Is Bank of America preparing for a Chapter 11?

Oct 19, 2011 17:23 UTC

Bank of America has managed to step into the kimchee several times over the past couple of months, an achievement that only warms the hearts of crisis communications professionals. First came the abortive settlement of $10 billion or so in put-back claims by some large investors. The State of New York and anyone else paying attention intervened. Settlement is now mostly muerto in political terms, although the big investors are still paying the big lawyers to soldier on in hope of forcing a settlement on all parties.  Only in New York are such things possible.

Then came the decision by Bank America CEO Brian Moynihan to impose a $5 per month fee on ATM transactions, this in response to the Dodd-Frank law which cuts about half of the profits for big banks in the electronic payments market. Consumers reacted in rage to the announcement, which arguably helped to catalyze the Occupy Wall Street movement. Truth is that the big bank’s cartel control in payments is under assault by more than Congress. Think technology, Apple and Google, and stay tuned for a future post on the payments revolution. Steve Jobs does get the last laugh on the big banks.

Most recently Bank America drew attention to itself by disclosing that it had moved all of the derivatives footings from its Merrill Lynch subsidiary to the lead bank, Bank of America N.A. Bloomberg ran the first story, reporting “BofA Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit.” This report led to comments and reports claiming that the Fed, by allowing this move, had somehow impaired the national patrimony and violated Section 23A of the Federal Reserve Act. Section 23A is among the more bizarre parts of the Fed’s enabling law and governs transactions between banks and affiliates.

Bill Black of University of Kansas City told me that the Bank America move was not merely an administrative exercise. “Here, B of A was not the counterparty,” says Black. “The 23A issue is moving an exposure [from Merrill Lynch] that is in trouble to the insured institution, apparently at book value, from an uninsured affiliate. That should be an easy call: ‘No.’ The Fed cares about BHCs and is institutionally primed to say yes to this kind of deal, while the FDIC is institutionally primed to protect the FDIC insurance fund.”

While I am sympathetic to concerns about potential losses to the FDIC bank insurance fund, the fact is that FDIC can reject any contract between any party and a failed bank. Truth to tell, however, such changes in the counterparty for OTC derivatives exposures are not that surprising for people who follow the securities industry. Goldman Sachs, Morgan Stanley, et al have moved their swaps business “in the bank” long ago. As Bloomberg notes, 99% of all of JPMorgan’s swap book flows through the lead bank. And yes, the Merrill business was particularly exotic, but keeping it in Merrill running through the smaller, FDIC insured Merrill depositories would probably be more of a risk to the Bank America group.

So the real question is why now? Susan Webber of Aurora Advisers, in her Yves Smith nom de plume on Naked Capitalism, commented on the motives behind and timing of the change:

You can argue that this is just normal business, the other big banks have their derivatives operations largely in the depositary. But BofA has owned Merrill for over a year and a half, and didn’t undertake this move until it was downgraded. Goldman and Morgan Stanley remaining big players in this business and don’t have a large depositary. If this was all normal business, BofA would have done this a while ago, and not in response to market pressure, and they would have gotten the FDIC on board. The way this was done says something is amiss.

Correct. To my earlier post regarding the need for a restructuring at BAC, “Housing, debt ceilings & zombie banks,” the move to put the derivatives exposures of Merrill Lynch under the lead bank could be preparatory to a Chapter 11 filing by the parent company. The move by Fannie Mae to take a large chunks of loans out of BAC, the efforts to integrate parts of Merrill Lynch into the bank units earlier this year, and now the wholesale shift of derivatives exposure all suggest a larger agenda.

I don’t have any access to inside skinny, but what I see suggests to this investment banker that a restructuring may impend at Bank of America. In the event, that is good news in a sense that this continuing distraction to the financial markets will be headed for a final resolution.

COMMENT

Tank of America is in sooo much more trouble than they want anyone to believe. I’ll give you just one example of why this is true. ReconTrust Co. the repo arm of B of A is a wholly owned subsidiary of that bank that is responsible for running the foreclosure auctions of B of A. In one state alone RepoTrust website lists more than 5000 homes to be sold at auction.
The problem is that many of the “assignments” are illegal since either the entity making the assignment lacks legal standing in the matter since it is not a legal party of interest. Parties with no legal claim can not assign anyone to do anything.
The contract is a nullity and any subsequent sale would be voided immediately by even the lowest Court in the land and expose the seller to damages in further litigation. This in conjunction with clearly separating the Deed of Trust from the actual Promissory Note breaks the Chain of Title further voiding any claim a Trustee may try to assert in moving the action forward or assigning a different Beneficiary or Trustee to acts on its behalf. I have attended several of these auctions and I can say each time I have attended not one person is bidding on the sale of those properties. It reeks of the SEC v. Deutsche Bank lawsuit when DB was fined $25 million for padding their auctions and buying their own properties to artificially inflate their sale rates.
If that turns out to be the case here, Tank of America is going down.

Posted by echobravotango | Report as abusive

Are the low US home mortgage rates for real?

Oct 11, 2011 17:33 UTC

We hear on almost a weekly basis that mortgage interest rates in the US are at all-time lows. The annual percentage rates in mortgage advertisements seem near an historic nadir. The Fed has even begun to purchase long-dated mortgage backed securities (MBS) in an effort to push rates even lower and, hopefully, spur more refinancing activity.

But are these rates real? Are all American consumers, especially low-income borrowers, able to borrow at those low teaser rates? The answer in both cases is no. This is a crucial question, as we have discussed on this blog before. Home mortgage refinancing is the primary conduit for the Fed to provide liquidity to the US economy. In August of last year, I noted:

‘In every Fed easing event during my career in finance (1986, 1992, 1998, 2002), it was the wave of refinancing of debt after the Fed eased interest rates that put permanent disposable income into the hands of households,’ notes a former Fed official who worked in the banking industry for decades. ‘In this last easing, however, FNM, FRE and the TBTF banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.’

Since last year, little has changed. On Friday, Housing Wire reported that “Prepayments, mostly through refinancing, on mortgages backing Fannie Mae and Freddie Mac securities increased substantially in September, higher than what some analysts expected.” In fact, prepayment on FNM 4s surged over 100%, but the real story was the fact that prepayments on higher coupon FNM paper actually fell as shown in the table below.

Fannie Mae 30-Year Prepayments (September):

Coupon (vintage) Change in prepayment rate (%) Amount outstanding (B$)
4s (2009) + 130 102
4s (2010) +157 112
4.5 (2009) + 80 227
4.5 (2010) + 100 124
5 (2009) + 29 69
5 (2005) + 5 51
5.5 (2008) - 8 65
5.5 (2005) 0 45
6 (2007) - 4 62
6 (2006) - 8 43
6.5 (2007) - 13 16
6.5 (2006) - 9 17

Source: Fannie Mae/Absalon

While most of the business currently being written by banks and the GSEs is related to refinancing, the vast bulk of the loans are being written against relatively low coupon loans. Home owners with older, high coupon loans are largely excluded from the refinancing activity.

More, two of every three mortgage refinancings done by banks and guaranteed by the GSEs since 2008 have gone to higher income households. Low income families who need the benefit of lower rates are mostly locked out. One key telltale in the Fannie data about the discrimination against low income borrowers: The average loan size of the older, high-coupon loans is almost half that of new loans.

Notice that virtually all of the increases in prepayments were recorded in FNM 4s and 5s, while prepayment speeds actually fell for the older, higher coupon loans. The higher income households who held high coupon loans from the 2008 and earlier time frames have largely refinanced, leaving only the low income borrowers trapped by the GSEs and investors in MBS who do not want these needy American families to refinance.

Remember that the Fed is already diverting more than half a trillion dollars a year from savers to the banks through low interest rates. The behavior of the GSEs and the top four banks – JP Morgan, Bank of America, Citigroup and Wells Fargo – which prevent lower income Americans with performing loans to exercise their contractual right to refinance borders on the criminal. But in terms of public policy, the blockade by the GSEs and the zombie banks is blocking the Fed’s efforts to reflate the consumer sector and help the US economy.

Treasury Secretary Tim Geithner has stated that the Obama administration is moving forward with plans to help more homeowners refinance out of higher rates. But Congress and members of the media should ask Secretary Geithner why he has been dragging his feet with respect to forcing the GSEs to refinance all of these older, high coupon loans to help the most needy Americans. The fact that Geithner and Federal Housing Finance Administration chief Ed Demarco are responsible for blocking more than 30 million American families from refinancing their mortgages is an outrage.

What should be done? In a presentation to the Mortgage Bankers Association in Chicago the other day, Alan Boyce of the Absalon Project listed a number of steps that Geithner and the White House need to embrace. Obama should require FHFA to direct GSEs to use all tools available to stimulate more home refinancings. Specifically:

•Eliminate loan level pricing adjustments for the refinancing of ALL loans currently guaranteed by the GSEs

•Eliminate the 25bp “Adverse Market Fee” imposed after the government takeover of Fannie and Freddie.

•Eliminate appraisals and paperwork as part of a new “Super-Streamlined” refinance program

The key requirement is that the borrower be current on the existing mortgage that is guaranteed by the taxpayers. Boyce believes that following this approach will have big benefits. Some 25 million new refinancings from 32 million tax payer backed loans will reduce mortgage payments of about $51 billion. Lower income borrowers will get over half of these savings.

And there are big benefits for the banks. Underwater borrowers at greatest risk of default will get some financial breathing room. Improved labor mobility provided by refinancing will reduce unemployment and also help to lessen the chance of a second wave of loan defaults. And, most importantly, the single biggest obstacle to the Fed’s efforts to add liquidity to the consumer sector will be removed. The hour is late, but prompt action now can make a big difference to the economy in 2012 and beyond. Does President Obama have the courage to act?

COMMENT

Please remember that an unknown percentage of the high coupon loans have seconds which will need to be resubordinated. What do your numbers look like when you screen out the loans with seconds (and thirds)?

Posted by VoxNihili | Report as abusive

The cure for higher ATM fees is competition

Sep 30, 2011 16:03 UTC

Why are Bank of America and other large US banks increasing fees for the use of debit cards and other services?

The short answer is regulation. The Fed’s low interest rate policy has a big effect on how banks price all services. Specific to ATM fees, Congress has decided to regulate the fees charged to vendors by banks on electronic transactions, essentially cutting this profit center in half for the largest banks that have $10 billion or more in assets. This fee is still far more than the actual cost to the bank providing the service, but such is life in America’s less-than-free market. Like airlines, the “too-big-to-fail” (TBTF) banks are not really profitable, thus pricing of one product is often skewed to make up for shortfalls in another.

When you look at the TBTF banks, which dominate the industry in the U.S. today, all of them feature business models where monopoly pricing power and the much abused free market operates. The reasons for this are complex, but the power of the TBTF banks – Bank of America, JPMorgan, Wells Fargo and Citigroup – largely stems from the fact that they remain heavily regulated and protected by these same captured regulators led by the Fed. Thus there is no competition for the services these large banks provide.

Despite the gazillions of words written about deregulation in the financial services industry, there is the Bank Holding Company Act of 1956, which provides the Fed with the power to regulate companies that own banks and thus it protects the TBTF institutions from competition. If Google, Wal-Mart and Amazon were permitted to own banks and thereby compete with Bank America et al in the electronic payments business, the cost of electronic payments to small vendors and consumers would plummet.

The fact that the Dodd-Frank legislation mandates some artificial relief for consumers and small businesses is lovely, but the real solution to the problem of the TBTF banks and their monopoly pricing power regarding electronic payments is competition. As former Fed of New York general counsel and White & Case partner Ernest Patrikis told me in a 2008 interview:

What is the rational for the Bank Holding Company Act and thereby making it more difficult for companies to acquire control of banks? I’ll give you two rationales. First is the Fed continues to believe in the separation between backing and commerce, something for which I do not have a lot of respect. Citicorp’s becoming a one-bank holding company and thereby gaining the ability to engage in all sorts of non-bank services was one prime motivation for amendments to the Bank Holding Company Act in 1968.

Which lead me to then ask Patrikis: Well, aren’t we done with the 19th Century? Isn’t Glass-Steagall over and done with? His reply:

No, not really. We still have the Bank Holding Company Act. While Gramm-Leach-Bliley greatly broadened the activities permissible for bank holding companies, it has not been entirely eliminated. Few countries in the world have limitations like that, maybe Japan. Most countries do not impose activity limitations on companies controlling banks. With limitations on transactions between banks and controlling persons, is that limitation necessary?

Much of what banks do today is not special and does require the vast protective apparatus of the Fed and other regulators, but these same regulators also protect the zombie banks from competition. While protecting deposits and other payment system functions is important, these safeguards exist today and would continue tomorrow if Wal-Mart, for example, were allowed to proceed with its wish to operate a bank. But how about Amazon or Google?

While the US banking industry has been successful so far in coercing the FDIC not to process applications by commercial firms to operate near-bank industrial loan companies allowed by some states, the rising consumer uproar over fees for ATM transactions and other services illustrates why we need to repeal the Bank Holding Company Act.

My friend Yves Smith, proprietor of Naked Capitalism, urged readers that use Bank of America to “take their revenge. Move your accounts to a small bank. Cancel your Bank of America credit cards. And be sure to let a bank customer services rep know exactly why you are done with them.”

I have a better idea: Open up the TBTF banks to competition. That will make the TBTF banks a lot smaller. And the regional and community banks will do just fine in this environment. The truth is that smaller institutions are better at underwriting credit and providing consumers with relevant, reliable services. Give them cheaper, more modern tools and services, and smaller banks will actually thrive.

Open up the US banking industry to less expensive transaction processing and other back end services that will come with deregulation of these industries and smaller lenders and agencies will do just fine. Annihilate the TBTF bank cartel in payments and the systemic risk problem will, to use the Marxist-Leninist term, “wither away”.

COMMENT

“the “too-big-to-fail” (TBTF) banks are not really profitable”… I call you out on this statement…. This is either a total LIE, or you’re buying into their fraud….
Prove this statement…. You can’t….

Posted by edgyinchina | Report as abusive

Housing, debt ceilings & zombie banks

Aug 17, 2011 15:08 UTC

In a Washington Post report this week, the Obama Administration was said to have decided to adopt a proposal to continue a major government presence in financing mortgages.  The Treasury subsequently denied this report in a statement posted by Deputy Secretary Neal S. Wolin:

“The Obama Administration believes that the private sector – subject to strong oversight and consumer protection – should be the dominant provider of mortgage credit.  That’s why, in each of the three options we outlined in our report to Congress, the government’s footprint in the housing finance market will shrink substantially.  That’s why, in each of the options, any government support for housing finance will be targeted and limited. This will help ensure that taxpayers are protected and the private sector bears the burden for losses.”

Would that any of this were really true.  Let’s go through this statement and pick out some of the more notable canards and omissions of fact.  First and foremost is the idea that the private sector is willing to take a leading role in housing finance in the U.S.

Since the 1930s, the U.S. has used a full-faith-and-credit guarantee for housing finance to turn disparate home mortgage notes into commodities attractive to investors.  The private mortgage market prior to the Great Depression and the New Deal is not comparable to the government-sponsored market for agency securities today, investment paper that is a close surrogate for Treasury debt itself.

The largest portion of the market for residential mortgage backed securities or RMBS has been government sponsored for 80 years.  By extending guarantees to private mortgage paper, banks were able to package the notes from each home mortgage and sell securities to investors backed by these notes.  This virtuous cycle provided liquidity for the banks, which recovered their principal and then were able to make additional home loans.  That cycle is now broken.

The role of the private sector in the RMBS market has been limited at best with private investors buying significant quantities of non-guaranteed paper only during times of market exuberance in the past decade.  Today banks are avoiding “first loss” risk on U.S. real estate and instead write almost all of their loan production to be guaranteed by one of the three housing agencies — the FHA, Fannie Mae or Freddie Mac.  Almost all of this flow of “new” loan business is refinancing for better borrowers.

This brings us to the second fallacy in the debate over the future of the government role in housing, namely that the current policy is meant to protect the taxpayer and the public generally.  You may have noticed that the Obama Administration has started to talk about creating opportunities to turn foreclosed properties into rental housing, a common-sense initiative that is born of necessity.  Hold that thought.

Empty homes represent tens of billions in future losses to the Treasury.  When the house is sold, the government takes the loss.  Thus the last thing either the Treasury or the White House wants to see is any effort to move the restructuring of the housing sector or the largest banks before the 2012 election.  Delay means higher cost to the taxpayer.

We talked about the need to restructure Bank of America as a precursor to clearing the U.S. housing market in an earlier post on Reuters.com, “Uncertainty and indecision threaten Bank America and global markets.” But given the recent debate over the debt ceiling, President Obama does not want to tell Congress that he needs at least a $1 trillion in borrowing authority to fix the GSEs and the largest banks.  Politics is the chief obstacle to fixing the housing mess.

Attorney Fred Feldkamp reminds us that “we knew virtually all the Texas S&Ls and banks were broke by 1984, but we could not get Congress to permit enough coverage in the federal debt limits and restructuring costs to close the vast bulk of them until FIRREA was passed in August of 1989,” he recalls.  “Even then, Congress tried to renege on the 1988 deals that kept the S&L problem from becoming twice as large.  It wasn’t until 1996-2004 that the people who were promised the 1988 deals received what they bargained for.”

One of the reasons that I have pushed for an FDIC resolution of some of the huge housing exposures facing the largest banks is that the cost can be kept off the federal budget.  FDIC is an industry funded mutual insurance scheme with powerful receivership and debt issuing authority, especially with the Dodd-Frank legislation.  The U.S. banking industry, not the taxpayer, has always paid to clean up the mess in previous crises via the FDIC.  The present housing crisis demands a similar response.

If the banking industry were to use the FDIC to restructure BAC and other large lenders, then immediately spin the smaller, better capitalized banks back into private hands, this would not only help Washington to focus scarce public resources on the losses inside the major housing agencies but would also greatly rehabilitate the industry’s public image.

Americans need to see some good examples of civic action, instances of private people and companies moving with purpose to solve our national problems.  A private sector approach to the housing problem, using the industry funded vehicle at the FDIC to restructure some of the largest banks and breath life into moribund housing assets, could be a powerful tool to that end.  But do we have the courage and the vision to make it happen?

COMMENT

For the record, I’m with Lambertstrether, too. I’ve been advocating widespread RICO prosecutions since 2008, but that is a side issue.

Regarding Chris Whalen’s article, I would like to see some data regarding his assertion that almost all of the “new” real estate loan business is refinancing for better borrowers. I suspect that his claim is true, but are we talking about a 75/25 split or a 95/5 split?

I also agree that the FDIC should now be used to clean up this banking mess. In 2008, the magnitude of the problems would have overwhelmed the FDIC, but there should be no more harm done to taxpayers at this point.

The banking industry needs to quickly expand the size of the FDIC and be start restructuring. BAC has a huge exposure to the tottering Eurozone.

Posted by breezinthru | Report as abusive

Uncertainty and indecision threaten Bank America and global markets

Aug 9, 2011 13:41 UTC

For the past several years, my firm has been arguing that restructuring is the only way to solve the problems facing the largest US banks — the top four institutions that exercise a de facto cartel over the US housing market. After years of earning what seemed to be supra normal returns from the “gain on sale” world of US mortgage originations, the large service banks are now drowning in the same sea of risk that once made them seem so profitable.

As investors have slowly become aware of the concentration of housing risk that surrounds these large banks, they have increasingly shunned them. First with Bear Stearns, then Lehman Brothers, and then the housing GSEs Fannie Mae and Freddie Mac, markets stopped facing these names in the interbank credit markets, then accelerated into a crisis which compelled government intervention.

Now the Obama Administration faces the same threat with Bank of America (“BAC”), an institution that is one of the largest lenders and also servicer of loans in the US.  Millions of payroll deductions, property tax payments and remittances flow through BAC daily. But losses from acquisitions such as Countrywide, Merrill Lynch, as well as hundreds of other operating entities, threaten to bring the bank down. Yet herein is an opportunity for national salvation.

BAC is a too big to fail zombie created by the Obama Administration and the Fed to protect US financial markets, but is now so vast and unstable that it threatens the global economy. But more corrosive and dangerous than the torrents of red ink inside BAC is the steady erosion of public confidence. Uncertainty is the enemy now, both with respect to BAC and to its large bank peers.

The only way to end the uncertainty and also accelerate the economic recovery is to put BAC through a restructuring using the powers under the Dodd-Frank legislation. While a restructuring by the FDIC may seem to be a horrible prospect, in fact it offers the first real hope of definiteness in the housing crisis, the multi-trillion dollar millstone around our collective necks. Indeed, the BAC situation illustrates why the Founders of the US embedded bankruptcy in the Constitution, namely the need for finality.

In mechanical terms, here is how it works. Let’s start the narrative with a last, Hail Mary move by BAC CEO Brian Moynihan, who put the shell corporation that is the legal successor to the Countrywide business into bankruptcy after settlement efforts fail. This engraved message from Moynihan to BAC’s creditors, litigants and even Treasury Secretary Timothy Geithner — “foxtrot oscar” — begins the real endgame.

Hopefully Secretary Geithner will know about the BAC filing before it occurs and will have begun the process under Dodd-Frank to give regulators and especially the FDIC the power to move immediately to protect BAC and its subsidiary banks. In our narrative, FDIC enters the bankruptcy litigation for Countrywide and asserts control of the entire BAC group. BAC becomes effectively a subsidiary of the FDIC, with the full capital and assets of the entire industry behind it.

Once the FDIC is in control of BAC, the process will then proceed like a typical bankruptcy, with the operating units continuing to do business in the normal course. For consumers and business customers, the situation at BAC will be mostly the same. But for investors and especially creditors, the situation will be far from normal.

In a Dodd-Frank resolution, the creditors of BAC will have an opportunity to file claims, much as with any failed bank. Unlike a bankruptcy, however, the FDIC will make all depositors of the subsidiary banks whole before considering claims of creditors of the parent, a significant difference investors ought to consider. Most important, however, will be the process of converting debt to equity in the restructured BAC, providing the resources to absorb losses, fund continuing operations and restructure.

The beauty of a restructuring is that it forces all parties with a claim on the failed company to speak now or forever hold their peace. It also requires the conversion of debt to equity, which increases capital dramatically and also lowers the operating expenses of the enterprise. A super-capitalized BAC with 2-3% asset returns, 30% tangible equity and gobs of cash flow will then be ready to sell assets, modify mortgages and do whatever it takes to restore the ability of the bank to support new leverage. That is why restructuring is the key to US economic revival.

Economists from Irving Fisher to Henry Kaufman have noted that without credit expansion, the US economy cannot grow. In fact, credit is contracting with public confidence in America’s banks. The solution to the financial crisis affecting BAC and the US economic malaise are the same, namely an orderly, immediate public process of restructuring for the top banks and housing agencies. Think of a BAC restructuring as a working model for the rest of the US and EU to emulate.

The good news is that a growing number of observers see what needs to be done, much to the delight of this lonely herald of woe. The bad news is that the Obama White House is clueless, but such is life in a democracy. We can only hope that some of the Americans I now hear talking about the need for restructuring will speak to President Obama and Secretary Geithner sooner rather than later. And if they need help, they know where to find me.

 

 

COMMENT

Fabulous proposal Chris, but isn’t there an argument that the major reason why BAC is presently a too big to fail zombie is because it bought Merril Lynch in October 2008 at the behest of the Treasury and Fed? Moreover, in November 2008 when BAC discovered that ML was in far worse shape than they expected, BAC tried to back out, but was instead coaxed/coerced into staying the course by the Treasury and Fed (at the tail end of Henry Paulson’s term). Would it not be perverse if the Treasury and the Fed now turn around and restructure BAC wiping out equity holders and haircutting creditors? Could not the argument be made by many of the equity holders that they suffered this loss because of intervention of the Treasury and Fed in November 2008?

Restructuring BAC is problematic because of the Treasury and Fed actions. But instead of restructuring BAC, why not go after Citigroup? It too is a too big to fail zombie, but to the best of my knowledge, it did not receive the same commitments that BAC did in the fall of 2008.

Posted by Kosta0101 | Report as abusive

“Reckless Endangerment” and the unwritten history of Washington

Jul 14, 2011 15:45 UTC

Some disclosures: I review the new book, “Reckless Endangerment: How outsized ambition, greed, and corruption led to economic Armageddon”, by Gretchen Morgenson and Josh Rosner, not because both authors are my friends. They are.  Nor do I review this book because it concisely summarizes the confluence of public policy and private avarice we all know as the subprime mortgage crisis. It does, and more.

No, I review this book because it names names. Names and more names, one after another, in that prosecutorial serial fashion readers of Morgenson know very well. The kind of relentless recitation of the facts and names meant to allow readers to follow the logical chain of a criminal act to an indictment.

With Rosner as the ferret of public and not so public data and Morgenson as the journalistic filter and wordsmith par excellence, the book delivers a readable yet detailed account of the people behind the mortgage debacle. When the show trials begin, the judges will have a copy of “Reckless Endangerment” close at hand.

The tale of how Washington played a crucial enabling role in the mortgage mess is a topic I have discussed with Rosner over many years. Morgenson and her fellow scribes at the New York Times have chronicled the debacle on a national scale, though Morgenson does so with a tenacity and sense of public indignation that probably irks some of her more pro-Wall Street peers on the Times’ business page.

This book soundly repudiates the notion that Wall Street led the subprime parade. Instead, it confirms that government intervention going back to FDR and the New Deal set the stage for a public-private orgy decades later. The book describes how government sponsored entities such as Fannie Mae, banks such as PNC Financial, corporations such as Sears Mortgage and private mortgage insurers  such as MGIC, led the way in the fall of 1993 to redefine the government-backed mortgage market, a market that has been backed by the government since the 1930s.

Recall in the early 1990s, when Citibank started to experiment in private mortgage securities coming out of the S&L crisis. Citi, Chase Manhattan and other large banks nearly failed just years earlier. Thus the move by Fannie Mae and the other members of the affordable housing coalition in 1993 to eventually broaden the definition of “conforming loans” to include loans with inferior credit quality and loans with private mortgage insurance is a key political event in the subprime crisis timeline, and also a sop for the big banks. Think of today’s real estate crisis starting in the 1980s, but delayed and made larger by the affordable housing coalition and Alan Greenspan’s Fed. This book tells that story.

Reckless highlights the relationship between former Fannie Mae CEO James Johnson, a Washington player who was a top adviser to Vice President Walter Mondale and former Countrywide CEO Angelo Mozilo. That fateful pairing of Johnson and Mozilo helped take the changes made in Washington to the legal framework of the government mortgage market and catapult them to the stratosphere on Wall Street.

The authors nicely describe how Johnson was the architect of “the disastrous home ownership strategy promulgated by William Jefferson Clinton in 1994. Johnson, after becoming chief executive of Fannie Mae in 1991 and under the auspices of promoting home ownership, partnered with home builders, lenders, consumer groups, and friends in Congress to transform Fannie Mae into the largest and most influential financial institution in the world.” Today, Fannie Mae is under government control again, after decades of being highjacked by various private agendas set by the affordable housing mafia.

The larger banks on Wall Street were not just copying and perverting the government market for mortgages. They also took example from Countrywide, Bear Stearns and the smaller, more aggressive mortgage firms. Countrywide, a firm that was an insurgent real estate company a decade before, grew to the point where by the end of 2005 it was a $250 billion asset national bank that was turning over its balance sheet three times a year.

Countrywide was selling most of that vast flow of new loan origination to Fannie Mae and Freddie Mac, but also sold a large chunk to private investors. Now Bank of America, which acquired Countrywide in 2008 for just $4 billion, faces tens of billions of dollars in legal claims arising from the Countrywide mortgage securitization franchise. Even today, years after the financial crisis began, Bank of America still faces the possibility of a restructuring because of the legal claims against Countrywide.

This fast moving book follows Johnson and Washington contemporaries such as former Treasury Secretary Robert Rubin through the Clinton years and into the mortgage boom years of 2004 and beyond. By then Johnson was sitting on the board of Goldman Sachs, the authors note, and setting the salary for then-Goldman CEO and later Treasury Secretary Hank Paulson. “Reckless” illustrates that people like Johnson, Rubin and Paulson, even when they reach the limit of their incompetence and fail miserably in positions of public trust, still seem to rise in power and private wealth.

“It is indeed one of the most frustrating aspects of this story — the rise of subprime, the dereliction of duty by so many who participated in the mortgage mess,” the authors note in a harmony that reflects both voices. “The cast of characters that helped create the mess continues to hold high positions or are holding jobs of even greater power.”

Hopefully with books such as “Reckless”, the frustrating fact of the impunity of money and power, graphically illustrated in this book, will change, and public officials will again start to act in the public interest — instead of their own.

COMMENT

@tmc

I have to disagree. Angelo Mozilo was born in 1938 so he would be unlikely to live long enough for your ideas to inflict suffering commensurate with his lifetime achievements.

He should receive a very speedy trial under RICO that results in the confiscation of all of his assets, even those he has carefully hidden away. Then, he should be incarcerated somewhere nice like the Federal Pen in Sandstone, MN where he can spend the remainder of his life cleaning the latrine.

Posted by breezinthru | Report as abusive

It’s a wonderful life 2011

Jan 3, 2011 21:02 UTC

About a year ago, Arianna Huffington called my friend and colleague Dennis Santiago and asked if my firm could provide a list of “good banks” for an effort she was planning. Along with Rob Johnson from the Roosevelt Institute, Huffington conceived of something called “Move your Money,” which sought to get consumers to move their business from large banks to smaller community institutions.

The effort was modestly successful in terms of increasing awareness of consumers about the alternatives for financial services. But it did not really change the competitive equation between the too big to fail (TBTF) behemoths — Bank of America, JPMorgan, Wells Fargo and Citigroup — and the rest of the industry and the economy. Now that insurgents like Washington Mutual, Countrywide, Lehman Brothers and Bear Stearns & Co. and many others have disappeared, the banking industry is more concentrated than any time during the past century, both financially and in terms of the industry’s icy grip on political power.

One of the themes that motivated the “Move your Money” effort was the image of James Stewart as head of the mutual Building & Loan, who fought to keep his bank open in the Frank Capra film “It’s a Wonderful Life.” His nemesis was Potter played memorably by Lionel Barrymore, the head of the big bank that sought to take over the Building & Loan and thereby gain a monopoly position in the allegorical American town.

But given the state of the U.S. economy and the fact that almost 15% of the banks in the U.S. are considered “troubled” by the FDIC, perhaps we should reconsider this interpretation of the film’s apparent story line. My friend Fred Feldkamp, a veteran lawyer with decades of experience in banking and securitization, notes that the Capra movie “portrays Potter as the owner of the bank in town, but I see him as a stand-in for the conservators FDIC put in place at selected ‘too big to fail’ institutions which were supposed to buy local banks, fix them and re-sell them to locals.”

If you think of Potter not as a Robber Baron a la J.P. Morgan but instead as a government bureaucrat working for the FDIC or even the Reconstruction Finance Corporation, that puts a different light on the big bank vs. the world battle, does it not? Feldkamp notes that from the Great Depression of the 1930s and again in the 1980s real estate bust, the government played an important role in restructuring the banking industry — and never more so than today.

“Small banks ended up being temporarily swallowed into the designated “banks of last resort” in various states,” Feldkamp relates regarding previous banking busts going back to the 1930s. “Conservators ran most of those banks until the mid-1950s.  I represented one such bank in the 1970s… The only way the “managers” (conservators) could be criticized was by the head office of the FDIC in Washington D.C. That happened if they acted like real “bankers” and made loans into the community.”

Today many of my friends on the left and right are engaged in a protracted rear-guard battle, arguing over whether government sponsored entities such as Fannie Mae and Freddie Mac were the cause of the mortgage bubble. Most recently we saw the clash between Peter Wallison of American Enterprise Institute and Joe Nocera at the New York Times, essentially disputing whether these government sponsored entities are the cause of the financial collapse that has been unfolding since 2007.

Liberals like my friends Nocera and Johnson still cannot believe that the government was the moved-mover in the mortgage mess, the catalyst for Wall Street’s entirely rational exuberance that merely followed Washington’s bad example. But such distinctions are meaningless. The corrupt relationship between the large TBTF banks and the federal government is long-standing and should be the focus of people on all points of the political compass.  Indeed, somebody should tell Nocera he owes Peter Wallison and AEI an apology.

Look at the just announced settlement between Fannie and Freddie and Bank of America, where the government-sponsored enterprises (GSEs) now controlled by the Obama Administration are providing what appears to be a huge subsidy to Bank of America to the tune of tens of billions of dollars. If you look at the most recent quarterly earnings disclosure to the SEC from Bank of America on future losses from the GSEs, then look at today’s settlement with the GSEs, which was approved by the Geithner Treasury, and it is hard not to conclude that the settlement was a gift.

The losses hitting Fannie and Freddie will be borne by the American taxpayer and not the bond holders of Bank of America. The single digit billions BofA paid to Fannie and Freddie is less than a quarter of my firm’s estimate of such losses prior to the announcement. And our estimates were by no means the highest.

How can bankers like JPMorgan Chase CEO Jaime Dimon, who settled his own tab with Fannie and Freddie on equally attractive terms last year, complain about Barack Obama when the supposedly liberal President is so generous with public subsidies for the zombie banks? The truth of the matter is that the federal government, through agencies like Fannie, Freddie, the Federal Home Loan Banks and the FDIC, have been calling the shots in the banking industry since the 1930s.

While American banks have, from time to time, shown a certain degree of independence, this in the form of speculative lawlessness known as “innovation,” all lenders in the U.S. are ultimately appendages of Washington. The degree of government support for the financial markets has never been greater in the history of the American republic and the largest players in the industry thereby exercise enormous political power. This is why calls from observers as disparate as Kansas City Fed President Thomas Hoenig, Vermont Senator Bernard Sanders and Dallas Fed President Richard Fisher to break up the largest banks are entirely on target.

COMMENT

Brill! THANKS, Arianna!

For years I’ve been favoring credit unions and small banks. Not only do I believe in their principles, I dig NOT feeling like a peon/number.

The big banks left, with our money (immoral home-loan policies), and then stole some more through the bailouts. I think their goal is to ‘delete’ the Middle Class and with it, a work force that requires something of the employer, and a populace that requires something of their government. No integrity.

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