The Gordon Gekko Mindset Still Rules Wall Street

Feb 11, 2011Bryce Covert

Among some good news from the COP about lower pay are signs that Wall Street is already finding a run-around.

Among some good news from the COP about lower pay are signs that Wall Street is already finding a run-around.

Remember how Wall Street isn't paid enough (even while executive pay has hit new records)? It looks like some people might disagree. The Congressional Oversight Panel, which oversees TARP, just released a report on the efforts of the specially created Office of the Special Master for Executive Compensation to deal with outrageous compensation at companies that preformed so badly they needed us to bail them out. The good news? The Special Master (a great title if ever there was one) has gotten compensation at the recipients of "exceptional taxpayer assistance" (i.e. AIG, Bank of America, Chrysler, Chrysler Financial, Citigroup, General Motors, and GMAC/Ally Financial) down 55% for the 25 top paid employees. The Master also shifted pay from cash to stock in an effort to actually tie pay to performance (a new concept around Wall Street). The hope is that this can help cut down on the freewheeling, risk-loving adventures that got us into this mess.

The bad news? The Special Master didn't find that any of the bloated pay given out before TARP was "contrary to the public interest" and therefore didn't claw any of it back. (This even though he found that $1.7 billion in payments were "disfavored" and "not necessarily appropriate.") The COP was pretty troubled by this tightrope walk -- its report stated that this

may appear to the public to be excessively legalistic, it may represent an end-run around Congress' determination that the Special Master should make every effort to claw back wrongful payments, and it may give the impression that the government condoned inappropriate compensation to executives whose actions contributed to the financial crisis.

Yup, pretty much. The Special Master has also put the details of his decisions into a "black box," preventing any other experts from duplicating his work and cracking down on firms in the future.

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And while the goal of getting pay aligned with performance is important (if not a little forehead smackingly "duh"), tying it so heavily to stock might create its own perverse incentives. After all, executives can play risky games with the stock price to get their pay up. Not to mention that bankers have already found ways around this to increase their profits even when their company's stock suffers. A recent NYTimes story laid the details bare:

Using complex investment transactions, they can limit the downside on their holdings, or even profit, as other shareholders are suffering.

More than a quarter of Goldman Sachs's partners, a highly influential group of around 475 top executives, used these hedging strategies from July 2007 through November 2010, according to a New York Times analysis of regulatory filings. The arrangements were intended to protect their personal portfolios when the firm's stock was highly volatile, especially at the height of the crisis.

In some cases, executives saved millions of dollars by using these tactics. One prominent Goldman investment banker avoided more than $7 million in losses over a four-month period.

The government has barred those firms that received multiple bailouts from hedging until they've paid the funds back -- but others are getting in on the action now. And while most high-level execs are barred from this practice and shareholders can see whether they engage in it, the activity of lower-level execs is unhampered and mostly hidden. This makes it even more likely they will be personally aligned against the fate of their own company. As Patrick McGurn, a governance adviser at RiskMetrics, told the NYTimes, "Many of these hedging activities can create situations when the executives' interests run counter to the company."

Don't expect the Gordon Gekko-like practices to let up anytime soon.

Bryce Covert is Assistant Editor at New Deal 2.0.

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Crank Up the Casino! Hedge Funds to Short American States and Cities

Feb 9, 2011Lynn Parramore

Today, Washington's lawmakers began hearings on the massive fiscal problems the Great Recession dumped on American states and cities. The looming possibility of municipal defaults, which some say could total hundreds of billions of dollars, is causing grave concern. Hedge funds are also deeply concerned about America's municipal debt crisis. They worry about how to best profit from it.

Today, Washington's lawmakers began hearings on the massive fiscal problems the Great Recession dumped on American states and cities. The looming possibility of municipal defaults, which some say could total hundreds of billions of dollars, is causing grave concern. Hedge funds are also deeply concerned about America's municipal debt crisis. They worry about how to best profit from it.

The Wizards of Wall Street have looked over the catastrophe of cash-strapped America and found it good for business. In their corporate laboratories, they are working furiously to whip up wondrous new financial products that will allow them to reap millions from misery. You might think that after plunging the country into said Recession with their fancy financial products, these Wizards might feel a little indelicate about gearing up for a game of shorting a community near you. Clearly you don't know Wall Street. The Financial Times reports that once-boring muni bonds are suddenly sexy:

For decades, this $3,000bn bond market was safe, predictable and dull. The traditional buyers of the bonds issued by states, cities and other local bodies were wealthy local residents lured to them by the tax breaks on offer for individual investors. They bought the bonds, held them until they matured and then bought more. Not now. State deficits have ballooned, local authorities are grappling with huge public sector pension liabilities and triple A bond insurance that used to prop up even the riskier municipal bonds is harder to find. The mounting concern over "munis" has brought with it hedge funds and financial institutions who want to bet on the bonds' creditworthiness, or make money on the back of volatile "spreads" -- the premiums at which munis trade relative to benchmark debt.

So much suffering. So many ways to squeeze money from it. The FT quotes the head of municipals at Arbor Research and Trading, who sums up the current hedge fund frenzy building: "There is a lot of blood in the water in the municipal space. Hedge funds smell that blood and are trying to figure out the best way to make money in the marketplace."

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What the Wizards have to do is figure out how to take short positions that will soar in value as the creditworthiness of munis fall into the crapper. And it's to credit default swaps -- those "innovative" financial products that helped bring you the financial crisis -- that the hedge hogs are turning. Credit default swaps are like insurance. Except that unlike insurance, which you can only buy on assets you really own, you can buy these goodies on your neighbor's house, too. The moral hazard problems of this sort of nonsense are well known, which is why Wall Street fought so hard to make sure credit default swaps were not regulated like insurance. Once upon a time, as my colleague Tom Ferguson explained to me, English insurers discovered that scoundrels would buy insurance on ships they didn't own and then leak voyage details to the French navy, so they could collect. Guess who sells most municipal bonds? Many of the same people who'll be betting on their failure now. See a problem here? If you don't own the underlying asset, then credit default swaps are simply gambling. So what we are talking about is an extension of casinos to every state and city in America. The European Union is finally moving on these vultures. But not us, it seems.

The perversity of gorging on suffering never seems to bother the American financial sector. JPMorgan feeds on our hunger with its lucrative food stamp card business. And AIG gets into the game of letting strangers bet on your life. Why shouldn't hedge funds make a little extra dough from the collapse of your hometown?

Lynn Parramore is Editor of New Deal 2.0, Media Fellow at the Roosevelt Institute, and Co-founder of Recessionwire.

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Food Stamps: JPMorgan & Banking Industry Profit From Misery

Feb 9, 2011Bryce Covert

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

This week's credit check: A record 43.6 million Americans are using food stamps. JPMorgan's segment that makes food stamp debit cards made $5.47 billion in net revenue in 2010.

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

This week's credit check: A record 43.6 million Americans are using food stamps. JPMorgan's segment that makes food stamp debit cards made $5.47 billion in net revenue in 2010.

You might think that if you're on food stamps, big banks won't be very interested in you. What could they possibly want with someone who's struggling just to put food on the table? But it turns out that you're actually part of a profitable business for big bank JPMorgan. While the money to pay for the stamps comes from the government, the technology to access it lies in private hands. Food stamps used to be literally stamps -- that is, pieces of paper -- but in this day and age paper is so old fashioned. Now you get your food stamps with a debit card, and JPMorgan knows all about creating plastic credit products.

As the head of this division at JPMorgan, Christopher Paton, told Bloomberg, "They act and feel very much like a debit card. A lot of stores increasingly take food stamps." What convenience! And Paton points out that his bank is the largest processor of food stamps in the country. These are boom times for such services -- a new report from the US Department of Agriculture reports that 43.6 million Americans are now using food stamps, nearly 14% of the population, which is a record number. Paton notes this trend himself: "Volumes have gone through the roof in the last couple of years," he says. "This business is a very important business to JPMorgan in terms of its size and scale." And the numbers bear him out. According to the company's most recent quarterly filing with the SEC, the Treasury & Securities Services segment, which is the division that includes the food stamp business, was up 2% in the last three months of last quarter and brought in $5.47 billion in net revenue for most of 2010.

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Paton's quick to point out that this isn't just about profit at JPMorgan -- it's also serving a "useful social function." And department execs don't have to sit around hoping for unemployment to skyrocket so they can make a buck -- more than 40% of food stamp recipients have a job, as Paton notes. Even if you get a job, you still have an almost one in two chance of still not being able to buy groceries, so JPMorgan can continue to make its profits as unemployment falls (someday).

But it does show a misalignment between what the banks want and what's good for the rest of us. It turns out that JPMorgan also provides unemployment benefit debit cards in some states on top of the food stamp cards. Talk about marketing off of misery -- the profit made from these cards shoots up as workers lose their jobs and can't pay for food. Whether or not they're providing a needed service, you would be hard pressed to find a way in which the business interest of this segment is not aligned with further economic ruin for America's workers. Instead of profiting when we all do well, they profit off of our misery.

And the decision to place card creation in private hands can turn out to be complicated for the actual users. While the government outsourced its card creation needs to JPMorgan, the bank in turn outsourced the customer service end to India. So if you're a food stamp user who has a problem or a question, don't expect to actually get someone in your own country to help you out. They can't be bothered to actually deal with the people they're giving such a necessary service to.

Bryce Covert is Assistant Editor at New Deal 2.0.

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In Mind-blowing Show of Hypocrisy, AIG Bites Hand That Feeds It

Feb 4, 2011Lynn Parramore

In the world of American Big Business, memory is short and chutzpah is long. At a little gathering of insurance folks in Washington, D.C., AIG's chief Robert Benmosche revealed that the company which used Uncle Sam as the Great Sugar Daddy deems the 'liberal' culture of relying on government bad for business. Bloomberg reports:

In the world of American Big Business, memory is short and chutzpah is long. At a little gathering of insurance folks in Washington, D.C., AIG's chief Robert Benmosche revealed that the company which used Uncle Sam as the Great Sugar Daddy deems the 'liberal' culture of relying on government bad for business. Bloomberg reports:

"American International Group Inc.'s mortgage insurer does more business in Republican-leaning states as it signs up more reliable customers than those in "more liberal" areas, Chief Executive Officer Robert Benmosche said.

"All of the states where we're a leader, where we're the No. 1 insurer, are red states, all of the states where we're at the bottom are blue states," Benmosche, 66, said yesterday at a conference in Washington. "Part of what we found out is that our model is about culture and it's about the attitude in the public. And what we find is where there's more of a tendency for people to be more liberal, more that the government is responsible for what happens to me."

After getting away with defrauding investors and then sucking up boatloads of taxpayer cash in a massive 182 billion government bailout initiated by red-stater George W. Bush, Benmosche condemns a culture of irresponsibility he believes is bred in blue states. Never mind that red states generally receive much more in federal dollars than they pay into the system. Such niceties of logic are irrelevant to corporate welfare kings who have been so emboldened by their post-financial crash free ride that they now have the temerity to trash the notion of government assistance.

You would be forgiven for thinking that the Bloomberg report is a parody. My colleague Tom Ferguson, Roosevelt Institute Fellow and U Mass Boston Professor of Political Science, could hardly believe his ears: "I wonder if it's really true," said Ferguson. "It sounds more like a CEO spouting at the end of some long, boring day spent talking to government officials about getting still more aid from taxpayers or 'regulatory relief' so his company can take even bigger risks at potential public expense. And if it is true, there may be a very simple explanation. The product he's talking about is mortgage insurance. Where would you expect to need the most insurance? Of course, in Republican states that went ga-ga on deregulation at the behest of companies like AIG. Benmosche's jeremiad may simply be the the 21st century's equivalent of of the plea to the judge for mercy because he's an orphan by the kid who killed his parents."

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AIG, of course, boasts an internal culture for which the word 'irresponsible' hardly seems adequate. 'Twisted' and 'sociopathic' come to mine. So does 'criminal'. In 2009, after receiving still more taxpayer rescue funds in the wake of accounting fraud revelations and posting monumental losses, AIG execs handed themselves $123 million in bonuses as a reward for incompetence and malfeasance. The company has also been fingered for engaging in macabre "stranger originated life insurance" practices which allow someone to bet against another person's life. Nice!

Memo to AIG: Next time you come begging for a bailout, you might want to skip the blue states.

Lynn Parramore is Editor of New Deal 2.0, Media Fellow at the Roosevelt Institute, and Co-founder of Recessionwire.

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Why Elizabeth Warren Is Still the Best Choice for CFPB Director

Feb 3, 2011Mike Konczal

She's handled staffing and criticism while building bridges. What more could you ask for?

She's handled staffing and criticism while building bridges. What more could you ask for?

The Consumer Financial Protection Bureau just launched its website. Meanwhile, Shahien Nasiripour has a story that found "... if the White House can't get a nominee through the Senate by July, the bureau will lack the authority to supervise nonbank lenders, according to a Jan. 10 report by the inspectors general of the Treasury Department and Federal Reserve obtained by The Huffington Post." One of the main reasons for creating a Consumer Financial Protection Bureau is to close a loophole called "regulatory arbitrage," which lets a lot of these nonbank subprime lenders avoid following the same rules that regular banks do when it comes to lending. So if there isn't a nominee soon, the CFPB is going to encounter a serious problem in doing one of the most important parts of its job.

So it's time to talk about who should lead it. People are currently having this conversation, putting forward potential candidates for the job. I've been following this since the bill passed and, at this point, I think Elizabeth Warren is the obvious choice. Warren is obviously credentialed enough -- a Harvard Law professor who came up with the idea, who has written extensively on the topic and is the third most cited scholar on bankruptcy and consumer-related finances. During the previous debate, there were three major critiques about her running the CFPB: that she wasn't experienced enough in starting a new agency, that she was disliked by industry, and that she wasn't confirmable. Since then she's done an excellent job starting up the agency, hitting the ground running. She has stalemated the critiques from industry and Republicans. And the Republicans have shown that they hate the agency itself but don't actually mind Warren as far as candidates go, so she's relatively more confirmable than people imagine.  She's made as good of a transition from campaigning to governing as anyone would have expected, and then some.

Starting Up The Agency

As for staffing, Warren is managing a team of 150 as they continue to build and launch the bureau. As far as all reports go, she's doing an excellent job. She is under some intense scrutiny, particularly from established regulators and lobbyists, and surviving a round of hostile questioning from a resurgent Republican House. There have been no horror stories. By all accounts, Warren and the CFPB team are getting along with Secretary Geithner and Treasury.

She has signed up Holly Petraeus to work on military affairs, giving the bureau a scope that builds on many different fronts. (The GOP has supported consumer protection bills for the military in the past.) And the most important hire, from my point of view, is former Ohio Attorney General Richard Cordray to help lead enforcement, an AG who is serious about getting to the bottom of the foreclosure fraud crisis. Warren has assembled a fantastic team with few, if any, pitfalls.

While assembling the team, Warren has also contributed to the complicated, yet very important, battle over servicing fraud, helping to veto an ill-advised notarization bill early on. She has been able to staff an impressive team while also contributing to one of the most important, ongoing situations in consumer finance.

Working With Community Banks

As Carter Dougherty has written at Bloomberg, Elizabeth Warren has worked closely with community banks. This has been a conscious effort to include their concerns in the process.

Community banks had two main objections during the fight to create the CFPB. The first was that they didn't need a new regulator because they already had several focused on consumer regulation. The second was that they didn't cause the crisis; the crisis was generated by the shadow banking sectors of fly-by-night mortgage originators, originators that Greenspan could have regulated but chose not to. One can imagine the community bankers being skeptical of someone promising to consolidate regulators, thus upsetting established bureaucrats, as well as taking on something that regulators have ignored in the past.

By all accounts, Warren is making inroads. The whole idea was based on regulatory consolidation from early on. If you look at what Elizabeth Warren wrote for the Roosevelt Institute's Make Market Be Markets conference, it was clear this was a goal of hers. You can see that she gets their concerns in her Politico op-ed, which was well received.

New Potential Allies

Rep. Jeb Hensarling (R-TX) has called the bureau a "consumer credit rationing agency." Reading his critique and other conservative GOP critics on the topic, I'm almost surprised by how impersonal their criticism is. If it was anyone else, they would still be trying to go after the CFPB's budget, scope and independence.

And many Republicans even seem to be warming to Warren. Rep. Randy Neugebauer (R-TX) has said, "She wouldn't be my last choice. I don't know whether she's my first choice, but she certainly wouldn't be my last choice... If [the Consumer Financial Protection Bureau] isn't going away, then what we have to do is deal with what we've got, and I think it's easier to deal with an agency where we have a little bit more permanency about its operations..." Which isn't that bad. She discussed consumer finance in a press release with Republican Senator Snowe. The Wall Street Journal seems almost surprised by how much outreach Warren is doing with the GOP. She has done extensive outreach to State Attorneys General, both Republicans and Democrats. She's emphasized transparency in her work as well. She is as well-respected by the GOP as any effective leader is going to be.

I'm never a good judge of conventional wisdom, but if it's that Warren can't get through the Senate, I think it's wrong, or at least very overstated. I think she'll have a better shot than anyone else. Warren and the CFPB aren't on the tea party's radar, and the Chamber has had real difficulty astroturfing this topic. The left is energized about this nomination, even more so since the strong role the CFPB will need to play in foreclosure fraud and servicing regulations has become clear. So what's the downside of her being the nominee?

Mike Konczal is a Fellow at the Roosevelt Institute.

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Breaking Records: High Pay on Wall Street, Low Wages on Main Street

Feb 3, 2011Bryce Covert

While Wall Street fat cats give themselves million dollar bonuses, the rest of us are more and more squeezed.

Last year sucked, didn't it? The recession dragged on, unemployment kept rising, wages fell... It turns out, though, there was one place where the streets were lined with gold: Wall Street.

While Wall Street fat cats give themselves million dollar bonuses, the rest of us are more and more squeezed.

Last year sucked, didn't it? The recession dragged on, unemployment kept rising, wages fell... It turns out, though, there was one place where the streets were lined with gold: Wall Street.

Yup, pay on Wall Street broke a record last year, hitting $135 billion -- up 5.7%. Revenue for firms is up to $417 billion, another record, rising 1%. And executives are seeing fit to give themselves a big pat on the back for that achievement, whether their firm saw such profits or not -- million dollar back pats. Even though Goldman Sachs' earnings are down 37% from 2009, pay is way up: head honcho Lloyd Blankfein will get $13.2 million in compensation for 2010. He's also getting a raise, with his base pay going from $600,000 to $2 million, and the base pay for all 470 partners will go up, the first time it's been raised since the company went public in 1999. Blankfein's not the only one seeing green: Blackrock CEO Laurence Fink is getting a bonus of $13 million, one of the largest for this season. But let's not forget: bankers still aren't getting paid enough.

Times are great! If the banking sector, which supposedly does so much to grease the gears of the economy, is doing so well, we must be too, right? Not quite. Average wages in 2009 (the last full year data is available) fell 1.5%. Adjusted for inflation, medium family income declined 5%, from $52,388 to $49,777, from its peak in 1999 to 2009.

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As outrageous as all of this is, it's really nothing new. Financial sector pay has been outpacing what the rest of us make for a long time -- ever since, surprise surprise, 1980. The recent FCIC report included this graph (h/t David Frum):

fcic-compensation-chart

Hmm. Wonder what could possibly have coincided politically with that departure point? Could it be the demise of Glass-Steagall? Free market obsession? Declining union power? Nah. It's probably just a coincidence.

Bryce Covert is Assistant Editor at New Deal 2.0.

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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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