle, have all concluded that a vibrant middle class is essential for a vibrant democracy. The members of the middle class hope to move up, so they want mobility to remain a desirable option, but they also fear moving down, so they are more likely to support a social safety net. In essence, the middle is the group that ensures stability as a barrier to legislative extremes that unduly reward the wealthy or harm the poor.

Unfortunately, inequality that chips away at the middle class can lead to violence. There was violence that occurred in the Depression, with riots in the Midwest. People also started to take the law into their own hands. In penny auctions, after your farm was foreclosed on, you showed up at the courthouse with all of your friends -- farmers who had their rifles with them -- and took over the bidding and bought back your farm for penny. As income inequality increases, the dispossessed may start to feel they have been treated unfairly and things can get ugly.

BC: Your work also predicted revolution. What's your current take?

BJ: The book did not predict revolution. The book said that if we allow income inequality to continue growing unchecked, then we would face a high risk of political instability or revolution. We discussed earlier how the book detailed a series of stages, or a narrative, for how growing economic inequality can lead to social upheaval. Unfortunately the narrative I detailed seems to be happening.

My best estimate is we have now passed through 60 percent of the narrative. A lot needs to happen before the risk of political instability becomes a reality. I am hopeful that with inequality now on the national agenda, we will see the reforms needed.

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BC: You've lately been focused on the dysfunctional aspects of our economy, particularly housing. What are their implications?

BJ: My take on much of the dysfunction in our economy today is that we have lost sight of what I call "actual capitalism." Instead, we have a strange system that people have variously described as crony capitalism, socialism for the rich, and corporatism. This shift is destabilizing our economic system as well as our democracy.

The housing crisis is even more significant because of its potential impact on our social fabric. Foreclosure can be one of life's most traumatic events. The 14 million people expected to face foreclosure will have lost their down payment, their dignity, their sense of belonging to a community, and their way of life. Do policy-makers seriously believe we can foreclose on one-quarter of all the mortgages in the nation without any social backlash?

This is a national tragedy. It is also a potentially dangerous brew. It would be natural for many of these millions of people, who are reading about bank malfeasance and enormous salaries in the financial sector, to conclude that they unfairly lost their homes so that a privileged few could realize enormous incomes and remain above the law. What happens to that anger? How will all of the children in these families believe in the American Dream?

What is striking to me is the lack of energy or creativity that has been applied to the problem. To fix our economy and society, we need to prioritize keeping homeowners in possession of their homes. This was one of the main goals of the New Deal, and as a result all kinds of valuable, creative financial mechanisms were created. The 30-year mortgage was effectively invented as part of the New Deal (at the time mortgages typically ran only five years), and the Federal Housing Administration was created in 1934. We absolutely can develop innovative solutions. But we have allowed a dangerous sense of complacency and inevitability to take over.

BC: Does the emergence of the Occupy Wall Street movement make you more or less hopeful for the nation's future?

BJ: It absolutely makes me hopeful that we will start to see some meaningful reforms. The Occupy movement is casting a bright and unforgiving light on some of the unacceptable practices in our society that, sadly, have become commonplace.

I believe the Occupy movement is not going away. The reason it grew so quickly is that it was the flashpoint for the country's anger and widespread feelings of unfairness. It's almost inevitable that in some way it will expand to include people who feel they've been unfairly foreclosed on, the record numbers of Americans experiencing long-term unemployment, and many of the unemployed in general who feel they've been cheated out of the opportunity to work - mainstream America.

The danger is that if the Occupy movement does not succeed, and nothing takes its place, we will move further along the narrative I described.

BC: We are heading into the presidential election season. What kind of leadership will be needed to reverse growing income inequality?

BJ: In Senator Jim Web's terrific book A Time to Fight, he noted that no aristocracy in history has given up its power willingly. Unfortunately, I believe that to change course will require a knockdown drag-out fight. And it's not going to be about consensus. It's going to require political leaders with courage who stand up and fight for what is right.

We certainly saw the need for this kind of conflict in the era of the New Deal. FDR was called a "traitor to his class." During his reelection campaign, he spoke at Madison Square Garden and said that never had the forces of "organized money" been "so united against one candidate" and "They are unanimous in their hate for me -- and I welcome their hatred." This kind of language gives you a sense of the antagonism that arose when Roosevelt worked to reverse extreme economic inequality.

BC: What action do we need to take to reverse these trends?

BJ: My comprehensive thinking on these issues, and how they could be addressed with specific policies, is in the new book, Making Capitalism Work for the 99%: A Manifesto.

Economic inequality has been building for over thirty years. It's so pervasive in our society that no single policy, such as a change in tax rates, will fix it. We need to recognize that reversing this trend will require a determined, systematic approach somewhat like the New Deal.

I think we need to act in four areas:

First, we must return to actual capitalism. This means accountability, the rule of law, fair and competitive markets, compensation, appropriate to the value created for society (by getting rid of many special privileges and protections now given to the financial sector), and several other reforms. If we recreate such a system, we will also see the return of an economic system that is far more conducive to job creation.

Second, we have to talk about tax policy. The capital gains rate is at the lowest point since World War II, and the carried interest rule seems like an unfair privilege.

Right now, 75 percent of all equity trading in the nation is high-speed, meaning computer-driven, activity. This type of massive speculation and arbitrage has little, if any, societal value. The proposed federal transaction tax would help address this. It would raise several hundred billion dollars in tax revenues over the next decade and to some extent tamp down on trading designed to take advantage of minute price variations by making it unprofitable.

Third, we've got to be far more creative in developing policies to keep people as owners of their homes. This must be a priority.

Fourth, we need to return to individual states the right to protect their citizens in economic matters. One missed check on the failure of the federal government in allowing the financial crisis to happen could have been state regulators. The Financial Crisis Inquiry Commission found that they tried, but were prohibited from, protecting their citizens because of federal preemption.

Of course there is one overriding issue here. Economic inequality is dangerous because wealth leads to political power. To accomplish a systematic reform agenda, we must eliminate the influence of money in politics; if that prevents all of this, then these ideas are all irrelevant.

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How to Break a Capital Strike? Full Employment

Dec 8, 2011Bryce Covert

If banks want to threaten capital strikes, the government should fight back by putting people to work and taking power away from banks.

If banks want to threaten capital strikes, the government should fight back by putting people to work and taking power away from banks.

Last week, Massachusetts Attorney General Martha Coakley announced she would be suing the five biggest mortgage servicers over robo-signing. The very next day, GMAC Mortgage said it would withdraw most of its lending in the state. It offered up the excuse that "recent developments have led mortgage lending in Massachusetts to no longer be viable." What recent developments would those be? Asking mortgage companies to adhere to the rule of law?

This could be called, as Matt Stoller was quick to point out, a capital strike -- a lender refusing to lend in protest of government policy. A capital strike is a theoretical situation in which lenders decide to shut down the economy by refusing to invest and hire workers in reaction to government intervention that forces them to make bad business decisions. Sound familiar? While banks saw their profits rise to $29 billion in the first three months of 2011, a 66.5 percent increase over the same period last year, the loans they gave out declined at the end of 2010 and hiring has been sluggish. They're not investing and hiring.

Wall Street is not in all probability actually on a capital strike. Besides the fact that the idea of all the firms getting together and executing an organized action is far-fetched, the reason they're not investing and hiring is because the economy (and therefore demand) sucks, not because the government hasn't given them enough backrubs. While the term "capital strike" used to be thrown around on the far left, the John Boehners of the world are now using it as a threat against enacting any government policy that might hurt the business sector's feelings. The idea is that if the government enacts too many regulations, raises taxes too high, and otherwise does things that business doesn't like, we risk them shutting down the economy.

Capital doesn't have a great reason to be on strike. Think times are bad? Firms are making a third more profit than they did before the recession. Feel overburdened by regulation? Only the large corporations are worried about new regulations -- small businesses aren't feeling affected. Taxes got you down? Taxes on corporate earnings are at a 60-year low.

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So besides GMAC's targeted action, it's highly unlikely that Wall Street has gotten together and decided to strike against the government. What's more likely, as Peter Frase suggests at Jacobin, is that the threat of a strike is having the same effect:

[J]ust as in a labor strike, sometimes you don't actually have to go out on the picket line: you just have to convince the other side that you're ready and willing to strike. Just as a union might use a strike authorization vote to increase its leverage at the bargaining table, so the right's economic propaganda is designed to tilt the political playing field away from labor and toward capital.

This is what John Boehner claims to be so worried about and what makes so many inveigh against Obama's supposedly anti-business policies. If we don't placate Wall Street, it'll shut down the whole economy! Do what it wants so that no one gets hurt!

But as Frase points out, just because a group goes on strike -- be it labor or capital -- doesn't mean we have to give in to their demands. When workers strike, management can either negotiate or try to break the strike. So if we follow the capital strike logic and assume that capital is threatening a strike (whether or not it would really do so), the government, as management, has the choice to negotiate or break the strike.

Wall Street got us in this mess. Why should we give in to its threat to strike? Instead, the government can break it -- and the best way would be for it to spend money in pursuit of full employment. It would seem on first glance that full employment would be in the best interest of the banks: employed people can spend more money on goods, increasing demand, greasing the wheels of the economy and therefore profits. Yet we can look back to the 1930s and 40s to understand why full employment could be the best tool for breaking capital's grip on our politics.

FDR also faced a slowdown in investment and called it a capital strike meant to take down his presidency and the New Deal. Roosevelt's Assistant Attorney General Robert Jackson himself said the slowdown in investment was a "general strike -- the first general strike in America -- a strike against the government -- a strike to coerce political action." The New Deal was a concerted effort to get people back to work. Why was capital so dead-set against it? In 1943, economist Michal Kalecki asked the same question: "The entrepreneurs in the slump are longing for a boom; why do they not gladly accept the synthetic boom which the government is able to offer them?" His answer had two important points. Firstly, if raising employment is left solely to the laissez-faire market, then "capitalists [have] a powerful indirect control over government policy." Anything to shake their confidence has to be avoided. Once the government takes over that function, though, that power is diminished. Secondly, those capitalists also lose power when workers aren't as dependent on their current employer for a job. If under full employment a worker is almost guaranteed work, he has much better leverage to demand higher wages, better benefits, etc. from his employer. Either way, banks will lose their hold over the economy.

Breaking the threat of a capital strike in this way is a win-win. It first and foremost puts people back to work. But it also has the nice effect of loosening Wall Street's stranglehold on politics. Its power will diminish. Sounds good to me.

Bryce Covert is Editor of New Deal 2.0.

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Would Eleanor Roosevelt Support Occupy Wall Street?

Dec 7, 2011Suzanne Kahn

She left clues in her advice columns about how she viewed activism aimed at changing entrenched policy.

In 1941, readers of the Ladies' Home Journal found out that Eleanor Roosevelt did not like mice, "but I do not shriek when I see one." In 1945, she told them that their husbands should help them with their dishes because, "I think anything connected with the home is as much the husband's work as the wife's." They learned all this and much more in Eleanor's monthly advice column.

She left clues in her advice columns about how she viewed activism aimed at changing entrenched policy.

In 1941, readers of the Ladies' Home Journal found out that Eleanor Roosevelt did not like mice, "but I do not shriek when I see one." In 1945, she told them that their husbands should help them with their dishes because, "I think anything connected with the home is as much the husband's work as the wife's." They learned all this and much more in Eleanor's monthly advice column.

Although it's not discussed nearly as often as her syndicated newspaper column, "My Day," Eleanor wrote an advice column for women's magazines from 1941 until 1962. For two decades, women asked her about how they should handle daughters who couldn't attract boyfriends, how she managed her budget, and what they should make of the major political issues of their day. By looking at some of the advice she doled out, it may be possible to piece together what she would have to say about the political issue of our day: Occupy Wall Street.

In 1962, she answered a question about another set of mass protests -- the anti-nuclear rallies of 1961 and 1962. Asked if she saw any value in women's groups marching in front of the White House for peace, she wrote:

The average person has a sense of frustration because he can think of no way to express to his government or to the world at large his desires for peaceful solutions to the difficulties that confront us. The demonstrations you mention are important if only because they dramatize the lack of more useful ways for people to show their devotion to the cause of peace. (McCall's, May 1962).

Similarly, in 1961 Eleanor also wrote about the frustration individuals felt about not being able to do more to prevent nuclear war. In "My Day" she wrote that the best an individual could do was "register...with our government a firm protest."

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OWS confronts massive inequality, not nuclear war and world peace, but Eleanor's take on the meaning and importance of protest in the face of overwhelming issues hits the nail on the head. OWS provides the average person with a way to express frustration and register a firm protest about an unfair economy. Critics have demanded that OWS propose solutions, but Eleanor might have pointed out that OWS makes clear the important point that there aren't easy, direct ways for the average person to fix the economy.

Viewed this way, OWS is doing something both Eleanor Roosevelt and the feminists of the 1960s and 1970s really understood: consciousness raising. Consciousness raising was a method of political mobilization developed by feminists in the late 1960s and 1970s. Formally begun by women's liberation groups, consciousness raising groups allowed women to share personal experiences and frustrations and come to understand that these were not isolated instances, but part of a larger pattern of political relationships that defined women's personal lives. Many feminists embraced consciousness raising methods because they hoped the realizations they inspired would move women to more concrete political action.

Consciousness raising came after Eleanor's time, but her advice column shows she understood the basic idea. Her column allowed women to see that their personal problems were shared. Eleanor urged her readers to take political action to address their concerns.

OWS similarly suggests that people consider how their personal challenges are rooted in political problems. "We are the 99 percent" invites people to identify with the protesters and think about how an unfair economy affects individual lives. Anyone who has been to an OWS rally has seen signs that do exactly that -- share their maker's own story about student debt, medical debt, etc. Consciousness raising is an important first step for many movements. The trick now is to find those more directly "useful" ways for people with raised consciousness to show their devotion to the cause.

Suzanne Kahn is a Roosevelt Institute | Pipeline Fellow and a Ph.D. student in history at Columbia University.

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Why "Free Market" Foreclosures Destroy Communities as Effectively as Any Central Planner

Dec 6, 2011Mike Konczal

mike-konczal-newWhile central planners reshaped communities in their own image, mortgage servicers tear them apart to maximize their profits.

Today is National Day of Action on Foreclosures. Occupy Our Homes has created a list events at their site. Here's a great video on what is going on in Brooklyn, which shows the devastation happening there:

While central planners reshaped communities in their own image, mortgage servicers tear them apart to maximize their profits.

Today is National Day of Action on Foreclosures. Occupy Our Homes has created a list events at their site. Here's a great video on what is going on in Brooklyn, which shows the devastation happening there:

Between 1853 and 1869, Baron Haussmann tore down and rebuilt major parts of Paris according to principles of hygiene and circulation. He installed roads, sewers, and other public works and demolished neighborhoods, rebuilding them alongside modern technology. These neighborhoods became more stratified by class and function and more easily controlled by state forces.

A general critique of city planners like Haussman is that they rebuilt their cities in order to make it, in James Scott's phrase, seeable by the state. This reconstruction of Paris was focused on simplification, legibility, and centralized, managerial control, regardless of the local knowledge and practices destroyed in the recreation. Critiques like this extend across modernity, especially to those Americans like Robert Moses who built highways through major metropolitan areas.

Though Scott was looking towards models of embeddedness developed by those like Karl Polyani, most people who develop these critiques invoke Hayek and the price system of the market as the superior way of planning. The profit-motive of the price system coordinates information across a vast network of agents who will never know each other. This allows for the most efficient use of society's resources. By seeking out profit opportunities, individuals will coordinate the whole.

There have been millions of foreclosures over the past several years and there will be millions more in the next few years. They are reworking neighborhoods in much the same way Baron Haussmann once did -- but this time the process is driven by the free market of financial capital rationally seeking profit rather than a central planner dreaming about how to make a city "modern." How are the results?

The central agents in this story are mortgage servicers. Servicers are entities that accept payments from borrowers. They also handle mortgages that become distressed and are the entities responsible for modifying them. They are distinct from the company that lent out the money. With the vast majority of mortgages now having run through this relatively new servicing model, one created alongside the slicing-and-dicing model that took over consumer finance, this is the key type of entity responding to the profit motive in the mortgage payment market.

How do the mortgage servicers earn their profit? At their core, they respond to three principal-agent problems in their "Pooling and Service Agreement" contracts. As Adam Levitin and Tara Twomey argue convincingly:

[S]ervicers do not have a meaningful stake in the loan‘s performance; their compensation is not keyed to the return to investors. Second, the servicing industry's combination of two distinct business lines -- transaction processing and default management -- encourage servicers to underinvest in default management capabilities, leaving them with limited ability to mitigate losses. Servicers' monetary indifference to the performance of a loan only exacerbates this situation...

Servicers' incentives in managing individual loans do not track investors' interests. This creates three interrelated problems. First, servicers are incentivized to pad the costs of handling defaulted loans at the expense of investors and borrowers. Second, servicers are not incentivized to maximize the net present value of a loan, but are instead incentivized to drag out defaults until the point that the cost of advances exceeds the servicer‘s default income. In other words, servicers are incentivized to keep defaulted homeowners in a fee sweat box rather than moving to immediately foreclose on the loan. Third, servicers are incentivized to favor modifications that reduce interest rates rather than reduce principal, even if that raises the likelihood of redefault.

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Here's a chart from the National Consumer Law Center’s report "Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior" (pdf) by Diane E. Thompson that outlines the logic of how services handle mortgages in trouble:

To expand for a second on their incentives, they include:

Maximizing fees. As a result of the servicing "Pooling and Service Agreement" contracts, servicers have an incentive to push borrowers into default and keep them there. The fees associated with them go straight to the servicer. And if the loan goes into foreclosure, the servicer is paid first before the investor recoups any money. So fee pyramiding and/or loading a loan up with fees to the point where it becomes difficult for the borrower to pay and then foreclosing without modification -- a nightmare scenario for both the borrower and lender -- is fantastic for the servicing firm.

Making bad modifications. If debt goes bad, there should be a good-faith effort to successfully work it out and modify it before a foreclosure happens. As Lou Ranieri, the pioneer of the mortgage-backed security puts it, "You are almost always better off restructuring a loan in a crisis with a borrower than going to a foreclosure... If we keep letting these things go into foreclosure it’s a feedback loop where it will ultimately crush the consumer economy." Since servicers are paid as a percent of principal, they have an incentive to make modifications that increase principal and reduce interest rates, even if these loans aren't sustainable. This goes double if they have exposure to junior-lien debts.

Quick turnaround without proper legal attention. Since the system is designed for servicing to be a thin business model, there is no infrastructure, nor means by which investors can force one to be created, to handle a troubled housing market. Proper staffing is a sunk cost that isn't easily recouped. It shouldn't surprise us that informants are saying that:

20% of files with phantom referrals, approximately another 35% of files had some problems in them. Those problems varied, and included among others, an ARM that had improperly adjusted up, a failure to properly account for a borrower’s principal and interest payments, and a failure to properly attribute payments between pre-petition and post-petition that led the banks to try to collect pre-petition obligations they were not permitted to pursue.

These all add to fee income.

So this is the fruit of the private securitization market that is now running our mortgage markets. What I find fascinating is that the key things that are motivating servicers in their profit-maximizing don't aggregate widely-dispersed information in the way Hayek described in The Use of Knowledge in Society. They aren't signaling, or absorbing the signals of, relative prices of scarcity or substitution. They aren't reacting to an increase in the price of tin without having to care why it has increased, nor are they increasing the price of tin by selling less of it, influencing people they'll never meet.

As Thompson puts it, "How servicers get paid and for what is determined in large part by an interlocking set of tax, accounting, and contract rules." At their core, they are reacting to the laws we use to restructure debt in bankruptcy, the prioritization of multiple liens in distressed debt, REMIC tax law, standardized contracts with poor monitoring of agents, a lack of enforcement of foreclosure laws, and, most importantly, the ability to skim off the top. If you look at the chart of incentives for servicers above, none of them are really relevant to either taking in or sending out information about the mortgage market.

We shouldn't think of any of these things that force homeowners into bankruptcy as reflecting any marginal information about housing, homeowners' ability and willingness to pay, or the availability of capital. They are a combination of laws we've chosen for ourselves about the managing of private property in housing and debt and a standardized contract among a handful of big financial firms that have ended up in a vicious battle over monitoring of the servicers themselves. And that doesn't even get to the externalized costs of a foreclosure to the community. The model is driven not by an abstract invisible hand but by the very real laws and contracts in which they are embedded. When those laws and contracts are faulty -- as they are here -- no useful information or allocation happens.

Which is all to say, if we had a central planning team of Baron Haussmann, Robert Moses, Le Corbusier, and Lenin running the United States mortgage market, I can't imagine they'd do more damage to our neighborhoods and communities than Bank of America's servicing arm is currently doing.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Occupy Our Homes: Shining a Light on Our Great Failure

Dec 2, 2011Bruce Judson

house-in-hands-150The housing crisis is America's most urgent economic problem, but until now, it's been the farthest from policymakers' minds.

house-in-hands-150The housing crisis is America's most urgent economic problem, but until now, it's been the farthest from policymakers' minds.

A recent article on Salon reports that the Occupy movement is planning to begin a nationwide action protesting the foreclosure crisis. Whatever your views of the movement itself, they are casting a bright light on the place where capitalism, our democracy, and our society have all failed: the housing crisis.

The financial crisis effectively started with the housing crisis, and it will not end until we find a way to resolve the housing crisis. Economists who have repeatedly forecast a healing economy have misjudged the need for a healthy housing market as a central component for any type of economic recovery. The administration's current plans for preventing foreclosures are woefully inadequate and housing prices are likely to decline as much as 20 percent this year, so our nation's cycle of economic misery will continue.

Since the mortgage meltdown begin in 2007, six million homes have been lost  to foreclosure. At present, another four million homes are at some stage of the foreclosure process. As the New York Times recently reported, one of the nation's leading housing analysts anticipates that a "staggering" total of more than 10 million of the nation's existing 55 million mortgages are "reasonably likely to default." Another recent article noted, "If the U.S. foreclosure crisis were a baseball game, we'd probably be in the bottom of the fourth inning." This national tragedy is a long way from over.

The housing and foreclosure crisis represents a conundrum with plenty of blame to go around: banks that violated lending standards in a search for easy profits; the creation of complex mortgage-backed securities whose risks were not fully understood; borrowers who took on far more debt than they could afford; the list goes on.

What the Occupy protesters recognize, either explicitly or implicitly, is that since the start of the housing crisis, government actions have by and large penalized suffering homeowners while rewarding banks that should have failed because of poor business decisions. The government has not adequately enforced the laws associated with ensuring that foreclosures are valid, and it appears to have no concerns when banks wrongfully take possession of homes (which, I believe, used to be called "criminal trespass" and  "breaking and entering"). On the flip side, all of the administration's plans associated with helping homeowners facing foreclosure have failed miserably.

All of this is bad economics, violates the rules of accountability and equal justice that are essential to a viable capitalist economy, and undermines our democracy. The Salon article reports that the Occupy protesters plan to "disrupt" foreclosure auctions. These actions are strikingly familiar to the "penny auctions" that took place during the Depression era. As detailed in my 2009 book, It Could Happen Here, which focused on the danger of growing income inequality to our nation:

Civil disobedience can emerge, even among the most conservative and normally upright citizens. During the Great Depression, foreclosed farms were auctioned on local courthouse steps. As the situation worsened, farmers took matters into their own hands. In what became known as "penny auctions," neighbors of bankrupt farmers would gather for an auction, physically prevent people from bidding on foreclosed farms, and then bid a token amount for the farms with the goal of returning the homesteads to their original foreclosed owners.

What is striking is the lack of creativity or sense of urgency that has been applied to the housing crisis. Here is a guiding principle for action: Homeowners must remain homeowners. Yes, this may not be an idea that is universally supported. And yes, it may be unfair to those who acted more responsibly. But the bailouts of the banks were also grossly unfair and I suspect hundreds of other significant, unfair government actions biased toward financial institutions and not consumers have taken place since the start of the crisis.

As a nation, we no longer have the luxury of concerning ourselves with fairness. Our economy is on life support, unemployment is far above the 6 to 7 percent level which then-candidate Obama called an "immediate economic emergency" when running for office in October 2008, and further declines in housing prices will send the economy into a greater tailspin.

We have adopted a dangerous complacency around the housing crisis that must be abandoned. If our economy and social fabric are to heal, a sense of urgency is desperately needed.

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One rarely remarked upon but dramatic aspect of the New Deal were the many innovations associated with ensuring continued homeownership. This was a central focus of FDR's effort to heal the nation. In 1933, Congress created the Homeowners Loan Corporation (HOLC), which bought up one in every five mortgages in the U.S. and reissued longer-term, lower monthly payment mortgages. In 1934, Congress created the Federal Housing Authority to insure long-term mortgages in a manner similar to the way the FDIC insures deposits, which ultimately made private lenders comfortable with 30-year mortgages. Most of us don't realize that the 30-year mortgage was effectively invented in the era of the New Deal and that previously mortgages ran for periods as short as five years.

A recent study estimated that 29 percent of all homeowners with mortgages are underwater, and it's likely that a sizable portion of this total is more than 25 percent underwater, which is generally agreed upon as the point where even solvent homeowners simply abandon their properties (also known as jingle mail, since the former homeowners send the house keys to the mortgage lender). As housing prices continue to drop, and I strongly believe they will, these numbers will continue to accelerate.

I do not have a specific policy proposal for fixing the housing crisis, but I have no doubt that with sufficient determination and creativity, this mess can be solved and we can move forward. The solution is likely to involve some pain on both sides -- losses for financial institutions and homeowners perhaps trading a portion of their equity (under the auspices of some new type of government agency) for a substantially lower mortgage principle. Or any number of completely different solutions. But both sides made mistakes and so shared pain is not a bad thing.

But what is bad is doing nothing. We simply cannot allow the impact of additional foreclosures to further destroy our economy or allow our social fabric to disintegrate as more and more people conclude that they were cheated out of their homes.

In the era of the New Deal, increasing farm foreclosures also led to riots and widespread violence in the Midwest, something we disregard today at our peril. In It Could Happen Here, I wrote:

These generally conservative farmers viewed their rebellion within the context of American principles.  Arthur Schlesinger, Jr., who published the three volume study The Age Of Roosevelt, wrote, "Theirs, as they saw it was the way not of rebellion but of patriotism." ...I have no doubt that these [rioting] farmers would have explained their actions as a combination of anger and righteousness that would be echoed in our modern era: A corrupt system of home loans, combined with an economic system that was run for the benefit of a privileged few, unfairly destroyed their lives.

The housing crisis emerged and has been exacerbated by a violation of the fundamental principles that make both capitalism and democracy work: accountability, bankruptcy for bad business decisions, enforcement of our laws, and equal justice.

I have written elsewhere that the Occupy movement will not simply disappear into the night. It is the flashpoint for the deep anger and sense of unfairness that pervades our society, for millions of people who feel their lives and dreams have been unfairly destroyed, while those who played a central role in causing their misery continue to profit. The transition of the Occupy movement to a focus on foreclosures was inevitable; this is the epicenter of our national tragedy.

The movement's focus on foreclosures will shine a necessary, even brighter light on our failure to address this central aspect of the financial crisis. These actions are an important and necessary wake-up call to our society about what is happening throughout the nation on a daily basis.

We can, of course, dismiss this latest act of protests. But if we do nothing, I wonder how far we stand from the violence of the New Deal era. At the time, FDR said, "The West is seething with unrest." Where will tempers flare next?

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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Judge Rakoff Demonstrates What Having Guts Looks Like

Dec 1, 2011Bo Cutter

Citigroup made shameful and dangerous decisions. It should have to explain itself.

On the whole, I have suggested a somewhat bleak view of our political system and our future prospects. But when there are moments and people to celebrate I want to do so. And we should all celebrate Judge Jed Rakoff. (As full disclosure, Judge Rakoff is a friend, and was a graduate school classmate at Oxford.)

Citigroup made shameful and dangerous decisions. It should have to explain itself.

On the whole, I have suggested a somewhat bleak view of our political system and our future prospects. But when there are moments and people to celebrate I want to do so. And we should all celebrate Judge Jed Rakoff. (As full disclosure, Judge Rakoff is a friend, and was a graduate school classmate at Oxford.)

On Monday this week, Judge Rakoff rejected an SEC offer to settle a securities fraud case against Citigroup that entailed a $285 million payment by Citigroup but not any admission of fault or wrongdoing. Judge Rakoff said the settlement terms were "neither fair, nor reasonable, nor adequate, nor in the public interest."

This decision complicates the SEC's life, and I would imagine that Citigroup is absolutely dead-set against acknowledging wrongdoing. But what Citigroup and other financial institutions did was wrong at a micro and a macro level and should not be glossed over.

First, what's at issue? Citigroup created a class of securities, Class V Funding III, which consisted of bundled mortgage-backed securities (in the industry jargon they are referred to as "negatively projected," i.e. they aren't going to be worth much), then sold these securities to investors, and then bet against their own securities (and their own investors). Judge Rakoff adds some color to this: "This (Citigroup's ability to 'dump dubious assets on misinformed investors') was accomplished by Citigroup's misrepresenting that the Fund's assets were attractive investments rigorously selected by an independent investment adviser, whereas in fact Citigroup had arranged to include in the portfolio a substantial percentage of negative projected assets and had then taken a short position in those very assets it had helped select."

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Citigroup made about $160 million on its transactions. Investors eventually lost about $700 million. This stinks.

At a micro level, Citigroup's blithe willingness to do this is terrifying. For example, I sit on the investment committee of a medium sized foundation. As it happens, we would never make this kind of investment, but someone similar to us could easily have done so. If we had considered this, do you think Citigroup or the broker or the sales person would have told us what these investments really were? Of course not. Someone could have -- and, obviously, people did -- invest in these securities thinking they were making a reasonably safe investment, not knowing that they were purposely designed to blow up. I haven't counted, but my sense is that a lot more players than Citigroup did this -- so whom can you trust?

This gets to the core of what's wrong at the macro level. Citigroup's decisions to design, sell, and short these securities are not ones respectable and responsible business people should make. They erode trust, they are corrosive, and they are dishonest. One of the main functions of our kind of financial system is intermediation, but if the mediators see the investors as prey, and are allowed to do so, then the system isn't working. This is why the Volcker rule makes sense. And Citigroup's CEO and board should be ashamed of themselves. They should have to explain why they believe there was no fault or wrongdoing here.

The economy is miserable. The political system is in gridlock. The super committee has just demonstrated that Congress can't accomplish anything. But on this big issue, Judge Jed Rakoff made a gutsy, and correct, decision.

Roosevelt Institute Senior Fellow Bo Cutter is formerly a managing partner of Warburg Pincus, a major global private equity firm. Recently, he served as the leader of President Obama’s Office of Management and Budget (OMB) transition team. He has also served in senior roles in the White Houses of two Democratic presidents.

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The Fed Scrambles to Save Banks, Stalls on Unemployment

Nov 28, 2011Mike Konczal

Side-by-side, two worst case scenarios elicit very different reactions from the Federal Reserve.

Side-by-side, two worst case scenarios elicit very different reactions from the Federal Reserve.

I never congratulated Charles Evans, President of the Federal Reserve Bank of Chicago, for dissenting in the most recent FOMC meeting on behalf of the unemployed. ("Voting against the action was Charles L. Evans, who supported additional policy accommodation at this time.") I'm a big fan of the Evans Rule and am surprised inflation doves haven't been more vocal about it. As Goldman Sachs noted, "This was the first 'dovish' dissent since December 2007 (President Rosengren)." Given that unemployment has turned out to be worse than the Fed's projections at any time, it is about time that those who are worried about unemployment inside the Fed start making noise.

These first murmurs instead stand in contrast to the financial bailouts. Bloomberg just released a big story, based on its successful FOIA requests, that uncovered just how aggressive the Federal Reserve was with its emergency lender-of-last-resort powers. Kevin DrumMatthew Yglesias, and Paul Krugman argue that what is really shocking is how total the rescue and backing of the financial sector was while the real economy was left to rot. As Krugman puts it, "The real scandal isn’t so much that those banks got rescued as that the rest of the population didn’t."

Part of why the bailouts were packaged the way they were was because Lehman Brothers' bankruptcy went a lot worse than the Federal Reserve's expectations of how the collapse of a major investment bank would go. When the collapse went far worse than its expectations, it reacted with maximum force.

Is there an equivalent story for unemployment? I'll try to graph this using the FRB's Summary of Economic Projections. From its FAQ: "Economic projections are collected from each member of the Board of Governors and each Federal Reserve Bank president four times a year, in connection with the Federal Open Market Committee's usual two-day meetings (typically held in January, April, June, and November)... The unemployment rate is the average civilian unemployment rate in the fourth quarter of a year."

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Members of the Federal Reserve get together four times a year and project their expectations of unemployment for several years going forward. Below is that data plotted against the unemployment rate. Specifically, it has the average projected unemployment rate across the entire year and takes the average of the core tendencies that are reported as that rate. The actual unemployment is in bold red and projections from each point going forward are in shades of orange (click for larger image):

As you can see, there's no point in which unemployment was projected to be worse than it actually was. Especially in 2009-2010 -- the actual unemployment rate was significantly higher a year or two later. Here's a zoomed in view of the 09-11 range (click for larger image):

If we were to replace the FRB with a group of monkeys armed with darts, one would imagine that they would make at least a few projections above the actual rate of unemployment. It's funny -- the FRB tried to revise how bad unemployment is but doesn't revise it anywhere near enough to lower it to where the economy actually is.

So to recap: Lehman Brothers goes worse than the Federal Reserve's projection and the Fed goes to the most extreme lengths it can find to extend emergency lending. Every single unemployment number turns out to be worse than all of the Federal Reserve's projections, and it finds every excuse to look the other way. Only Charles Evans has the courage to say that we should let inflation go to 3 percent while unemployment is over 7 percent to catch up to trend growth. Amazing.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Mortgage Servicers: Getting Away with the Perfect Crime?

Nov 28, 2011Matt Stoller

Without prosecutions, there's nothing keeping fraud from becoming a standard business practice.

Without prosecutions, there's nothing keeping fraud from becoming a standard business practice.

In 2004, the FBI warned Congress of an "epidemic of mortgage fraud," of unscrupulous operators taking advantage of a booming real estate market. Less than two years later, an accounting scandal at Fannie Mae tipped us off that something was very wrong at the highest levels of corporate America.

Of course, we all know what happened next. Crime invaded the center of our banking system. Wall Street CEOs were signing on to SEC documents knowing they contained material misstatements. The New York Fed, riddled with conflicts of interest, shoveled money to large banks and tried to hide it under the veil of central bank independence. Even Tim Geithner noted that Lehman had "air in the marks" in its valuations of asset-backed securities, as the bankruptcy examiner's report showed that accounting manipulation to disguise the condition of the balance sheet was a routine management tool at the bank. There's a reason Charles Ferguson got an Academy Award for his work on the documentary Inside Job.

And yet, no handcuffs. The big news on prosecutions in the traditionally high-powered Southern District of New York are convictions for relatively petty insider trading that are unrelated to the collapse of the economy. The criminal charges could have been filed in the 1980s. U.S. Attorney Preet Bharara has brought minor civil suits against banks, but nothing significant, and no criminal indictments for the Ponzi scheme of the last four years.

And what happens when this kind of fraud goes unprosecuted? It continues, even today. The same banks that ran the corrupt home mortgage securitization chain are now committing rampant fraud in the foreclosure crisis. Here's New Orleans Bankruptcy Judge Elizabeth Magner discussing problems at Lender Processing Services, the company that handles 80 percent of foreclosures on behalf of large banks (emphasis added):

In Jones v. Wells Fargo, this Court discovered that a highly automated software package owned by LPS and identified as MSP administered loans for servicers and note holders but was programed to apply payments contrary to the terms of the notes and mortgages.

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The bad behavior is so rampant that banks think nothing of a contractor programming fraud into the software. This is shocking behavior and has led to untold numbers of foreclosures, as well as the theft of huge sums of money from mortgage-backed securities investors.

Here's how the fraud works: Mortgage loan notes are very clear on the schedule of how payments are to be applied. First, the money goes to interest, then principal, then all other fees. That means that investors get paid first and servicers, who collect late fees for themselves, get paid either when they collect the late fee from the debtor or from the liquidation of the foreclosure. And fees are supposed to be capitalized into the overall mortgage amount. If you are late one month, it isn't supposed to push you into being late on all subsequent months.

The software, however, prioritizes servicer fees above the contractually required interest and principal to investors. This isn't a one-off; it's programmed. It's the very definition of a conspiracy! Who knows how many people paid late and then were pushed into a spiral of fees that led into a foreclosure? It's the perfect crime, and many of the victims had paid every single mortgage payment.

A lack of criminal prosecutions means that unethical business practices like this one drive out ethical business practices. After all, why should a bank hire an ethical default servicer that charges a high price for its product when it can pay nothing to one that simply extracts from investors and homeowners?

The joke that is the U.S. Attorney network has become very old and very stale. And unfortunately, because of Attorney General Eric Holder, that joke is on us.

Matt Stoller is a Fellow at the Roosevelt Institute and former Senior Policy Advisor to Congressman Alan Grayson.

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