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

Jan 18, 2011

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

Visit msnbc.com for breaking news, world news, and news about the economy

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

Visit msnbc.com for breaking news, world news, and news about the economy

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

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

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

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Wall Street Isn't Paid Enough

Jan 14, 2011Bryce Covert

Sky-high bonuses send a clear message about where our values lie.

Sky-high bonuses send a clear message about where our values lie.

A Bloomberg article from yesterday compared some numbers that should serve as a stark wake-up call: traders and investment bankers (read: people on Wall Street) make more in this country than neurosurgeons, cancer researchers, engineers, and four-star generals. That's right, folks -- if you go into the noble profession of trying to eradicate one of the most pernicious diseases, you can't expect to get paid nearly as much as someone trading derivatives of oil prices. I also suspect that General Patraeus feels his sacrifice to our country and his four-star status should earn him more than someone on the floor of the stock exchange. But of course you can't look to the banking industry for some humility in recognition of their sky-high checks. "The bottom line is all the people in investment banking understand that they work harder and are under more stress," Jeanne Branthover, a managing director at Wall Street recruitment firm Boyden Global Executive Search, told Bloomberg. "Many don't think they're paid enough." What a terrible life that must be! If only they could afford to buy yachts and go relax in the Caribbean.

But the outrage doesn't end there. Compare the estimated $2 million in pay that an M&A banker with 10 years of experience can expect to the $80,970 per year the average teacher in the top 10% will get. (Median teachers will be paid between $47,100 and $51,180 per year.) What's the value a dedicated teacher adds to our society? Educated children, who can expect higher incomes, greater productivity, and a better chance at coming up with the new ideas that take our country forward. Not to mention the harder-to-calculate benefits of children who learn to share, make friends, abide by social norms, and understand their role as citizens. What's the value that we get from a derivatives trader? It's still unclear.

Not to mention that those truly suffering right now (as opposed to the stressed out bankers who demand more zeroes on their bonus checks), i.e. the unemployed, when lucky enough to find a job are now landing ones that have dismal pay. Sixty percent of new jobs last year were in temp work, leisure and hospitality, and retail. Leisure pays an average hourly wage of $13.14 and retail will get you $11.84, while temp packagers only get $8.62.

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All of this sends a signal to young people as we live through this great recession. As I've mentioned before, we face some serious financial insecurities, greater than what many of our parents had to face when they were growing up. This means many of us will be calculating when we choose what to study in college and where to aim our career goals. Should I become a cancer researcher or a banker? The pricetag comes into play. Add to this the debt students are asked to take on at every step of their education, and the prospect of being awarded $2 million for two years in an MBA program versus $571,000 for 2-3 years in medical school and 6-8 years in residency that neurosurgeons must go through seems pretty enticing. Primary care doctors, which we desperately need more of, can expect to earn $186,044 per year for about the same amount of school and residency it takes to get into surgery. No wonder, then, that the smart calculate that they're better off going into specialties when looking at their student loan bills. The even smarter skip medicine and head straight to lower Manhattan.

Compensation is a way of valuing an employee. As the bankers rightly point out, harder work should usually lead to higher pay. So should the value put back into society. Bankers work hard, and we need them to facilitate lending and make the gears of the economy run smoothly. But does that value outrank the work a neurosurgeon does to save someone's life, like Dr. Rhee's miraculous work that led to Rep. Giffords opening her eyes two days ago? Should a banker make 20 times what a cancer researcher does? Our compensation scales are out of whack.

Bryce Covert is Assistant Editor at New Deal 2.0.

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Plus ca Change...Rooseveltians React to Obama's New Economic Adviser

Jan 7, 2011

What does Obama's choice of Gene Sperling as his new top economic adviser mean? Roosevelt Institute fellows and ND20 friends weigh in.

Thomas Ferguson, Senior Fellow at the Roosevelt Institute and Professor of Political Science at U Mass, Boston:

What does Obama's choice of Gene Sperling as his new top economic adviser mean? Roosevelt Institute fellows and ND20 friends weigh in.

Thomas Ferguson, Senior Fellow at the Roosevelt Institute and Professor of Political Science at U Mass, Boston:

Before he joined Treasury as Geithner's "Counselor," Sperling "earned" almost $900,000 advising Goldman Sachs on its philanthropic ventures, plus almost half a million dollars more from the Philadelphia Stock Exchange. Never mind the fees and honoraria he picked up from all the other financial luminaries. The key point is that payments on this scale to such political figures do not represent normal market rates for real services. He took in more from Goldman alone than many full time lobbyists earn in a year. What the White House really just announced are the names of the financial monsters with gold-plated access to the highest levels of economic policy making. That is, the winners of a rigged, money-driven lottery, and the people paying are going to be the rest of the citizenry. It's enough to drive one to drink a giant pot of tea.

Bo Cutter, Senior Fellow at the Roosevelt Institute and served as leader of Obama’s OMB transition team:

Gene Sperling is a very able man, whether or not he is a good choice as Chair of The National Economic Council is a different question. My own view is that both the President and the nation require a fundamentally different economic policy. Gene is certainly capable of delivering that policy but is he temperamentally ready to lead in developing it, and has President Obama asked for it?

Marshall Auerback, Senior Fellow at the Roosevelt Institute:

President Obama has spoken of Reagan as a transformational president, and he was quite dismissive of the Clinton Administration during the 2008 primaries. Yet with the appointment of yet another Clintonista, Gene Sperling, one would be hard-pressed to find any differentiating factor between the Clinton and Obama presidencies. Arguably, the current administration is even worse, since Clinton at least had a few progressive voices such as Robert Reich in his Cabinet. True, Clinton faced relatively minor problems while Obama is neck-deep in recession and must deal with stagnant income growth. The difference in conditions allowed the former president to reshape his administration by positioning and spin doctoring, which provided the illusion of success. But Obama can only succeed by altering outcomes. Americans want jobs, lower unemployment, economic growth, a reduced deficit and an end to the recession. They will not be assuaged or appeased by nice speeches or perceived moves to the center via "triangulation".

Edward Harrison, Founder of Credit Writedowns and New Deal 2.0 Contributor:

The Gene Sperling pick is very much in line with what I expected now that the Obama Administration has moved into re-election mode. Beside making the technical recovery stick, above all, the administration wants to present a more pro-incumbent business face. The Sperling announcement allows them to do so without being perceived on the left as completely submitting to Wall Street. There is nothing objectionable about Gene Sperling's positions on issues of substance for the Democratic base. However, in my view, the Sperling appointment is another indication of the revolving door between Wall Street and politics. Sperling is yet another Clinton appointee who left for big money on Wall Street only to re-appear in the Obama Administration. How do the French put it? Plus ça change, plus c'est la même chose.

Lynn Parramore, Editor of New Deal 2.0 and Media Fellow at the Roosevelt Institute:

Welcome to another episode of 'As the Revolving Door Turns', a depressing soap opera that has become a signature of the Obama administration. Sperling is yet another example of an adviser with close ties to Wall Street formed by chains of big money. He is also a known deficit hawk -- just the sort of discredited economic thinking we should be leaving behind as the nation continues to suffer. This sounds like good news for Wall Street; bad news for the American people.

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Bill Daley Can Build Bridges

Jan 7, 2011Bo Cutter

I believe Bill Daley is a wonderful choice as White House Chief of Staff. I know him well and believe he has all of the right skills: he is very smart; he is a real manager; he has been a cabinet member; he has the gravitas and experience to tell the president what he has to know, rather than what he wants to hear; he has as good a network as anyone in America; he is action- and decision-oriented; and his heart is in the right place.

Shaping the future with today’s choices.

I believe Bill Daley is a wonderful choice as White House Chief of Staff. I know him well and believe he has all of the right skills: he is very smart; he is a real manager; he has been a cabinet member; he has the gravitas and experience to tell the president what he has to know, rather than what he wants to hear; he has as good a network as anyone in America; he is action- and decision-oriented; and his heart is in the right place.

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Progressives' initial reaction may be skeptical. I would urge people to cut Bill Daley a break. Yes, he most recently comes from a banking background -- it happens to be just about the only major American bank that managed itself well during the financial debacle. Yes, he comes from a business background. I'm obviously a bit conflicted on this point because so do I. But I think "Main Street" is a natural ally for a large number of progressive issues, and I know that the Obama-business relationship is poisonous right now. Bill Daley can build bridges here that the Obama Administration badly needs to have built.

Roosevelt Institute Senior Fellow Bo Cutter is formerly a managing partner of Warburg Pincus, a major global private equity firm. Recently, he served as the leader of President Obama’s Office of Management and Budget (OMB) transition team.

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ND20 Alert: Eric Alterman's 'Kabuki Democracy' Will Be Released Jan. 11

Jan 6, 2011

alert-button-150Eric Alterman's widely-discussed essay in The Nation on the systemic obstacles to progressive governing has been expanded into a book that will appear on shelves next Tuesday, Jan. 11.

alert-button-150Eric Alterman's widely-discussed essay in The Nation on the systemic obstacles to progressive governing has been expanded into a book that will appear on shelves next Tuesday, Jan. 11. In the essay, Eric outlined in gory detail how the American economy has been captured by international banking and corporate interests determined to squeeze as much money out of ordinary folks as they can, and how liberals face daunting odds in confronting them. Eric will be discussing his new volume, Kabuki Democracy: The System vs. Barack Obama, at Manhattan's Barnes and Noble on 82nd Street and Broadway at 7pm the night of the release. Fans of his historically-grounded work and provocative style can also catch him Jan. 11 on The Brian Lehrer Show on WNYC, Hardball on MSNBC, and ParkerSpizer on CNN.

After that he'll be touring the country, touching down in Seattle, Portland, San Francisco, Capitola and Washington, D.C.

Click here for complete tour schedule.

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Don't Let the New Financial Elite Become the Ruling Class

Jan 6, 2011Mike Konczal

Their beliefs spell certain doom for the American middle class.

Their beliefs spell certain doom for the American middle class.

There's been a series of back-and-forths about the rumored shortlist for the National Economic Council spots and their ties to Wall Street. Brad Delong notes that he himself has been a Rubinite for 18 years and that "you want to draw your White House staff from successful managers...and that there are only three groups of successful managers who are Democrats: Hollywood studio executives and their ilk, people who have made careers in government and academia, and executives who have worked for traditionally-Jewish investment banks. If you want managers in a Democratic administration, that's where they have to come from. " Felix Salmon responds here and here.

DeLong's point seems to restate the issue, which is: why is there such an overlap between Wall Street and the Democratic Party, and what consequences does that have? Finance is a big sector, and Democrats could pick from any number of places within it (or elsewhere), yet they go for the large investment banks.

I'd point out a few consequences. The first is that as Tim Duy wrote in a must-read post, "What I find curious is that DeLong neglects to mention what I believe was a central element of the Rubin agenda, and an element that was in fact the most disastrous in the long run -- the strong Dollar policy." More:

The strong Dollar policy takes shape in 1995. At that point, Rubin made it clear that the rest of the world was free to manipulate the value of the US Dollar to pursue their own mercantilist interests. This should have been more obvious at the time given that China was last named a currency manipulator in 1994, but the immensity of that decision was lost as the tech boom engulfed America.

Moreover, Rubin adds insult to injury in the Asian Financial Crisis, by using the IMF as a club to enact far reaching reforms on nations seeking aid. The lesson learned -- never, ever run a current account deficit. Accumulating massive reserves is the absolute only way to guarantee you can always tell the nice men from the IMF and the US Treasury to get off your front porch.

It's also very likely that the Rubinites in the administration are the ones pushing for deficit reduction as we come out of the worst downtown since the Great Depression. They are also likely emphasizing the "structural" nature of unemployment, particularly generated by the believed uncertainty of the budget deficit. Rubin himself has pushed in these directions recently. These two claims are disastrous for the Democrats, and the worry from many on the outside, myself included, is that these are the voices most strongly heard on economic policy.

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A larger problem, though, is that the mentality of the new financial elite could take over policy and ideological thinking within the party supposedly working for the interests of working people. From Chrystia Freeland's fantastic new Atlantic Monthly article The Rise of the New Global Elite:

The good news — and the bad news — for America is that the nation’s own super-elite is rapidly adjusting to this more global perspective. The U.S.-based CEO of one of the world’s largest hedge funds told me that his firm’s investment committee often discusses the question of who wins and who loses in today’s economy. In a recent internal debate, he said, one of his senior colleagues had argued that the hollowing-out of the American middle class didn’t really matter. “His point was that if the transformation of the world economy lifts four people in China and India out of poverty and into the middle class, and meanwhile means one American drops out of the middle class, that’s not such a bad trade,” the CEO recalled.

I heard a similar sentiment from the Taiwanese-born, 30-something CFO of a U.S. Internet company. A gentle, unpretentious man who went from public school to Harvard, he’s nonetheless not terribly sympathetic to the complaints of the American middle class. “We demand a higher paycheck than the rest of the world,” he told me. “So if you’re going to demand 10 times the paycheck, you need to deliver 10 times the value. It sounds harsh, but maybe people in the middle class need to decide to take a pay cut.”...

When I asked one of Wall Street’s most successful investment-bank CEOs if he felt guilty for his firm’s role in creating the financial crisis, he told me with evident sincerity that he did not. The real culprit, he explained, was his feckless cousin, who owned three cars and a home he could not afford. One of America’s top hedge-fund managers made a near-identical case to me — though this time the offenders were his in-laws and their subprime mortgage. And a private-equity baron who divides his time between New York and Palm Beach pinned blame for the collapse on a favorite golf caddy in Arizona, who had bought three condos as investment properties at the height of the bubble.

It is this not-our-fault mentality that accounts for the plutocrats’ profound sense of victimization in the Obama era... Yet many of America’s financial giants consider themselves under siege from the Obama administration — in some cases almost literally. Last summer, for example, Blackstone’s Schwarzman caused an uproar when he said an Obama proposal to raise taxes on private-equity-firm compensation — by treating “carried interest” as ordinary income — was “like when Hitler invaded Poland in 1939.”...

A Wall Street investor who is a passionate Democrat recounted to me his bitter exchange with a Democratic leader in Congress who is involved in the tax-reform effort. “Screw you,” he told the lawmaker. “Even if you change the legislation, the government won’t get a single penny more from me in taxes. I’ll put my money into my foundation and spend it on good causes. My money isn’t going to be wasted in your deficit sinkhole.”

He is not alone in his fury. In a much-quoted newsletter to investors last summer, the hedge-fund manager — and 2008 Obama fund-raiser — Dan Loeb fumed, “So long as our leaders tell us that we must trust them to regulate and redistribute our way back to prosperity, we will not break out of this economic quagmire.” Two other former Obama backers on Wall Street — both claim to have been on Rahm Emanuel’s speed-dial list — told me that the president is “anti-business”; one went so far as to worry that Obama is “a socialist.”

Instead of soul-searching for why the financial crisis happened, they incriminate middle-class Americans. Instead of looking at the latest research finding that securitization and Wall Street intermediation increased the supply of credit, and supply always finds its demand, they blame average Americans for demanding too much credit.

And the most worrisome thing is that the obvious solutions for where we are -- a short period of higher inflation, massive credit writedowns, and a larger government deficit paid for with higher taxes on the rich and the largest banks -- are all things this new financial elite hate. And the current debates about "structural unemployment" or a lack of interest in jobs covers for this elite's obvious belief -- that the American middle-class was an anomaly of history, an artifact of the Cold War and the post-WWII era. They believe that Americans are going to have to take a massive cut in wages in order to recover. This was the argument in the age of Keynes, and it is the argument now. No wonder the Democratic party looks paralyzed from the outside.

Mike Konczal is a Fellow at the Roosevelt Institute.

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Drinking Austerity Kool-Aid in 2011

Jan 4, 2011Marshall Auerback

What’s coming in 2011?  We asked thought leaders to share their perspectives on the biggest challenges for the year ahead, along with the changes they’d like to see and the hopes they cherish. Marshall Auerback explains how misguided attempts to reduce the deficit kill jobs, squeeze the working and middle classes, and inflate crude oil prices. And a corrupt political system doesn't help.

The beginning of the year always seems a good time to lay out some broader themes which could develop throughout the year, good and bad, so here goes:

What’s coming in 2011?  We asked thought leaders to share their perspectives on the biggest challenges for the year ahead, along with the changes they’d like to see and the hopes they cherish. Marshall Auerback explains how misguided attempts to reduce the deficit kill jobs, squeeze the working and middle classes, and inflate crude oil prices. And a corrupt political system doesn't help.

The beginning of the year always seems a good time to lay out some broader themes which could develop throughout the year, good and bad, so here goes:

The good news is that the US budget deficit still looks to be large enough to support modest top line growth and sustain and stabilize incomes, even if it's not large enough to bring the jobs we need. As I've argued many times in the past, higher government deficits facilitate private sector deleveraging and continuously add to incomes and savings. It is no coincidence that the financial burdens of households and corporations have continued to fall (and savings rates risen) as government deficits have increased.

Unfortunately, the new Congress appears bent on misguided deficit reduction. By next week, the House of Representatives will have a deficit hysteric majority, with many pledged to a balanced budget amendment. And the world seems to be leaning towards fiscal tightening pretty much everywhere. The unemployment benefits program has been extended, but benefits still expire after 99 weeks, and less in many states. Net state spending continues to decline as state and local governments continue to reduce their deficits.

It is true that state tax collections are up quite nicely these days. But even with the recent improvement many states' total monthly collections are just getting back to 2007/2008 levels, so they are not in the position to ramp up spending. The commentators who are crowing about the current increase in revenues do not understand the historical significance of the extreme weakness we have seen for two full years. As Philippa Dunne (co-author of the excellent Liscio Report) has pointed out to me, sales taxes began to show signs of trouble in early 2007. Catch-up in the funding of unfunded pension liabilities will also continue to be a drag on demand.

Clearly, much of the emotion surrounding government deficit spending could be rectified if we simply viewed the deficits for what they really are. The budget balance is the difference between total revenue and total outlays. At the federal government level, if total revenue is greater than outlays, the budget is in surplus and vice versa. It is a simple matter of accounting with no theory involved. That's it. In other words, without any discretionary policy changes, the budget balance will vary over the course of the business cycle. When the economy is weak, tax revenue falls and welfare payments rise, so the budget balance moves towards deficit (or an increasing deficit). When the economy is stronger, tax revenue rises and welfare payments fall and the budget balance becomes increasingly positive. Automatic stabilizers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom (see this for further explanation).

To judge from statements on both the left AND the right, it is clear that very few politicians get this basic accounting point, which increases the odds that these social programs will continue to come under attack in 2011. This has already occurred in the UK over the past few months. There, a Tory-led coalition government has completely drunk the deficit reduction "Kool-Aid". Instead of the public sector providing employment leadership at a time when the private sector is not yet ready to expand jobs growth, David Cameron's administration has been cutting jobs and forcing unemployment up (see the UK's Labour Market Statistics). As the austerity drive deepens, the deflationary impact of these job cuts will undermine private sector employment growth. Not that this will stop the cuts from happening here in the US. This sort of economic vandalism has now metamorphosed into "responsible fiscal action", if one is to believe the vast majority of the "experts" in the mainstream commentariat.

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The attacks on public sector unions reflect another flank in this ruthless pincer movement on middle and working class Americans, as this NYTimes article illustrates. It is fascinating to see how the public narrative in the media has gradually shifted over the past year from Wall Street's sociopathic practices (which were directly responsible for the creation of the crisis) to the alleged greed of public employee unions and their pension benefits, many of which were the product of agreed wage negotiation packages in which unions were receiving these pension benefits in lieu of increased wage benefits. During 2008, we were told that the government's hands were tied and that sanctity of contracts had to be honored. This was when the Federal Reserve authorized 100% payouts to the likes of Goldman Sachs on AIG's credit default swaps (in effect allowing the Fed to act as an extra budgetary vehicle of the Treasury, which is a violation of the Constitution and shows how patently false the Fed's claims of independence are). But I don't seem to recall many Wall Street types going on about the sanctity of contracts when agreements with the UAW were reworked to save GM or now when public employee union pension benefits are under attack. The argument seems to be that the states are suffering from a genuine solvency crisis in which everybody has to make sacrifices, including the "greedy" unions. So why should big financial firms, which would otherwise have been toast but for the munificence of the suffering American taxpayer, be any different? If the attacks outlined in the NYTimes piece reflect a broader trend this year, then it has ominous implications for the country as a whole.

Another worry related to the potential diminution of spending power is the troublesome rise in crude prices. Net demand is not up appreciably, and Saudi production remains relatively low. Peak oil dynamics could well be at work here. In a broader sense, what Paul Krugman describes -- "we're living in a finite world, in which the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices" -- could well prove accurate. Which, in the absence of countervailing support to incomes via fiscal policy or increased private sector activity that increases jobs, means cuts in other areas of discretionary spending. Hardly a healthy trend in a world still constrained by inadequate demand. Crude prices are already up enough to be a substantial tax on US consumers that has probably more than offset whatever aggregate demand might have been added by the latest tax package.

A federal pay freeze has been proposed. The Fed's zero rate policy and its continuation of "quantitative easing" both serve to reduce net interest income earned by the economy.

Bank regulators continue to impose policies that work against small bank lending, whose wholesale funding costs are substantially higher than their "too big to fail" counterparts. The Dodd-Frank "financial reform" entrenches the dominance of the systemically dangerous institutions at the expense of the 6,000 or so other banks that engage in classic loan intermediation activity -- the sort of thing we want our banks to be doing.

Overseas, the euro zone looks set to muddle through with very weak domestic demand. The periodic disruptions to the credit markets have hitherto been mitigated by repeated European Central Bank bond buying of the national debts in the secondary markets, but at the cost of further fiscal austerity being imposed on the periphery countries.

What about the emerging world, which has hitherto been held out as the major repository of global growth? Does China slow as a result of fighting inflation? Or Brazil? Maybe India as well?

Finally, there is the odious problem of political corruption, which manifests itself in many forms, but most recently through the cynical revolving door policy between Wall Street and government. Peter Orszag's move to Citi after spending months launching broadsides against Social Security from his perch at OMB and then the NYTimes goes beyond cynicism. Nobody expects a former government official to live like a monk after spending time in public service. But the idea that someone would help plan, advocate, and carry out an economic policy that played such a crucial role in the survival of a financial institution and then, less than two years after his administration took office, would take a job that (a) exemplifies the growing disparities the administration says it's trying to correct and (b) unavoidably call on knowledge and contacts he developed while serving at OMB is sickening in the extreme. That his successor also comes from Citi simply perpetuates the incredulity. All this, under an ostensibly "progressive" Democratic administration.

The revolving door between Wall Street and Washington calls attention to the rotten heart at the core of the American polity today -- what James Galbraith has felicitously termed "the predator state". The state has become too weak and therefore remains another instrument of corporate predation. The revolving door policy (eagerly embraced by this president, much like his predecessors) perpetuates the problem because it enhances the dominance of the so-called "FIRE" (finance, insurance, real estate) sector of the economy. The FIRE sector simply acts as a parasite on the production and consumption core, extracting financial and rent charges that are not technologically or economically necessary costs. Its revenue takes the form of what classical economists called "economic rent," a broad category that includes interest, monopoly super-profits (price gouging) and land rent, as well as "capital" gains. Its ethos consists largely of denuding the state of any provision of public goods, privatizing the public domain and erecting tollbooths to charge access fees for basic necessities such as health insurance, land sites, home ownership, the communication spectrum (cable and phone rights), patent medicine, water and electricity, and other public utilities, including the use of credit cards or the credit needed to get by. It's a zero-sum economic activity. One party's gain (that of Wall Street usually) is another's loss. It looks like we'll have much more of the same as we enter into 2011.

"Happy" New Year everybody.

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

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2011 Will Bring More De facto Decriminalization of Elite Financial Fraud

Dec 28, 2010Bill Black

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Wallace Turbeville Explains it All on Clearinghouse Governance

Dec 16, 2010Mike Konczal

mike-konczal-2-100Get the 411 on reforming those who control derivatives trading.

There's been a lot of blogosphere attention to this Louise Story article in the New York Times, A Secretive Banking Elite Rules Trading in Derivatives (see Felix Salmon, Kevin Drum).

For those who are interested in the regulation of derivative clearinghouses after the Dodd-Frank Act, I'd highly recommend this paper by Wallace Turbeville, Derivatives Clearinghouses In the Era of Financial Reform (pdf). It was presented at the Roosevelt institute's The Future of Financial Reform conference:

mike-konczal-2-100Get the 411 on reforming those who control derivatives trading.

There's been a lot of blogosphere attention to this Louise Story article in the New York Times, A Secretive Banking Elite Rules Trading in Derivatives (see Felix Salmon, Kevin Drum).

For those who are interested in the regulation of derivative clearinghouses after the Dodd-Frank Act, I'd highly recommend this paper by Wallace Turbeville, Derivatives Clearinghouses In the Era of Financial Reform (pdf). It was presented at the Roosevelt institute's The Future of Financial Reform conference:

Will It Work? How Will We Know?: Wallace Turbeville from Roosevelt Institute on Vimeo.

Turbeville is a derivatives specialist at Better Markets and a visiting scholar at the Roosevelt Institute; he formerly led VMAC LLC as its CEO, which he left in late 2009 to devote his efforts to financial reform, energy, and environmental policy issues. He's an expert in clearinghouse issues. This paper is fantastic, both as an overview and as a detailed response to many arguments.

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For instance, in relation to the New York Times article:

Decision Making and Governance. In the Reform Act, the public has entrusted the clearinghouses with an enormously important role in the economy. Much has been written about potential influence of the clearing members, in particular the banks, on clearinghouses. Our legal colleagues have been concerned with formal governance issues and ownership shares and the CFTC has promulgated proposed regulations limiting ownership by clearing members and requiring independent directors. These issues are important. But far more important is the influence of dealer banks as sources for clearinghouse volume and, as a consequence, revenues. Banks control and direct volume. The Reform Act even provides rules allowing a non-bank counterparty to choose the clearinghouse to be used for a trade. But if that counterparty depends on a bank to be available when it needs a price hedge or credit, it is naïve to think it will resist the desires of that bank.

The real business of a clearinghouse is credit management. This is typically controlled by a tremendously powerful risk committee. Dealer bank involvement on risk committees is common and freely acknowledge. Clearinghouses assert that bank knowledge of risks is helpful; and that their influence is appropriate since the clearing members represented by the banks are at risk if something goes awry.

But 2008 tells us that the public is also at risk if the clearinghouse does not properly balance prudent risk
management with the mandate of the Reform Act. At a minimum, the public’s interest should be represented by membership on the risk committees of major clearinghouses. Regulatory representation, or representation by other public interest organization, would legitimize the process as long as resources and expertise were provided to challenge decisions such as which derivatives are cleared and which are not.

At a recent roundtable held by the SEC and CFTC on clearing, a representative of JP Morgan said that the financial sector would support a governmentally owned clearinghouse that was guaranteed by the government. It is an intriguing idea, especially if the italicized language were dropped. A government guarantee might even make sense, so long as it kicked in after the clearing members bore all of the losses they could; a!er all, that is where we are anyway.

To the general argument over why clearing hasn't happened if it is such a good idea and why end-users would resist a mandate or not create one themselves, which are central to the debate:

Why the preference of bi-lateral transactions over clearing? Here are some possibilities:

• Financial institutions can offer credit to customers in the form of foregone collateral to cover risk. The credit is tied to an advantageously priced derivatives trade. The price of the credit, embedded in the derivatives price, is obscured. In practice, derivatives embedded lending is considered by banks as much more lucrative than straightforward corporate lending.

• Customers may value the hedge and the embedded credit extension more than a derivatives price which is tight to the market. O!en, their primary task is to hedge and the price is secondary. Think of a regulated utility whose fuel and purchased power costs are passed through to consumers, but who need to hedge to please the ratings agencies and equity analysts.

• The credit extension is not reported by the customer the same as direct lending, so their balance sheets appear healthier. These motivations are predominant among end users.

I recommend reading the whole thing.

Mike Konczal is a Fellow at the Roosevelt Institute.

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