Credit Card Interest Rates Near 60% as Banks Return to Risky Borrowers

Feb 2, 2011Bryce Covert

Maxing out your knowledge of the tricks and traps in consumer debt.

This week's credit check: Average credit card APR is 14.72%. Interest rate for banks borrowing from the Fed is 0-.25%

The latest news from the credit card industry: interest rates are soaring. Wait -- didn't the CARD act put a stop to all that abusive behavior? Turns out they've found some ways to bend the rules.

Maxing out your knowledge of the tricks and traps in consumer debt.

This week's credit check: Average credit card APR is 14.72%. Interest rate for banks borrowing from the Fed is 0-.25%

The latest news from the credit card industry: interest rates are soaring. Wait -- didn't the CARD act put a stop to all that abusive behavior? Turns out they've found some ways to bend the rules.

It's true that the bill put a cap on how and when companies could jack up interest rates after a card is signed. But rates are now reaching record highs before accounts are opened, at an average of 14.72% APR. If your credit is really bad, you could end up with a rate as high as 59.9%. And just as banks protest that the rates are high in order to balance out risk, like addicts who can't kick the habit they're ramping up lending to risky borrowers again. Yes, they're being more cautious -- this time credit scores alone are no longer enough for their screening purposes. They're now scrutinizing other behavior, such as registering on a job site (something that millions of unemployed Americans are probably doing). They've got a new classification system worked out too: "strategic defaulters," whose scores took a hit when they walked away from an underwater mortgage; "first-time defaulters," who once had a strong score but hit financial trouble because of the recession; "sloppy payers," who only pay some bills on time; "abusers," who are defiant about paying; and "distressed borrowers," who just can't pay. Those last three categories are the ones they're trying to weed out; they're focused on wooing defaulters who theoretically would have a good score if the crisis hadn't happened. But when 14.5 million are out of a job, more and more people may find themselves simply unable to pay. Not to mention that they may also start to feel defiant.

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It's no surprise that banks want back in the high-risk business. Despite the cushy goodies they give away to wealthy customers, the heart of their profits is made off of those who are drowning in debt and unable to pay it back. Consumer advocate Elizabeth Warren made this clear in an anecdote she recounted in the 2006 movie Maxed Out. She describes going into a room of banking executives with statistics that prove that if they screened out customers least likely to pay they could cut bankruptcy losses in half. "Then a fellow in the back said ‘Professor Warren,' and everyone got quiet," she says. "'But it would cut those people off, and that's where we make all of our profits.'" While they figured out this new source of revenue, financial wizardry kept pace to help put more and more people in this situation. In a presentation to the Make Markets be Markets conference in 2010, she wrote, "[T]he financial industry has perfected the art of offering mortgages, credit cards, and check-overdrafts laden with hidden terms that obscure price and risk... Study after study shows that credit products are deliberately designed to obscure the real costs and to trick consumers." While the CARD act and the new Consumer Financial Protection Bureau are working to undo that damage, it's clear where the banks' priorities lie: in finding ways to trap borrowers into debt they can't get out of. And putting high rates in hard-to-understand signing contracts is one of their useful tools for doing it.

You might remember the debtor's revolution, started by one someone who definitely qualifies as an "abuser." Ann Minch told Bank of America to "stick it" in a YouTube address before she would pay a cent on an account whose rate had been jacked up to 30% -- and for no good reason. Her media wave finally led to the bank trying to get her to accept a lower rate: 16.99%. Did she take it? Nope. She told the customer service rep, "Because you guys are getting your money from the Fed at 0% interest, or at the most .25, that 12.99% is more than a generous profit margin for you guys." And he finally agreed to her terms. It's a good reminder -- banks are borrowing their money at the lowest interest rate the Fed can possibly offer, despite reneging on so many loans that they had to be bailed out (and caused the global economy to collapse). If they're not risky borrowers, who are? Yet they see fit to charge their risky customers excessive interest rates.

Why the high rates? They say it's to combat the risk inherent in lending to certain customers. But the truth of the matter is that while they know that there's risk -- if they didn't realize it before, they learned that lesson in the financial crash -- their profits come from fees and interest paid by borrowers who can't stay on top of their bills. They just can't stay away from fleecing low-income customers.

Bryce Covert is Assistant Editor at New Deal 2.0.

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FCIC Report: What was a Major Cause and What was Trivial?

Jan 31, 2011Mike Konczal

With such a wide breadth of topics, it's difficult to determine what advocates of reform should pay attention to.

With such a wide breadth of topics, it's difficult to determine what advocates of reform should pay attention to.

I'm still reading and enjoying the FCIC report. I think it's one of the best introductions to what happened and I'm learning new stuff throughout it. But one problem I'm having is that while the breadth of the topics is all-inclusive, it is difficult to discriminate between how much causation to assume from many of the issues, especially as we get further along in the crisis.

One thing I'm thinking about these days is the role of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 in the crisis. I think it's pretty much been proven to be a disaster of a bill. If we learned that it helped spark the shadow banking panic, so much the better. During the financial reform debates I did an interview with Stephen Lubben about it. I've been meaning to learn more since.

The FCIC document brings up the derivative amendments that were snuck into the bankruptcy reforms and their role in the crisis:

The CFMA effectively shielded OTC derivatives from virtually all regulation or oversight. Subsequently, other laws enabled the expansion of the market. For example, under a 2005 amendment to the bankruptcy laws, derivatives counterparties were given the advantage over other creditors of being able to immediately terminate their contracts and seize collateral at the time of bankruptcy. (p. 48)

Regulatory changes -- in this case, changes in the bankruptcy laws -- also boosted growth in the repo market by transforming the types of repo collateral. Prior to 2005, repo lenders had clear and immediate rights to their collateral following the borrower’s bankruptcy only if that collateral was Treasury or GSE securities. In the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Congress expanded that provision to include many other assets, including mortgage loans, mortgage-backed securities, collateralized debt obligations, and certain derivatives. The result was a short-term repo market increasingly reliant on highly rated non-agency mortgage-backed securities; but beginning in mid-2007, when banks and investors became skittish about the mortgage market, they would prove to be an unstable funding source. Once the crisis hit, these “illiquid, hard-to-value securities made up a greater share of the tri-party repo market than most people would have wanted,” Darryll Hendricks, a UBS executive and chair of a New York Fed task force examining the repo market after the crisis, told the Commission. (p. 114)

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The repo runs of 2007, which had devastated hedge funds such as the two Bear Stearns Asset Management funds and mortgage originators such as Countrywide, had seized the attention of the financial community, and the run on Bear Stearns was similarly eye-opening. Market participants and regulators now better appreciated how the quality of repo collateral had shifted over time from Treasury notes and securities issued by Fannie Mae and Freddie Mac to highly rated non-GSE mortgage–backed securities and collateralized debt obligations (CDOs). At its peak before the crisis, this riskier collateral accounted for as much as 30% of the total posted. In April 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 had dramatically expanded protections for repo lenders holding collateral, such as mortgage-related securities, that was riskier than government or highly rated corporate debt. These protections gave lenders confidence that they had clear, immediate rights to collateral if a borrower should declare bankruptcy. Nonetheless, Jamie Dimon, the CEO of JP Morgan, told the FCIC, “When people got scared, they wouldn’t finance the nonstandard stuff at all.”

To the surprise of both borrowers and regulators, high-quality collateral was not enough to ensure access to the repo market. Repo lenders cared just as much about the financial health of the borrower as about the quality of the collateral. In fact, even for the same collateral, repo lenders demanded different haircuts from different borrowers. Despite the bankruptcy provisions in the 2005 act, lenders were reluctant to risk the hassle of seizing collateral, even good collateral, from a bankrupt borrower. Steven Meier of State Street testified to the FCIC: “I would say the counterparties are a first line of defense, and we don’t want to go through that uncomfortable process of having to liquidate collateral.” William Dudley of the New York Fed told the FCIC, “At the first sign of trouble, these investors in tri-party repo tend to run rather than take the collateral that they’ve lent against.... So high-quality collateral itself is not sufficient when and if an institution gets in trouble.” (p. 293)

But it's sort of flat. I can't tell if this was a major cause of the panic, a minor cause, a clarification of standard practices, industry-wide, etc. There's little original data or research, which is probably expected given the exercise, but it's tough to distinguish the interesting small things versus the interesting important things. For a general reader that won't matter too much, but for people trying to figure out where to go next it is very important.

Luckily, they are doing large data dumps on what they researched and found to go with the report. I'm hoping that this will allow researchers, academics and interested parties to dig in and fill in the missing shades and depth in the causes of the crisis.

Mike Konczal is a Fellow at the Roosevelt Institute.

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FCIC Report: Ownership Society as Bridge to a Permanent Republican Majority

Jan 31, 2011Mike Konczal

While the GOP now tries to blame the crash on government sponsorship of homeownership, it was part of their strategy to turn the country into homebuyers -- and Republicans.

While the GOP now tries to blame the crash on government sponsorship of homeownership, it was part of their strategy to turn the country into homebuyers -- and Republicans.

Brad Miller has a post at Huffington Post called "Republican Amnesia on the Financial Crisis." The important story is that that during the 2000s, conservatives and libertarians hated the CRA and the GSEs because they believed that these institutions blocked or slowed the ability to give loans to poor people. After the crash, the right did an immediate about-face, blaming these institutions for lending too much.

I'm not making that up. Check out the Miller post. I've been documenting this for a while. As Cato put it in 2003, "...by increasing the costs to banks of doing business in distressed communities, the CRA makes banks likely to deny credit to marginal borrowers that would qualify for credit if costs were not so high." Bill Black walks through Wallison's turnaround on everything, and the GSEs in particular, here and here.

Meanwhile, David Frum is reading the FCIC report. His post on the CRA, "Did Washington Push Banks to Make Bad Loans?," ends with the quote: "George Bailey of It’s a Wonderful Life retired from mortgage lending forever. In the new anonymous securitized market, high-flown liberal egalitarian ideals became the material out of which self-interested and consequence-indifferent financial engineers built the biggest economic bomb since World War II."

Firstly, and the FCIC report emphasizes this in passing, but we had a credit bubble, and bubbles showed up everywhere, not just in housing. Secondly, I'm actually surprised that the FCIC didn't cover deregulation and securitization, considering they do cover the deregulation in the early 1980s that led to the S&L crisis. The private securitization market was the creation of the early Reagan administration, specifically through the Secondary Mortgage Market Enhancement Act of 1984 (SMMEA) in which Congress preempted a variety of state laws that inhibited private home mortgage securitization.

Ownership Society

But to the point, we need to distinguish between the idea that a regulator made the financial system do something versus turning a blind eye while the financial system did it on its own. Regulators didn't step up when the subprime market, the housing bubble, the CDO market, or the shadow banking system were all growing quickly, in part because they believed these things would regulate themselves. Greenspan was certainly of this belief. Being able to say that you were promoting homeownership was a great tagline for both parties, but that's a side effect of letting the market spin out of control.

But are "high-flown liberal egalitarian ideals" the reason that subprime mortgages and homeownership were pushed so hard and got so big in the 2000s, while regulators did nothing? Let's look at George W. Bush's 2004 Ownership Society fact sheet, and what I would characterize as the four-legged stool of The Ownership Society: tax cuts for the wealthy, health savings accounts, privatizing Social Security, and mass homeownership. Homeownership is a big deal in the fact sheet:

...The President believes that homeownership is the cornerstone of America's vibrant communities and benefits individual families by building stability and long-term financial security... The President also announced the goal of increasing the number of minority homeowners by at least 5.5 million families before the end of the decade...

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What he really promoted was homebuyership, not homeownership. But politically, why was this a big deal for Republicans? Egalitarian concerns? As the historian Rick Perlstein found in a 2005 special Ownership Society edition of the American Enterprise Institute's magazine,  Grover Norquist wrote that:

Bush's vision also calls for efforts to increase homeownership. Here's a hint of what that could mean: in House Speaker Dennis Haster's Congressional district in Illinois, 75-80 percent of voters own their own homes. In Democratic minority leader Nancy Pelosi's district in San Francisco, the number is 35 percent... A transition of great political importance is under way. Fifty years from now the move to an Ownership Society will be recognized as a change to America's political landscape as dramatic as the move from farms to factories.

Here's James Glassman:

Bush wants more ownership because he wants to change the shape of America. He understands that people who own stocks and real estate -- who possess wealth of their own -- have a deeper commitment to their community, a more profound sense of family obligation and personal responsibility, a stronger identification with the national fortunes, and a personal interest in our capitalist economy. (They also have a greater propensity to vote Republican.)

Here's more from what Perlstein found in that 2005 American Enterprise Institute magazine (my bold):

The places with the higehst levels of homeownership generally vote Republican.... "Our analysis shows that this connection between homeownership and voting Republican holds broadly at every level--from large regions all the way down to metro areas....more and more of the places offering new homes to young families following their dreams are in the heart of Red America." Not wanting to own your own home is revealed as downright European; Kotkin singles out Prague's homeownership rate at "about 12 percent." No Republicans there! He concludes by calling cities like Fresno, Orlando, Dallas, Houston, Phoenix, Las Vegas, and Atlanta "Our New Cities of Aspiration" -- "the de facto headquarters of the American dream."...

Once more our conservative think tank hammered home the electoral point: "Married couples with families, a key Bush constituency, had the highest rates among all groups: over 83 percent." No wonder Bush won: "Homeownership momentum continued right up to the election. Sales of new homes rose 4 percent in the fall, to an annual rate of 1.2 million units -- the third highest level on record. Sales of previously owned homes also rose to their third highest level."

Especially bustling? California, where first-time homeowners are said to "head for towns like Tracy, Modesto, and Grass Valley. Along the way, many embark on a journey that ends with them voting Republican."

They thought that getting homeownership rates up to 70% would secure a permanent Republican majority. They looked at the data and saw that suburban homeowners are more worried about tax issues, crime, and tend to vote more conservative on economic issues, and they thought they could let the financial sector do its thing and turn a critical mass of swing voters into suburban bourgeois tax-haters. There's an element of the GI Bill and post-war suburbanization in this strategy, which was designed in part by the GOP to get people to the new suburbs and weaken the power of Democratic city bosses.

They actively applauded themselves for pulling off this distinctly political project in their magazines. And then they blame poverty programs and the idea of government when it all collapses.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Stop Socializing the Downside and Privatizing the Upside

Jan 31, 2011Joan Williams

wanted-signWanted: A grand narrative about the people's right to share in prosperity-- and not just pay for economic catastrophes.

wanted-signWanted: A grand narrative about the people's right to share in prosperity-- and not just pay for economic catastrophes.

I have been watching Clint Eastwood films lately and thinking about his role in fueling the belittlement of government. In Dirty Harry, for example, the Eastwood character is a loner who stands up to lily-livered bureaucrats who lack the cojones to do what needs to be done and to morally corrupt politicians who cave in to bad guys for a living. This kind of film was part of a sustained, and dazzlingly effective, cultural agenda to discredit government.

A key mechanism of enforcing this view is the snarl -- it's not really an argument -- that having the government undertake any given task is... socialism.

For thirty years, Democrats have lacked a cogent response. In the debate over health care, they tried to counter the socialism charge by designing reform according to Republican principles: no to single payer, no to the public option, yes to private health insurance (an industry so inefficient that Americans spend one third of their health care dollars on paperwork, but I digress).

Democrats are left still facing sneers of socialism. Trying to counter this charge by messing around with policy design details is a strategy fated to fail. What we need instead is a way of reframing the debate that begins to reverse the discrediting of government.

The financial crisis presented a golden, largely squandered, opportunity to begin this process. No better time than the present. Americans recently heard reports of bank profits so high that major banks are declaring dividends. This presents a teachable moment to send a much more effective message than Obama's old fashioned populism that demonizes bankers as "fat cats."

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Here's a fresh response: What conservatives are proposing is to privatize the upside of the economy while socializing the downside.

Take the banks. Back during the Great Recession, they were only too happy to socialize risk. But now, with profits aplenty, banks have lost interest in sharing. After we socialized the downside risk, now they want to privatize the upside risk.

This doesn't make a whole heck of a lot of sense. But it's a consistent theme in Republican proposals. Take the new Republican health care proposal. It wants to preserve for private industry the right to insure relatively healthy people off whom insurers can make a profit. Again, Republicans want to privatize the upside and let industry keep those profits, and socialize the downside -- and then deride government for needing to levy taxes to cover the costs of shouldering that risk.

A similar dynamic is at work at the local level. A recent California ballot initiative makes it more difficult for local governments to impose fees on developers as a condition of approving development. The fees required the developers to pay for the costs of the water, sewers, schools, and parks that would serve the new subdivisions. Not surprisingly, the developers hate fees because they prefer to socialize the costs of infrastructure and privatize the profits of development.

So here's the message: The next time Republicans snarl "socialism," Democrats need to re-examine the baseline assumptions. Often you'll find a proposal to privatize profits and socialize risk. Calling that out is the first step towards changing Americans' negativism towards government.

Joan Williams is the author of Reshaping the Work-Family Debate.

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Detours, Diversions and Delays: Servicers Obstruct Foreclosure Cases

Jan 24, 2011Thomas A. Cox

foreclosure-gavel-150Homeowners and their lawyers waste resources while the banks and their lawyers bide their time. **This is the final part of a three-part series.

foreclosure-gavel-150Homeowners and their lawyers waste resources while the banks and their lawyers bide their time. **This is the final part of a three-part series. Read part 1 here and part 2 here.

As we pursue pre-trial discovery efforts, the servicers' lawyers' hide the ball tactics come into full play. In addition to throwing up unjustifiable objections, they stonewall for months on end in producing documents to which homeowners are undeniably entitled. We recently won a $2,500 sanction award against JPMorgan Chase after the bank stalled for almost a year in producing documents that it was obligated to produce within 30 days of our request.

While the lawyers for servicers are usually graded and paid for how fast they can rush a foreclosure case through the legal system, the rules change in that very small percentage of cases where lawyers show up to represent homeowners. At that point, the servicer is likely to remove the case from the grading system. The servicer's lawyer is also likely to start billing the servicer at an hourly rate. When a case finally gets to a trial list, there are repeated requests from the servicer's lawyer for continuances and delays so that the servicer can put off sending a witness to testify at trial.

Cut and Run

When we confront a servicer with clear proof that it cannot prove its right to a foreclosure, it will seldom pull back and take action to correct the problem. In one recent case where HSBC Bank was the foreclosing plaintiff, we developed clear proof that the note endorsement it was relying upon was signed by a person who had utterly no authority to endorse on behalf of the party from whom HSBC claimed to have acquired the note. Thus there was no proof that HSBC had any right to foreclose. Nevertheless, it convinced an unknowledgeable trial judge to give it summary judgment. We appealed the case to the Maine Supreme Court and fully briefed it. While I was working as a volunteer lawyer on that case, the value of the work that I put into that appeal would have been well in excess of $20,000. On the day that its opposing brief was due, HSBC filed consent to the granting of the appeal, finally conceding at that late stage that it could not prove its entitlement to a foreclosure. It did not much care that it had forced that kind of legal effort on behalf of the homeowner because it does not have to pay the homeowner's fees when it mismanages its cases.

Just a few weeks ago, we saw a similar development from the same servicer law firm, this time representing a Deutsche Bank securitized trust on a loan serviced by JPMorgan Chase. The trial court granted summary judgment to Deutsche Bank, even though it was clear that JPMorgan had failed to send the homeowner a proper notice of default and right to cure. Again, we appealed the case to the Maine Supreme Court, and again the foreclosure plaintiff capitulated only after its lawyers realized that we were not giving up and that it was about to lose.

In the now notorious FNMA v. Bradbury case, in which I exposed the dishonest affidavit practices of GMAC Mortgage's Jeffrey Stephan when I deposed him this past June, GMAC recently moved to dismiss the case after two failed motions for summary judgment, a failed motion to prevent any sharing of Stephan's deposition with other lawyers, and an imposition of sanctions upon it for its bad faith conduct. In moving to dismiss, GMAC admitted that it could not prevail in the action. This admission came after we invested legal work that, if a private lawyer had been billing, would have cost well in excess of $40,000.

In the "hide the ball variation 2" case described in my previous post, where GMAC filed a dishonest mortgagee certification signed by Jeffrey Stephan, it moved to dismiss that case only after we named that client as a plaintiff in the class action that we have brought against it.

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The pattern that emerges from these and similar cases shows the practice of foreclosure industry lawyers to litigate right to the point where they are about to lose and to then cut and run. In this process, they are usually getting themselves off the flat fee charged in unopposed cases and onto an hourly fee arrangement that they like, and they are content to see homeowner's lawyers' time diverted from representing other homeowners.

Wear Down the Opposition

Working with homeowners to obtain modifications can be some of the most rewarding, and yet most frustrating, work that we do as foreclosure defense lawyers. Until Maine's new foreclosure mediation program began on January 1, 2010, we were almost never able to obtain loan modifications for our clients. We couldn't even get employees of servicers to talk to us. With the program now fully operational, we are able to negotiate loan modifications in many cases. It is very satisfying to see a homeowner walk away with a loan payment that he or she can afford, experiencing the relief from a terminated foreclosure action.

The flip side of this picture is the outrageous abuses of the loan modification process that we constantly see. The servicer leagues ahead of all others in this misconduct is Bank of America. We often have Bank of America customers come to us before foreclosures begin. These homeowners are desperate. They have suffered diminished or lost incomes for one reason or another and have been attempting to work out loan modifications before their reserves are totally gone and they are forced to default. Bank of America often ignores these homeowners or puts them through endless cycles of financial disclosures (repeated time after time because it routinely loses these papers), or it simply tells homeowners that they must default before it will even talk to them.

It gets worse. Even in the rare cases where a homeowner has obtained  entry into the HAMP modification process from Bank of America, which is supposed to involve a three-month trial payment period, it strings them along in the temporary payment for nine or 12 months or longer, only to finally, and without any justification, deny a permanent modification. By the time these homeowners get to us, they are angry, discouraged, depressed and exhausted. They are often ready to just give up and to walk away from their homes to bring an end to the tortuous process. I suspect that this is exactly the result that Bank of America wants.

Even when we come into these cases as lawyers, the same exhausting process continues. Agreements that we reach in mediation are not kept. Our efforts to obtain conversions of temporary payment plans to permanent modifications become an effort of guerilla legal warfare. Over the past few months, there have been abundant reports of the perverse incentives that motivate loan servicers to pursue foreclosures and avoid loan modifications. In the line of foreclosure defense on a daily basis, we see directly the suffering inflicted on homeowners who hope for nothing more than a fair chance to stay in their homes.

Where is the outrage?

Certainly the military families who have been abused by JPMorgan Chase must be outraged. Homeowners all over the country experiencing these abusive tactics are outraged. Overworked and tireless foreclosure defense lawyers are outraged by the abuses that we see on a daily basis. Very few judges, like Judge Arthur Shack in New York, have become outraged. But I do not see the outrage at out largest (and taxpayer bailed-out) financial institutions coming to a boiling point. When I testified in front of the House Judiciary Committee in December, I did not come away with any sense of outrage there. When I saw the report about the abuse of American military families, I thought that would become a tipping point, but I has not even made headlines in the nation's print and television media. What is it going to take?

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

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Banks Aren't Lending Because of the "F" Word: Foreclosure

Jan 24, 2011Mike Konczal

Since banks have cash in their pockets, why aren't the lending gears grinding?

Since banks have cash in their pockets, why aren't the lending gears grinding?

There was lot of interesting back-and-forth on balance sheet recessions at the end of last week. Here are Ryan Avent and Mark Thoma each explaining the argument. David Beckworth pushes back on the concept here (as well as here):

[T]he explanation incorrectly assumes the entire U.S. economy is on a deleveraging cycle....[The balance sheet recession view] fails to recognize that for every debtor there must be a creditor. Thus, for every debtor who is cutting back on spending in order to pay off his debts, there is a creditor receiving money payments. In principle, these creditors should be increasing their money spending to offset the decline in money spending by the debtors -- but if that were happening, there would have been no decline in overall total current-dollar spending. Instead, creditors are sitting on their money because they see an uncertain economic future...

If these creditor households, firms, and banks all simultaneously started spending their excess money balances, this would increase total current-dollar spending and in turn spur a real economic recovery. Moreover, knowing that the real economy would improve would feed back and reinforce current spending decisions by the creditors -- creditor households would buy new cars and remodel their kitchens, creditor firms would build new plants, and creditor banks would increase lending. A virtuous cycle would take hold and push the economy back toward full employment. But this virtuous cycle is not taking off because creditors are still hanging on to their money balances. What is needed to kickstart this cycle is an entity powerful enough to incentivize all the creditor households and firms to start spending their money simultaneously.

Enter the Federal Reserve. It alone has the ability to provide these incentives through its control of monetary policy. The fact that total current-dollar spending has remained depressed for so long means that the Federal Reserve has failed to do its job and effectively has kept monetary policy too tight.

Andy Harless writes a comment I agree with:

"why aren't the creditors who are receiving the increased payments spending the money?"

There's no reason to expect them to spend it, because it's not income; it's just a return of capital. The question would be, "Why aren't they re-lending it?" The reason they aren't re-lending it is that, with debtors trying to pay down their loans, the demand for loans is too low to produce high enough interest rates to justify the risk. You can call it an excess money demand problem, but the excess money demand is a result of the balance sheet problem, because money happens to be an asset that becomes attractive when loan demand is weak.

There are two questions to be answered. The first is whether or not we are on a deleveraging cycle and what the consequences of this would be. The second is whether or not fiscal and/or monetary policy can impact deleveraging.

The economy is deleveraging; that's not made up. The Federal Reserve's latest quarterly Fed Flow of Funds came out last week, and consumers continue to delever:

You can also see this at the FRBNY Consumer Credit Panel.

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What are the consequences of this? I want to recommend this excellent presentation (pdf) by Karen Dynan of Brookings, who walks through likely consumer spending scenarios related to consumer deleveraging. She finds that there is more to come. It certainly looks like consumers are develeraging too fast for it to come just from households paying down debt. Indeed, Dynan finds that a large majority of the deleveraging is coming from writing off bad debt.

When there's a charge-off event, two things happen that are relevant to whether or not the money is relent. The first is that the borrower signals he or she is a credit risk, which will reduce access to credit. The second is that the lender's probability of financial distress goes up, so they want to be more restrictive in how they lend; they have suddenly gotten themselves in the real estate business through replacing a debt asset with an abandoned home in a flooded market. This is the opposite problem of someone saving too much and becoming a better credit risk while a bank has too much to lend.

I think the spillover effects from foreclosures, abandoned properties, limbo REO houses, etc. are real and have consequences for consumer spending, borrowing and investments in neighborhoods. That at least some, if not many, of these foreclosures are the result of a broken, too-thin servicer model is one reason I spend so much time arguing for moving foreclosure negotiations from servicers to bankruptcy judges. We can fix a lot of this with a Chapter M for Mortgage expedited bankruptcy process (and some inflation).

Sometimes people float the argument that mass foreclosure waves should boost consumer spending power, since those homeowners are getting free rent. I think that overestimates how many people stay in their house once foreclosure starts. There's evidence that many people who are delinquent on a first mortgage are still paying junior lien claims. And if you are losing your home, you often have had an unemployment spell; it's not clear that you've boosted your income.

There's other criticisms of this approach. JW Mason reminds us that claims that fiscal consolidation will reduce aggregate income are empirical, ones that are likely true but that we shouldn't take for granted.

 

Mike Konczal is a Fellow at the Roosevelt Institute. **Don't miss Mike speaking with CNN about the nature of our unemployment crisis here.

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Another Big Kiss for Big Business? Volcker Out, Immelt In

Jan 21, 2011

Today, President Obama welcomes Jeffrey Immelt to his White House inner circle as chair of a newly created jobs council after saying good-bye to economic adviser and Wall Street critic Paul Volcker, who is leaving after a two-year term. Is this good news for workers...or corporate executives? Our economic brains at the Roosevelt Institute weigh in.

Today, President Obama welcomes Jeffrey Immelt to his White House inner circle as chair of a newly created jobs council after saying good-bye to economic adviser and Wall Street critic Paul Volcker, who is leaving after a two-year term. Is this good news for workers...or corporate executives? Our economic brains at the Roosevelt Institute weigh in.

"Volcker out and Immelt in, because the administration now wants to emphasize ‘recovery' and ‘jobs' instead of ‘crisis stabilization'? Since when did any stabilization not include jobs as a top priority? What we actually have here is the disappearance from the scene of the best known and most visible critic of the excesses of the financial sector and his replacement by the sitting CEO of a company that is heavily dependent on government aid of all sorts, including diplomatic assistance to invest more in China. This is not about jobs, but political money -- the White House knows that after Citizens United, it will need to raise about a billion dollars -- that's right, a billion -- for its reelection campaign. That's the context in which this and its other recent appointments need to be judged."  ~Thomas Ferguson, Roosevelt Institute Senior Fellow and Professor of Political Science at U Mass, Boston

"President Obama seems to be putting all efforts into cultivating the confidence of the corporate community. One can see the appointment of Mr. Immelt in this light. It is an interesting question as to whether the CEO of a multinational corporation that employs many people outside of the USA will be a leader who aligns his thinking with the needs of the American people and job creation within the 50 United States. Corporations with large Foreign Direct Investments have very interesting incentives regarding military spending, exchange rate negotiations and labor policies that may not align with the well being of our citizens. It is important that Mr. Immelt embrace the larger concerns of U.S. society if he is to be a successful public servant and foster the reelection of President Obama in 2012." ~ Robert Johnson, Roosevelt Institute Senior Fellow and Director of the Institute for New Economic Thinking

"GE Capital, the major subsidiary of GE, is a major shadow bank. It used GE's high-quality credit rating to become a major player in the capital markets, much in the same way AIG FP used the boring insurance industry's high credit rating. GE Capital was the single largest issuer of commercial paper going into the financial crisis...GE has been at the forefront of blurring a 'financial services'-centric model of business onto the remains of a hollowed-out manufacturing base, one kept in a minimal state just strong enough to qualify for high credit scoring...All in all, not especially a big win for the Jobs and Competitiveness." ~ Mike Konczal, Roosevelt Institute Fellow (read further analysis from Konczal on this topic here).

*Ferguson's comments also appeared in a press release put out by the Institute for Public Accuracy.

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Immelt's Appointment is No Win for Job Creation

Jan 21, 2011Mike Konczal

Far from being a job producer, GE mostly operates as a shadow bank that profits off of pure financialization.

Joe Klein says of Volcker's replacement:

Far from being a job producer, GE mostly operates as a shadow bank that profits off of pure financialization.

Joe Klein says of Volcker's replacement:

Gotta admit I'm not too pleased by the departure of Paul Volcker from Barack Obama's circle of advisers. He was one of the few, along with Elizabeth Warren, in the current administration who had a proper perspective on the outrageous behavior that the financial community considers business as usual. And while the appointment of his replacement Jeffrey Immelt, of General Electric, signals a desire to snuggle up to the business community -- at least Immelt comes from the manufacturing sector. He has experience actually making products, a skill notably lacking among every one of Obama's other economic advisers.

Again, I'll repeat: the important distinction here is between the business community, which should be encouraged to create more jobs, and the financial community, which should be shamed for its casino-gaming shenanigans and kept away from the inner circles of economic policy-making.

Um, no. Firstly, the idea that we have 15 million unemployed people because of our weakened competitiveness is just wrong and lacks any real substantial evidence. But the idea that GE can, as Joe Klein puts it, point a way forward from a financialized economy is also wrong. Two points:

1. As Raj Date cleverly put it, to understand the bailouts, you need to understand "the Killer G's": Goldman Sachs, GMAC, and GE Capital.

GE Capital, the major subsidiary of GE, is a major shadow bank. It used GE's high-quality credit rating to become a major player in the capital markets, much in the same way AIG FP used the boring insurance industry's high credit rating. GE Capital was the single largest issuer of commercial paper going into the financial crisis.

GE Capital received major bailouts during the crisis, including having the FDIC guarantee more than $50 billion dollars of unsecured debt. To put that in perspective, only about $24 billion of GE Capital's funding comes through deposits, allowing a shadow bank with massive unsecured debt obligations and only a small depository base to be carried through the financial panic. Both graphs from Date:

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2. Next I want to point out the book "Financialization and Strategy: Narrative and Numbers" (by Froud, Sukhdev, Leaver, Williams), which does an extensive case study of General Electric and the financialization of the manufacturing business model from 1980 onwards:

Our analysis of the undisclosed business model is relatively straightforward and focuses on seven principles of GE’s cost recovery under Welch:

1 run the industrial business for earnings;

2 add industrial services to cover hollowing out of the industrial base;

3 buy and sell companies through acquisition and divestment to achieve returns and growth objectives;

4 rely on large-scale acquisition to prevent like-for-like comparisons and to increase opacity and the power of narrative;

5 grow the financial-services business up to the limit of the company’s credit rating;

6 accept the balance-sheet costs in terms of return on capital but focus on managing return on equity and cost of capital;

7 add financial engineering to smooth earnings and manage growth...

The story of GE Capital is a story of upward mobility, as GE has found growth of sales revenue by moving beyond captive finance into many other lines of financial business. GE has sold financial services since the 1930s, starting with domestic credit for refrigerators, a classic form of captive finance. Up to the late 1970s, GE was arguably not so different from other US corporates, such as GM or Westinghouse, with a financial-services division whose central activity was captive finance. However, through the 1980s and 1990s, GE Capital greatly expanded and increased its offering in everything from LBO finance to store cards. GE has stayed away from retail banking and, after its problems with Kidder Peabody, moved out of securities dealing. But, in general, its expansion has been as a general supplier of consumer and commercial financial services, while also developing niche areas, such as mortgage insurance. The company’s expansion into financial services is neatly summarized by Fortune: ‘GE Capital pours wealth into the corporate coffers by doing just about everything you can do with money except print it’ (21 February 1994). Hence, GECS overtook General Motors Acceptance Corp. (GMAC) in terms of total assets in 1993 and was twice as large by 1997 (Forbes, 21 April 1997)...

In all this, the GE Capital board was engaged in high-stakes risk management where misjudgments about a class of business would have undermined GE’s financial record. By way of contrast, Westinghouse, GE’s conglomerate rival, had its finance arm liquidated by the parent company after losing almost $1 billion in bad property loans in 1990 (The Economist, 30 April 1994). GE Capital’s expertise in making acquisitions is acknowledged by S&P as one of the factors that supports its triple-A rating: ‘GECC (GE Capital Corp.) tends to be a very savvy buyer, understanding the various business risks and pricing the acquisition appropriately’ (S&P 2002: 2).

If the expansion of GE Capital rested on judgment and controls, it also reflected the structural advantage of the triple-A credit rating, which effectively made the financial business (as user of the credit rating) dependent on the industrial business (as credit-rating generator), and this in turn set limits on how much GE could expand without risking reclassification by credit-rating agencies. GE Industrial may be a low-growth business but it has high margins, is consistently profitable over the cycle and has funded almost all of the dividends that GE Consolidated has paid out, as well as providing the funds for acquisitions and repayment of debt. This solid industrial base is the basis for GE’s triple-A credit rating, which allows GE Capital to borrow cheaply the large sums of money that it lends on to consumers and commercial customers...

If there's demand, I can dig into the huge debate in the analyst community about what was going on with GE and earnings management, a worry that hit an explosive moment post-Enron and Worldcom during the Sarbanes-Oxley debates.

GE has been at the forefront of blurring a "financial services"-centric model of business onto the remains of a hollowed-out manufacturing base, one kept in a minimal state just strong enough to qualify for high credit scoring. Marcy Wheeler has written about how that manufacturing part of the company is driven by outsourcing.

All in all, not especially a big win for the Jobs and Competitiveness.

Mike Konczal is a Fellow at the Roosevelt Institute.

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How Banks and Servicers Play Hide the Ball

Jan 21, 2011Thomas A. Cox

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

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

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

Logic does not control the foreclosure industry's practices.

Variation Number 1: MERS hides the ball

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

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

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

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

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Variation Number 2: Fannie and Freddie hide the ball

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

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

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

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

Variation Number 3: obstructing homeowners' discovery efforts

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

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

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

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

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

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

Jan 20, 2011Thomas A. Cox

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

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

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

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

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The Foreclosure Game

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

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

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

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

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