Putting “trust” back in American housing finance

May 17, 2011 17:12 UTC

News reports suggest that New York prosecutors are preparing fraud charges against a number of large investment banks for defrauding insurance companies with respect to mortgage loans. These allegations and many civil claims with precisely similar predicates illustrate one of the most important aspects of the subprime financial crisis, namely the construction and collapse of the non-bank financial sector.

Thousands of trusts based on a variety of different assets were created to sell bonds to investors, and some of these trusts carried private mortgage insurance. Most of the trusts used to fuel the subprime debt debacle were filled with residential mortgage loans, but other types of loans and commercial paper also were used as collateral. Roughly a third of the US financial markets were financed by the non-bank sector, which has largely disappeared. Thus deflation abounds.

The subprime investment vehicles of 2007 were almost precise copies of the trusts employed in the years leading up to the Great Crash of 1929. The investment trusts of the early 1900s were often fraudulent vehicles used by Wall Street to enrich the sponsors and stiff investors — like many private deals done during the past decade. Railroad trusts and other seemingly reputable issuers of debentures were highly unpredictable and the assets underlying a trust were always opaque. There was no SEC and no public disclosure standards to provide even minimal information to investors about the assets inside a trust. And the Robber Barons owned the courts, too.

In 1925, during the laissez faire presidency of Calvin Coolidge, the progressive Chief Justice of the Supreme Court, Louis Brandeis, laid down the law on the assignment of all collateral, from commercial receivables to mortgage notes. We wrote about this important Supreme Court decision in a previous piece on Reuters.com. The key paragraph in the Brandeis decision in Benedict v. Ratner follows:

But it is [268 U.S. 353, 363] not true that the rule stated above and invoked by the receiver is either based upon or delimited by the doctrine of ostensible ownership. It rests not upon seeming ownership because of possession retained, but upon a lack of ownership because of dominion reserved. It does not raise a presumption of fraud. It imputes fraud conclusively because of the reservation of dominion inconsistent with the effective disposition of title and creation of a lien.

The Brandeis decision struck down the practice of making a simple, often verbal common law pledge of receivables. The claims supposedly held by Ratner, the creditor of a defunct company over which Benedict was the receiver, was eventually rejected by Brandeis in a decision that shook the ground of American finance and began a seven-decade long debate over the proper construction of secured financial transactions in the US. It led to the adoption of Article 9 of the Uniform Commercial Code, which even today governs the methods used to create most commercial security interests in collateral.

In plain terms, the above paragraph means that an assignment of collateral is deficient without “the effective disposition of title and creation of a lien.” A financial transaction involving security that lacks these features “imputes fraud conclusively,” wrote Brandeis. Indeed, by that measure, many mortgage backed securities (MBS) created over the past few decades are fraudulent as a matter of law.

While the Benedict decision was good for investors, it also arguably encouraged the 1929 crash. The strict requirements set by Brandeis for delivering collateral to the trustee effectively brought the Wall Street sausage factory to a halt for more than a decade — a situation not unlike what we see today in the evaporation of private mortgage finance since Lehman Brothers failed. This same systemic breakdown in the non-bank, non-GSE finance sector since 2007 is why housing prices remain weak now four years since the subprime crisis started. As I told Tom Keene on Bloomberg Television, there will be no economic recovery until we fix the non-bank financial sector.

The Trust Indenture Act of 1939 began the rebuilding process for secured transactions in the private sector. It required an independent trustee to act on behalf of bondholders. The Act also mandated that bond indentures conform to certain standards set forth by the SEC and the Act itself, and that issuers must report financial information periodically. It was not until the 1970s, though, that Wall Street lawyers were able to convince regulators that pledges of mortgage notes to a trust as collateral could be accomplished consistent with Benedict v. Ratner.

In those days, the way to make private MBS compliant with the law was to physically deliver each properly-endorsed mortgage note to the trustee. That is how documents for MBS deals done under the laws of the State of New York read even today. But do investment bankers and other professionals always do what the documents say and Benedict requires? Of course not.

Unfortunately, members of the bar in the US began to attack Benedict and to go so far as to suggest that common law pledges of collateral were OK. Some even said that Benedict need not be interpreted strictly. In “Rethinking Benedict v. Ratner” Edward Janger wrote:

To the extent that commercial law professors mention Brandeis’s role in the case, it is to point out with a certain self-aggrandizing satisfaction that the great Brandeis even got the law wrong.

Such new thinking was common in the 1990s and allowed the private mortgage finance industry to compete with government sponsored entities like Fannie Mae and Freddie Mac — for a while, anyway. From the start, Wall Street firms cut corners on documenting the transfer of title from the seller of the mortgages to the trust, relying on the revisionist view of the Benedict decision and other new era concepts like federal common law. This is one of the key complaints of mortgage insurers against the banks that created trusts and securities based upon false descriptions of the security.

But now we know that this was all nonsense. The creation of the ersatz housing title registry, Mortgage Electronic Registration Systems (MERS), by the banking and mortgage servicing industry was effectively an end-run around the clear legal standard set by Brandeis. In litigation and foreclosures, these make-believe standards for securitizing home loans are turning into dust in the hands of the banks and investors. Lenders who relied upon MERS to document their secured interest in a mortgage are increasingly at risk when the title is contested.

Benedict v. Ratner is still the leading case on the question of when there is an invalid lien,” veteran securities attorney Fred Feldkamp said. “This is confirmed by the manner in which the requirements Brandeis stated in Benedict were incorporated when Frank Kennedy wrote the Bankruptcy Code (and the 1983 Uniform Fraudulent Transfer Act). Kennedy was ‘bowing’ to the genius of the Brandeis opinion, NOT denying it.”

In more and more cases where the supposedly secured party cannot produce a properly endorsed mortgage note, the courts are ruling in favor of the debtor. Experts in the fields of the law and forensic accounting tell me that missing or nonexistent mortgages leave investors effectively unsecured — and leave debtor homeowners unsure about the identity of the true note holder.

Anyone familiar with the carnage today in the mortgage servicing world understands that Benedict v. Ratner is again the operative standard for secured transactions in the state and federal courts. In particular, the ancient concept that “the collateral follows the note” affirmed and codified by Benedict is very much operative in the world of home foreclosures. As one attorney told me: “If you don’t have the note today, you don’t have no game.”

A very troubling issue raised by the last comment is related to the issue of missing documents, namely the growing number of foreclosure cases where a mortgage was pledged multiple times. One of the dirty little secrets about MERS and the use of electronic registry systems generally is that they enable fraud. A bank or non-bank seller can pledge the same loan as collateral multiple times if there is no hard requirement to deliver the physical note as per Benedict, which is an open invitation to fraud.

There are a number of proposals in Congress at present for fixing the private mortgage finance sector, but virtually none address the issue of what constitutes a good sale or pledge of a mortgage note in the US. It is interesting to note that a recent paper by the Federal Reserve Bank of New York on housing finance does not even mention the issue of collateral or Benedict v. Ratner.

Sad to say, neither federal regulators nor the large banks have any interest in talking about the issue of good sale and/or delivery of collateral to a trust because of the massive amounts of litigation presently underway. The question of documentation related to loan sales is at the forefront of some of these disputes. Investors want to know how these disputes will be resolved and, more so, what the rules are for loan sales going forward.

One thing you can depend upon is that there will be no fixing of what is wrong with the US real estate sector until Congress addresses once and for all the issue of delivery of a note as collateral for a mortgage backed security. Unless, and until, we fix the private mortgage securitization market, the housing sector will not stabilize and the chance of further deflation will remain a threat to economic recovery.

 

 

 

 

 

COMMENT

Prosecuting Wall Street investment banks and their “geniuses” is not only a matter of democracy, but more importantly, it is about survival of America that we all love…and the only path for our kids’ future.
How did we become just one big hypnotized mass, even after the truth has been revealed? We’re walking around as if we’re mesmerized, not standing up, not demanding justice, still paying our mortgages to lenders who don’t even legally own them…
However, there are few people like NY Attorney General and we should all stand up with them.
Please read my blog post about MA Register of Deeds, a real people’s hero: http://tinyurl.com/3qsu87x

Posted by Senka | Report as abusive

More debt and inflation will not create economic prosperity

May 5, 2011 19:31 UTC

“[F]or many philosophers, conflict is inevitable in politics because a government should seek both to make its people equal in wealth and opportunity and also to safeguard their liberty, but it cannot do both because people can be made equal only through serious constraints on their freedom. This is not simply a statement of the obvious fact that different people and different communities hold different values. The argument claims that even a single sensitive person cannot express, either in how he lives or how he votes, all the ideals he knows he should recognize.”

Justice for Hedgehogs
Ronald Dworkin

In an article in the April 28, 2011, New York Review of Books, “For a National Investment Bank”, Robert Skidelsky and Felix Martin argue that the Obama Administration ought to create yet another state sponsored financial institution in the US to explicitly stimulate the economy by issuing debt. This is a truly bad idea whose time has come and gone.

The authors rightly describe the lack of aggregate demand in the US, something we have also discussed at some length in this space. “Few dispute that the US is not enjoying a normal recovery by recent standards,” they write. So true. But their suggestion of creating a new government sponsored enterprise (GSE) to address slack growth and employment lacks imagination and practicality. Skidelsky and Martin specifically want to use the NIB to finance public infrastructure projects, but without the new debt required showing up on the federal budget. How clever.

Nowhere do Skidelsky and Martin, nor most neo-Keynesian economists, admit that much of the nominal economic growth of the past several decades in the US was increasingly supported by debt and inflation. The national investment bank they propose would take its place alongside dozens of existing New Deal and Great Society agencies such as Fannie Mae and the Federal Housing Administration, as well as the Bretton Woods GSEs including the IMF and World Bank. Martin, an economist at Thames River Capital LLP, worked at the World Bank for two stretches between 1998 and 2008 and must be familiar with this history. The NIB is more of the same stuff in policy terms.

The NIB proposal shows just how bankrupt the American political discourse has become when it comes to economics, but especially on the left.  It also reveals the indifference of liberal economists to the political consequences of economic policy choices. This is not to suggest that Republicans are exactly fonts of economic innovation at present. Most Republicans are indistinguishable from big government Democrats in terms of their willingness to prune back the corporate state. Fiscal conservatives have been fighting this battle for decades now.

The first observation about the NIB proposal is that we are talking, once again, about using debt to create the illusion of economic prosperity. Skidelsky, Emeritus Professor of Political Economy at the University of Warwick and the author of Keynes: The Return of the Master (2009), is an unabashed advocate of the aggressive state in action. Yet what he and Martin propose promises few benefits in economic terms. Indeed, you cannot make an argument for more GSEs on utilitarian grounds.

The most offensive thing about the NIB proposal is that it pretends to rely upon Keynes. Skidelsky and Martin say that they intend some sort of pump-priming, jump starting catalyst for private sector growth. Keynes was no apologist for using debt to simulate real economic growth but he also believed in individual economic liberty, which he greatly benefited from. Living through the privation in the UK during and after WWII, Keynes understood the desperate situation facing Britain. Modern economists spend too little time considering politics when assessing the motivations of the day.

My friend Sol Sanders and William Alpert talked about Keynes in The Institutional Analyst last month (Keynes, Keynesianism — and Keynesianitis): “‘The day is not far off’, he wrote, ‘when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems/the problems of life and of human relations, of creation and behavior and religion.’  In 2010 we are still waiting.”

The same lack of demand and unemployment that faced Keynes and the leaders of the Western economies after WWI and WWII, and to which Skidelsky and Martin rightly raise in alarm, has driven liberals today to embrace ever more inflation and debt. An aggressive combination of reflation by the Fed and restructuring of the housing and banking sectors is the way to restore US economic growth, but you won’t hear about restructuring large banks from adherents of the neo-Keynsian faith.

Skidelsky and Martin assess the political situation facing the Obama administration, saying “that it has become politically impossible to increase the deficit.” Quite right. But the solution offered by these two honorable gentlemen is to create yet another GSE to issue more debt off the books? Such expedients are entirely transparent to the marketplace, but Skidelsky and Martin do not seem to appreciate that more incremental debt buys less and less bang for the buck in terms of nominal economic growth.

Skidelsky and Martin, and their American contemporaries led by the likes of Paul Krugman, call for “fiscal stimulus,” but what they are really arguing for is permanent inflation. The Fed has been pursuing the reflation path via quantitative easing, but with less than astounding results, owing to the lack of benefit for US households.

The only way to fix the twin problems of deflation and unemployment is to keep money easy and restructure the insolvent parts of the banking system and economy. In both the US and EU, the policy has been implemented but the lack of financial restructuring of the insolvent banks of the US and EU is the chief obstacle to economic renewal. To restructure and renew is the alternative to the proposal from Skidelsky and Martin.

Instead, Skidelsky and Martin want to layer more state-guaranteed debt on top of an already wobbly foundation. This is not only bad economic policy, but it has truly hideous political implications. John Stuart Mill acknowledged that utilitarianism had to admit the moral superiority of classical liberalism and that, to save it, certain preferences (those the classical liberals generally would favor) simply had to be acknowledged as preferable.

Why is it that so few economists ever assess the social and political implications of their policies? Skidelsky and Martin are following the road to hell trodden by Franklin Roosevelt in the 1930s. Not only do we have the New Deal zombies like Fannie Mae and the Federal Housing Administration as examples of failure, but dozens of parastatal banks and development entities in the EU that are effectively insolvent today. The embrace of the fascist economic model proposed by Skidelsky and Martin has not saved the EU from economic malaise.

As Ronald Dworkin notes in his new book, Justice for Hedgehogs, the differences between different ethical and political systems do matter very much. Keynes believed in using temporary government action to help restore private economic activity, but I doubt he would have supported the type of debt accumulation much less the creation of permanent GSEs that Skidelsky and Martin propose.

Instead of embracing a permanent state of inflation, as has been the case in the US since the 1970s, we need to deflate the bubble and start again. It is not too late for President Obama and Congress to restructure the US financial system, fix the housing market and create the conditions for true economic growth. All we need to succeed is leadership and the knowledge that the bastard children of Lord Keynes cannot help us in the difficult task ahead.

COMMENT

So far, the restructuring of insolvent financial entities has been done on the backs of taxpayers.

What exactly do you mean by “restructure”? Are you referring to restructuring in the “Greek” sense?

Posted by breezinthru | Report as abusive

Why Congress should vote no on raising the debt ceiling

Apr 13, 2011 14:38 UTC

By Christopher Whalen
The opinions expressed are his own.

“A spectre is haunting Europe — the spectre of communism. All the powers of old Europe have entered into a holy alliance to exorcise this spectre: Pope and Tsar, Metternich and Guizot, French Radicals and German police-spies.”

–Karl Marx – Friedrich Engels
The Communist Manifesto

There is a specter haunting the industrial nations, too — the specter of debt default and deflation. All of the powers of the post-WWII regime of neo-Keynesian economic management have entered into a holy alliance to exorcise this specter: Fed Chairman Bernanke, European Central Bank Head Jean-Claude Trichet, Democrats in the American Congress and the German centrist tendency under Angela Merkel.

All of these champions of the status quo ante are, ironically enough, serving as agents for the bond holders of the largest US and EU banks, the clients of PIMCO, Black Rock and even my friend David Kotok at Cumberland Advisors. These agents of the global creditor class are betting on the likes of Bernanke, Trichet and Merkel to collect their debts for them like so many China gunboats — and thereby plunge hundreds of millions of people into penury for decades to come.

It is no small irony that the interests of the banks and bond holders in the US are being protected by a Democrat from Chicago named Barack Obama. Far from being a leftist, Obama is a global technocrat who turned out to be the most perfectly compliant stooge for the interests of the large banks and institutional investors. With Timothy Geithner at Treasury and former JPMorgan banker William Daley at the White House, the only decision Obama needs to make every day is what shirt to wear.

On Capitol Hill, however, the long slumbering Republicans are starting to discover the political power of fiscal sobriety. In the negotiations with the White House over the budget for fiscal 2011, House Speaker John Boehner (R-OH) managed to win some significant concessions from the White House on spending issues — even if entitlements and military spending were off the table this time around. The next and more important fight comes over the question of raising the US debt ceiling. Once again, President Obama is not even in the game.

Secretary Geithner and his boss, JP Morgan Chase CEO Jaime Dimon, have made clear their distaste for a fight over extending the debt ceiling, in part because a debt default by the US would end the pretense of “too big to fail.” If Washington is willing to contemplate a default by the US Treasury, who cares about the fortress balance sheet of JP Morgan and other US zombie banks? But for a number of reasons, democratically elected governments from Lisbon to Dublin to Washington need to begin the process of financial restructuring whether the banks like it or not. And all of the political servants of the banksters are doing their best to avoid debt write downs.

In Ireland, for example, the new government of Fine Gael leader Enda Kenny is in a struggle with Trichet and his vile contemporaries at the ECB. The Euro central bank is essentially trying to keep together an under-funded bailout of the continent’s corporate and bank debts at the expense of public taxpayers. So muted is the political discourse in Western Europe that people are barely protesting — at least not yet. But offering Ireland the choice of default or decades of deflation and unemployment to repay its foreign obligations at par is untenable and risks comparisons with the German war reparations after WWI.

The Kenny government should reject the self-serving advice of the German-dominated ECB as well as the technocrats inside Ireland’s finance ministry, and tell Angela Merkel and French President Nicholas Sarkozy to try harder. Specifically, if the ECB and the core nations of the EU are not willing to offer Ireland more generous terms to bail out the private debts of EU banks, then the Kenny government should take the example of the people of Iceland and tell the technocrats in Brussels an emphatic “no” to bailing in the Irish bank debt at public expense.

Frankly, if you weigh the trade off between the immediate cash flow benefit to Ireland of walking away from its foreign debt and being cut off from the global capital markets, as Trichet has threatened to Kenny, a default seems the obvious choice. And with Portugal and other “peripheral” states of the EU tottering, the Kenny government has more leverage than it knows. Putting a gun to the head of Trichet right about now and daring him to blink might prove a very satisfying experience for any Irish officials with the guts to play the hand God has dealt to them.

In Washington as well, some Republicans are starting to appreciate that saying no to more debt and devaluation a la the Paul Krugman school of economic mismanagement is good politics. It is wrong to call Krugman and his ilk “Keynesians.” Lord Keynes was neither an apologist for debt or inflation, nor was he a free trader. He valued strong national industry and financial markets that were only supplemented by global capital and trade flows. What would Keynes tell Ireland today?

For the same reasons that the Kenny government needs to impose haircuts on Ireland’s creditors, the US Congress needs to vote no on the debt ceiling increase as part of a larger shift in thinking on debt and spending in Congress. Just as the people of Iceland have done the right thing by saying no to repaying corporate debts of UK and Dutch banks (all of which are now nationalized naturally), Americans need to take a page from the history books and begin the actual process of default on all manner of debt and entitlements obligations.

The only way we can force our citizens and also our trading partners to talk about the economic issues that are driving America’s growing mountain of debt is to stop adding to the pile. The role of the dollar as the primary means of exchange for global commerce and finance are the twin evils at the heart of the US fiscal disease. The role of the dollar as the world’s “reserve currency” is likewise a terrible millstone around the necks of American workers.

Saying “no” on raising the debt ceiling is the way for deficit hawks in Congress in both parties to seize the fiscal agenda and start a long overdue conversation about America’s place in the world. As I wrote in my book, Inflated: How Money and Debt Built the American Dream, this discussion must include an end to the dollar as the primary global means of exchange. When the dollar ceases to be the global currency, then the Fed can no longer monetize deficits with impunity as today.

One way of forcing this adjustment process is to start imposing losses on holders of dollar debt. Painful as it will be, helping the world to readjust the level of debt in the industrial nations back to realistic levels and rebalance the global currency markets into a peer-to-peer framework is a necessary process if America is ever to achieve a sustainable economic model. The only question is when and where will emerge the political leadership to do the right thing and begin to actively restructure debts.

Barack Obama has already failed that test of leadership by studiously avoiding any response to the US real estate meltdown, but new leaders in many heavily indebted nations will face the same issues — chronic levels of debt that will only grow heavier as and when global interest rates rise. If the ECB manages to bully Prime Minister Kenny in Ireland, do they really expect a more malleable regime after the next election?

The looming threat of debt is why we should expect to see a majority of Republicans and perhaps more than a few Democrats in Congress seek to block any increase in the US debt ceiling unless the measure includes a balanced budget amendment to the US Constitution.

My view is that Congress should vote down any debt ceiling measure unless President Obama agrees to sign the balanced budget amendment. Even if Secretary Geithner has to run the US government on cash, like the good people of Iceland and Ireland today, it will be a good thing for America’s political debate to default — at least for a few weeks. Then people will know that the once unthinkable is very possible.

COMMENT

I find it disappointing that Reuters would publish such a trite and hypocritical commentary on such an important issue. The suggestion that the government should switch in mid-course to a cash budget is utterly absurd for one. For another, the ideological bias of the author’s opinions demonstrates profound ignorance of the intricacies of central banking. The interrelation of inflation, interest rates, exchange rates, liquidity, and economic growth are far too complex to be dismissed as a conspiracy.

But above all, the idea that Americans will have to work like slaves to pay off the national debt to angry Chinese is both comical and utterly fictitious. The worst case scenario in the far future if we were to amass unrepayable amounts of debt is no worse than the author is proposing as the solution in the present day – default. So why default today when we can default tomorrow? This makes no sense.

Posted by prometheo | Report as abusive

A new deal for the 21st century

Jan 20, 2011 19:13 UTC

Below is an excerpt of a speech titled “A New Deal for the 21st Century: Less Entitlement, More Accountability.” I am scheduled to deliver the keynote talk today in Indianapolis at an event sponsored by the Indiana Leadership Forum.

In a January 2011 article in The Nation magazine, author William Greider bemoans the death of New Deal liberalism: “When the party of activist government, faced with an epic crisis, will not use government’s extensive powers to reverse the economic disorders and heal deepening social deterioration,” Greider writes, “then it must be the end of the line for the governing ideology inherited from Roosevelt, Truman and Johnson.”

Greider is not the only observer to note the end of the New Deal and the related unwillingness of liberals to fight efforts by members of both parties to roll-back the size of government. “[T]he public is being sold a big lie — that our problems owe to unions and the size of government and not to fraud and deregulation and vast concentration of wealth,” former Secretary of Labor Robert Reich told the New York Times. “Obama’s failure is that he won’t challenge this Republican narrative, and give people a story that helps them connect the dots and understand where we’re going.”

President Herbert Hoover said of the New Deal that it was an attempt to crossbreed Socialism, Fascism and Free Enterprise, part of a collectivist revolution led by FDR and carried within the Trojan horse of economic emergency. The New Deal was also a way for the Democrats to finally end decades of largely unbroken Republican rule in Washington. FDR had, after all, nominated Al Smith three times as Democratic presidential nominee. The former New York governor had lost each election. FDR and the New Deal not only enabled the growth of government, but also of the private and public unions that came to underpin the finances of the Democratic Party after WWII.

Today the debate among and between liberals as to how the government should respond to the latest financial crisis is a function of not so much about ideology but of shrinking revenue and burgeoning obligations. The New Deal Model of defined benefits has been replaced with defined contributions or, more recently in the auto industry, profit sharing.

Whereas after WWII the U.S. seemingly had the resources and borrowing capacity to address any national want or need via government fiat, today constraints on resources seems to be the dominant theme. This fundamental lack of growth and revenue, particularly in the private sector economy, is leading to a dearth of job opportunities — a reality that seems to have replaced the open horizons and endless opportunities that are part of the mythology of the American dream. But this is a circumstance that has been building for decades.

At least since the early 1970s, when the Nixon Administration made the decision to leave the gold standard and embrace a series of socialist policy expedients, stagflation, that is, rising prices and receding job growth and economic activity, have been the predominant trends, relieved by tax cuts and spurts of monetary exuberance by the Fed.

Where we are going as a nation looks an awful lot like America a century and more ago, the era of rampant political corruption and financial excess known as the Gilded Age, taken from Mark Twain’s wonderful novel. The Gilded Age was an era following the Civil War that saw rapid growth and relatively low inflation, even compared with the post-WWII period.  But it was also a period when large railroads and banks basically ran the country unchecked.

Today large banks are in explicit control of Congress and the White House, and the individual American seems helpless to push back. And Democrats and Republicans alike today look to big business for financial sponsorship. The Robber Barons of the 21st Century are the managers of large banks and of the various government sponsored-agencies, and their corrupt political enablers in Washington.

Liberal advocates such as Greider, Reich and others focus on the bad acts committed by ostensibly private banks and investors during the most recent Fed-induced mortgage boom. Today’s liberals have a hard time dealing with the takeover of our public institutions by large corporations, which are themselves largely unaccountable to their shareholders. Many people fail to identify the corrupt relationship between the federal government and large banks, for example, as driving social issues such as domestic jobs losses, foreclosures and growing disparity between rich and poor.

“Increasing inequality in the United States has long been attributed to unstoppable market forces,” Robert Lieberman writes in Foreign Affairs reviewing the new book, “Winner Take All Politics”. “In fact, as Jacob Hacker and Paul Pierson show, it is the direct result of congressional policies that have consciously — and sometimes inadvertently — skewed the playing field toward the rich.”

The political narrative in America over the past fifty years has been a function of the Cold War, left vs. right, liberal vs. conservative, but is this really an accurate description of the political situation in America today? The focus by some commentators on the rich echoes the debates of a century ago, when Americans felt that opportunities were being decreased by the wealth and power of the great captains of industry and finance, the likes of Carnegie, Morgan and Rockefeller. In the new book, “Exploring Happiness: From Aristotle to Brain Science” by Sissela Bok, the author notes:

“Opinion surveys show that Americans are twice as likely (60 percent) as Europeans (29 percent) to believe that the poor can get rich if they only try hard enough. While most Europeans feel that where you end up is largely a matter of luck or other circumstances beyond your control, fewer than half of Americans agree. Armed with these beliefs, lower-income Americans are less likely to blame society when inequality grows and more inclined to believe that persons of great wealth must deserve their good fortune.”

Today, however, political as well as economic power is exercised by managers such as JPMorganChase CEO Jamie Dimon, whose former colleague Bill Daley is now White House chief of staff.  Daley, the seventh and youngest child of the late Chicago Mayor Richard J. Daley, is not only the representative of JPMorgan in the White House, but is the replacement for Rahm Emanuel as chief fund raiser for Obama in the 2012 general election.

“These banks again have unfettered access to the very top of the political decision making in the United States,” says MIT professor Simon Johnson, “and reflects the fact their status is completely undiminished, despite all the mistakes they made and all the damage they did to the rest of the economy.” Johnson argues that unless the largest banks are broken up, another major financial crisis is inevitable, a view that shared by a number of other Americans in and out of government.

Click here to continue reading the speech.

The Ibanez Decision: What it means for home owners and investors

Jan 10, 2011 18:09 UTC

Last week the Massachusetts Supreme Court issued a decision voiding several home foreclosures by US Bancorp and Wells Fargo. The news caused the financial markets to retreat with bank stocks down hard. News reports and some analysts are predicting that the decision in U.S. Bank National Association vs. Antonio Ibanez, will mean an apocalypse for commercial banks, especially those involved in issuing residential mortgage backed securities or “RMBS.” But like most things in life, the reality is a little more subtle.

We’ve seen this movie before — in the 1930s and 40s — when disputes over foreclosures and property titles dragged on for years, even decades. I wrote about this issue previously for Reuters.com — “Everything that Americans should ask about home mortgages”). In that article, I discussed how sales of mortgage notes to investors depends upon the unsteady foundation of state law property title regimes and the partial, post-WWII fix put in place by the states.

In simple terms, in the late 1950s the states’ attorneys general for the lower 48 states subjected the mortgage note to the Uniform Commercial Code, but left the mortgage itself a purely state law document. This duality is part of the dispute now partly decided by the MA courts for foreclosures in that jurisdiction. While the founders of the U.S. provided the Commerce Clause of the Constitution to enable interstate trade in goods and services, the ownership and transfer of property remains an entirely state law matter.

Since the 1950s, however, Wall Street lawyers have taken the view that the sale of a mortgage note to another party is governed by the UCC and therefore does not require that the documentation down at the court house be up to date.  Some financial counsel even went so far as to say that the mortgage document was incidental to the note and thus that the mere possession of the note was sufficient to obtain all of the rights under the mortgage as well. And in a narrow sense, under the UCC, this view is correct, as the banks argued in Ibanez.

But the MA Court decision raises some interesting questions that neither the banks, the several states, nor the Congress have addressed. First, Ibanez illustrates just how sloppy banks have become with respect to changing the lien on the property when a note is sold. In the decision, the Court shows how one mortgage was originated and then sold half a dozen times before it was eventually deposited in a trust created by Lehman Brothers. This last corporate vehicle then sold securities to investors using the mortgaged property as collateral.

The trouble is, the final “assignment” of the mortgage note to the trust was never properly completed by the seller, again relying upon the Wall Street view that the UCC protected such shoddy or non-existent legal work. The Ibanez case raises questions as to whether the investors who own the RMBS issued by the trust have any recourse to the underlying collateral, namely the house owned by Ibanez, as well as the work of lawyers and other professionals. It will come as no surprise that the trustee for the securitization trust also is a party to the Ibanez lawsuit.

It needs to be said that the transfers of a note under the UCC must comport with state law. The UCC specifically requires the note be delivered to the assignee in good order. Thus the Wall Street view of property title, where the assignment of the note is never actually completed or is merely done generically, is clearly a violation of the UCC and does not provide a legal safe harbor for defective RMBS. Indeed, the Ibanez case now drives another nail into the coffin of the private RMBS market — as if that were needed.

Second, the Ibanez decision makes clear that in Massachusetts at least, the note holder cannot commence foreclosure proceedings unless the chain of title is perfected and in good order with the state courts. The banks in the Ibanez case proceeded to foreclosure based upon the Wall Street world view that says that the UCC protects the assignment of notes in the creation of RMBS. The MA Supreme Court, however, has stated emphatically that the note holder must follow state law with respect to the transfer of property titles, including upon foreclosure.

A couple of weeks ago I helped to organize an open letter to regulators regarding the need for loan servicing standards. In order to convince a number of people to sign the letter, we included the words “consistent with state law” in the bullet point about mortgage modification. The MA Court decision illustrates that when it comes to the ownership and transfer of real property, state loan still prevails despite all of the clever subterfuges used by the banking industry to subvert our federalist system.

The Ibanez court decision only applies in MA. It does not mean that delinquent borrowers in MA or anywhere else are likely to be able to win forgiveness of their loans because the information about the lien holder of their mortgage is not up to date. But the Courts in MA have made clear that all of the documentation (and fees) must be up to date before a foreclosure proceeds. This will add expense for banks, but will really not affect the overall flow of foreclosures nationally.

Perhaps the most striking aspect of the Ibanez decision is the light it sheds on the huge liability facing large banks from the investors who purchased hundreds of billions of dollars in private label RMBS. One of the reasons that my firm remains cautious about the outlook for Bank of America, Wells Fargo and JPMorgan Chase is the huge liabilities facing these banks from investors in and insurers of private label RMBS that, in many cases, have significant defects between the note and the underlying mortgage.

In the case of MA, at least, these defects in the collateral lien on the underlying mortgage may leave investors open to large losses and expenses related to defending their rights and pursing claims on negligent financial institutions, lawyers and other professionals. As we wrote in The Institutional Risk Analyst last week when we proposed a “Brady Plan” for the mortgage sector: “This is the choice: address the problem in the mortgage sector now with restructuring and thereby jump-start the U.S. economy, or face years of additional uncertainty and losses for the banking system as we ‘extend and pretend’ under Obama and Geithner.”

COMMENT

I have been trying to work with Chase Home Finance forever to secure a loan modification. However, Chase has done everything to make this impossible. I would not have believed it if I would not have seen it first-hand. So, I am filing a lawsuit against Chase and/or joining the hundreds of class action lawsuits against them for home loan modification fraud. This will be very expensive for the banks. Just one single lawsuit that the firm that I am working with is filing is seeking $10 million in damages. Wow, I think the big banks will never recover from the huge losses in the MBS and are actually insolvent. Watch and listen to what I say. Their stock is going to plummet, because the government will not assist them again. Bank of America, Chase, GMAC, etc. are insolvent. Just like in the 1930s, but they don’t want to admit it yet. They are going to be hit with tens of thousands of lawsuits along with millions of people declaring bankruptcy and strategic defaulting on over-priced properties in a glutted real estate market. Mark my words. I told you ahead of time.

Posted by DavidBFullerton | 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.

Posted by JnetNW | Report as abusive

Everything that Americans should ask about home mortgages

Oct 20, 2010 15:42 UTC

Americans are discovering the concept of foreclosure and the loss of a home in a very real and disturbing way.  Despite the rhetoric from Washington and sensationalist media, the process of resolving defaulted mortgages is moving ahead, one reason why the U.S. will not be Japan.  But we have all forgotten the experiences of the 1930s when it comes to home foreclosure.

We seem to be moving from voluntary foreclosure moratoria put in place by banks for public relations purposes in 2010 to unilateral state law foreclosure moratoria like those put in place during the 1930s in 2011.  States such as Michigan are considering “new” laws to limit foreclosures by creditors.  But all Americans are also experiencing a journey back to the 1930s, a journey of remembering and one that is teaching this writer something new each day.

In the 1930s, a total of 28 states enacted foreclosure moratoria and a 1934 Supreme Court decision upheld such laws provided that a state of emergency existed.  Many of these state law moratoria remain on the books today and were last invoked during the 1980s.  The Iowa laws provided for suspension of foreclosures in the event of natural disasters such as drought, Neil Harl reported in his book, “The Farm Crisis of the 1980s,” or by order of the governor of the state.  These state moratoria drove the banking industry to look at changes in how home sales are financed and particularly the rights of investors.

Another Supreme Court decision that predated the Great Depression already had set in motion a series of changes in commercial practice in the U.S. regarding mortgages.  In Benedict v. Ratner, 268 U.S. 353 (1925), Justice Louis Brandeis simply and accurately said that ambivalent mixtures of possession and control of collateral for debt are “conclusively fraudulent,” veteran mortgage securities attorney Fred Feldkamp recalls. This decision and the resulting body of precedents would eventually lead to agreement on new disclosure procedures that would exempt validly secured loans under Article 9 of the Uniform Commercial Code, including possessory pledges of mortgage notes.

“To survive the Brandeis logic, one must assiduously follow the UCC and avoid all the pitfalls of the Uniform Fraudulent Transfer Act,” Feldkamp said in an email last week. “Otherwise the state mortgage recording laws and Benedict v. Ratner could turn an investment record error into a fraud and may require them to rescind the investment –either under securities laws or common law fraud.”  Then a young attorney, Feldkamp worked on an early legal opinion for one of the mortgage insurers in the 1970s that helped define the first loan servicer agreements and pave the way for the securitization boom.

What does the Benedict v. Ratner decision by the Supreme Court and the related agreement by the states in the 1950s mean to today’s families fighting foreclosure and communities striving to clear the real estate markets?   First and foremost, the key thing to understand is that the fundamental principles on which securitization was built are (1) sound financial assets namely homes and (2) ALWAYS remember — the collateral follows the debt –and ownership of the debt is most clearly represented by possession of a note.

The basis of the original “true sale” opinion for mortgages was that respected counsel in 48 states all agreed (and opined to attorneys such as Feldkamp and to the credit rating agencies) that if there is a dispute between a bona fide holder of a mortgage note and a different assignee of record of the mortgage, the note holder always wins.  The fact of the mortgage note coming under the UCC means that while the record at the courthouse regarding the assignee of record on the mortgage may be a complete mess, this is not necessarily evidence of fraud nor does it void the obligation of the borrower to repay.

Thus when that young activist lawyer is telling you and yours to fight a foreclosure — this even though you have not paid the mortgage in more than six months — it is time to start looking for a new place to live.   The fact is that despite all of the bad press, MERS (done correctly) eventually wins in most foreclosure hearings that are contested.  This is not reason for joy in terms of the human suffering involved in the loss of a home.  But the sad fact is that the family that is not paying the mortgage probably is unable to pay property taxes either.

Ultimately it is important for Americans to learn how mortgages are priced and sold, both to borrowers and investors alike.  There are big legal problems now being exposed in this multi-trillion dollar industry, a financial sector which is essential to the economic well-being of the U.S.  For example, what happens to the investor in a mortgage backed security if the underwriter fails to deliver the mortgage note to the trustee?   This is just one issue that will be litigated by the banks, investors and housing agencies in Washington for years to come.

But the most important thing for all consumers to understand is that when a mortgage is in default, the fact that the title records at the court house are in disarray does not void the mortgage note nor does it change the fact that the loan is bad.  Foreclosure is a tragedy for one family, but an opportunity for another and the means by which communities and financial institutions defend their tax base and financial health.  This process of liquidation and sale is why the U.S. will recover from the housing mess.

The bad guys in the housing bust are not the banks who must foreclose on homes, but the politicians in both political parties who used reckless housing policies to further their personal interests. This is a bipartisan national scandal.  Barney Frank, Chris Dodd, Phil Graham, Alan Greenspan and their contemporaries are the authors of our collective misery, not the local banker who must clean up the mess created by government intervention in the housing market.

COMMENT

A beautifully written and throughly misleading piece.
One has to wonder what his “Risk Analysis” stand was, back when all of the freshwater economists were poo-pooing the obvious fraud that the industry was so eagerly engaged in.

Despite false claims that “nobody-could-see-this-coming” many did.

At this point, there are all types of flavors of “how do we corrupt established rules” to prevent the widespread fraud from taking down the insolvent banking sector.

Most sickening is the excuses about “saving”; real estate, the economy, homeowners…etc. What Christopher and his lobbying ilk are trying to “save” is the corrupt insolvent institutions that played fast and loose with the law to make a bonus buck.

We don’t need to codify fraud, we need punishment to encourage honest players.

Christopher, the truth is that “The bad guys…” are, in fact, the banksters. No amount of shuffle and jive are ever going to convince the American people otherwise.

Posted by MediocreFred | Report as abusive
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