Opinion

The Great Debate

Everyone’s housing market profits were fictitious

By Maureen Tkacik
October 27, 2011

By Maureen Tkacik
The opinions expressed are her own.

Also read part one of this series, How Ed DeMarco finally cried fraud.

A big clue something had become dysfunctional at Fannie Mae and Freddie Mac came in the first week of 2011, when the government mortgage market makers announced the terms of a settlement agreement they’d reached with Bank of America, and were immediately pilloried for extending the bank another “backdoor bailout” by the likes of Maxine Waters and the American Enterprise Institute.

By the end of January an internal investigation had convened, all other settlement negotiations had been suspended, and Edward J. DeMarco, the acting Fannie/Freddie overseer pending the confirmation of his replacement, found himself suddenly faced with the challenge of replacing himself as congressional Republicans vowed to stonewall Obama’s pick. Part one of this series traced DeMarco’s unlikely conversion in 2011 from coddler of banks to unyielding litigator of bank fraud. It’s a rare shift in Washington, where “corruption” is a process that’s practically synonymous with “aging.” What’s often forgotten when bureaucrats fail as spectacularly as they have at Fannie and Freddie is the critical roles played by cluelessness, incuriosity, faulty reasoning and fraudulent economic logic as well.

Consider what the inspector general learned about the corporate procedures for pursuing “putback” claims in place at Freddie Mac. While purchase contracts entitle the GSEs to force banks to buy back any delinquent loan in which it finds evidence of fraud, Freddie restricted examiners to screening only mortgages which had defaulted within two years of origination, a tiny sliver of total foreclosures comprising less than one-tenth of defaults from the years 2004 to 2007—the vintage of the Countrywide loans. When one of DeMarco’s deputies noticed this apparent oversight and began warning executives that “Freddie could passively be absorbing billions of dollars of losses” merely by refusing to glance at 90% of their files, the enterprise … chose to absorb the losses, repeatedly resorting to a boilerplate argument justifying the two-year policy holding that:

loans that had demonstrated a consistent payment history over the first two years following origination and then defaulted in later years…likely did so for a reason such as loss of employment, which is unrelated to [fraud].

Oh really.

The deputy spent six or so months attempting to politely introduce his colleagues to the concept of the “teaser rate.” Perhaps, he writes in one email, Freddie was failing to take into account that “from 2005 through 2007 there was a substantial increase in non-traditional mortgage products [which] frequently featured ‘teaser’ rates initially resulting in low payments” which would “increase dramatically two, three, or five years after origination” when “rates reset and/or the repayment of principal began”—thus rendering virtually any deliberate fraud essentially “invisible” for the first few years of the life of the loan.

The examiner, though, was either himself mistaken, or trying to be polite, because those dates are off by a few important years. As he might have gleaned from the company’s annual survey of adjustable rate mortgage trends, a 28-year-old Freddie Mac tradition available online, the “substantial increase in non-traditional mortgage products” began well before 2005; what changed in 2005 is that housing prices in the hottest markets finally, slowly began to edge down a bit, meaning that each passing month was rendering increasing numbers of borrowers “underwater” on their loans.

But when Freddie executives attempted to get themselves off the hook by blaming plummeting housing values for the uptick in foreclosures, the inspector general shoots them down in a fascinating footnote (emphasis mine):

Freddie Mac staff advised FHFA-OIG that they disagree with the senior examiner’s causation hypothesis. Alternatively, they attribute the reversed pattern of foreclosures shown in Figure 3 to falling home prices leading to negative equity or “underwater” mortgages. However, causation is irrelevant to the issue in controversy. Regardless of the cause of these defaults, the search for representations and warranties defects is the point of the loan review process; and if the search does not begin, then the defects will not be found.

Causation is irrelevant to the issue in controversy?

Pretty bold statement for a professional investigator! If only it didn’t so elegantly articulate the widespread attitude of the political establishment toward the crisis itself: We get it, we get it, “it’s the economy stupid etc.” so do yourselves a favor and stop nagging us with demands for truth and justice while we’re trying to pass this freaking jobs bill… But imagine if someone involved here had paused to contemplate the irrelevant just briefly, pondering the methodology with which one might calculate the likelihood that a particular defaulted loan conforms with…

    Foreclosure Causation Hypothesis A: Borrower can afford to make mortgage payment of X but defaults when faced with a payment of 2X after the introductory teaser rate expires

vs.

    Foreclosure Causation Hypothesis B: Borrower’s mortgage balance is now 2X the value of his house.

…only to think, Holy Cow, what if it turns out that each causation hypothesis might also serve as a causation hypothesis for the other causation hypothesis? That is, what if the “teaser rate” enabled so many Americans to pay the mortgage on houses they couldn’t otherwise afford that housing prices kept rising artificially, in turn enabling borrowers to refinance their loans just before their payments were scheduled to balloon? That is of course, the central dynamic of the post-2001 housing market: people buying houses they could not afford with the help of kickbacks that collectively, over time, wound up rendering the whole housing market (artificially) unaffordable to just about everyone — unless you used one of those new mortgage products.

In the absence of any underlying economic fundamentals that might plausibly justify an unprecedented expansion of homeownership in an era of total wage stagnation, obscene gas prices and the whole litany of other hardships the 99% endured throughout the Bush Administration, it is a Ponzi scheme. Fannie and Freddie knew this.

Between 2000 and 2006, a period during which median household income moved almost suspiciously in alignment with the consumer price index—both gained about 17%—the mortgage behemoth’s “conforming” loan limits rose 65%, from $252,000 to $417,000 in average markets and $340,000 to 625,000 in designated “high cost” areas—and even those caps drastically understated the housing bubble, which drove housing prices up more than 100% in many markets. A full 40% of mortgages originated in 2004 were ARMs, the highest share since 1994—when fixed rates were much higher. It wasn’t merely a bubble, although you won’t even find that word in the IG report. Fraud was ubiquitous throughout the process, top to bottom, year after year upon year. More than ten million foreclosure filings into the bust, nearly a quarter of outstanding mortgages are still underwater.

Given the crappy hand the proverbial 99% have been dealt here, it is obvious now and has been for a few years what Fannie and Freddie, as federal taxpayer-capitalized entities which own or guarantee half of all outstanding mortgages in America, must do: avoid foreclosures wherever possible by enacting massive mortgage relief programs, find ways to lure owner-occupants to hard-hit areas and deter would-be slumlords from dragging down property values further, and more generally do whatever possible to preserve the value of its assets.

But on many separate occasions, they have chosen to do the opposite. Reviewing thousands of local Fannie Mae real estate transactions, the recent Detroit Free-Press investigation portrayed an institution seemingly hellbent on foreclosing and liquidating properties en masse to big investors as quickly as possible, even when banks and borrowers were in the midst of ironing out some sort of deal that would ostensibly work out better for both parties, then selling off the properties in secret transactions from which local househunters complained of being “shut out.” As one local housing expert lamented: “Even the worst slum landlord understands that basic concept. Why wouldn’t you take the $10,000 from the homeowner? But they will take $2,000 or $3,000 from an investor?” It didn’t make sense. “It has really seemed…punitive,” says series author Jennifer Dixon. “Like they really want to punish people for falling behind on their mortgages.”

Alan White, a Valparaiso University law professor and expert on housing policy and the foreclosure epidemic, agrees: “Fannie has said their average recovery rate on a foreclosure is 50%, so if the homeowner can cough up anything more, it only makes business sense to offer them a modification, but the idea is that this would somehow create unthinkable ‘moral hazard.’ There is definitely a sort of anti-borrower ideology driving a lot of it. But I also think they’re in a hurry to clear their books and get these loans off the balance sheet while taxpayers are footing the bill.”

White was reluctant to indict DeMarco for his policies, however; like many of the other nine mortgage finance “experts” I consulted to figure out what the hell they’d done with taxpayers’ $180 billion and counting, White blamed DeMarco’s “narrow interpretation of his mandate” as a guardian of taxpayer dollars, for his failure to grasp the economics of achieving that mandate.

Burning down the houses

In the worst of the crisis, the economics of post-bubble Washington lacked even the typical slumlord’s grounding in reality. Because causation was irrelevant to the handling the crisis, naturally the first guy former Treasury Secretary Hank Paulson called for advice when he realized he’d have to nationalize the mortgage giants in the summer of 2008 was, according to Andrew Ross Sorkin’s Too Big To Fail, the Madoff of macroeconomics himself, Alan Greenspan. The former Fed chairman suggested a course of action so bizarre it turned out portentous: Fannie and Freddie ought to use their bailout money to buy up vacant homes in bulk and burn them; a million would probably do the trick.

Paulson reportedly nixed this idea “with a laugh”; the book dismisses it as a “rhetorical flourish befitting [Greenspan’s] supply-and-demand mind-set.” But the wily financier Bill Gross, whose bond fund PIMCO employed Greenspan as a consultant, endorsed it the next month in a letter to investors. The scheme’s obvious drawback was of course, the universal refrain at the time went, “politically impossible.” The robo-foreclosure industrial scale eviction frenzy that actually transpired wasn’t any more politically correct than setting a few ZIP codes on fire, however, and it was about equally stupid, akin to dealing with the aftermath of Madoff by ordering a hit out on every one of his victims, letting a few die and informing the rest that you’ll happily call off their assassinations as soon as they recruit five new high net worth “investors” who have somehow never heard of Madoff.

But what should we expect from Greenspan, a guy whose legacy, mission statement and unifying theory all boil down to the one consistent conviction he ever stooped to plain English to voice: that there’s no need for laws against fraud. If Greenspan were in charge, Madoff would be in Fiji or Uzbekistan with a dozen bodyguards, and there would be nothing the government could do about it. And that’s much closer to reality than most people realize, because Greenspan’s bankrupt nonsense ideology still saturates every debate, policy decision, news update and barroom conversation that happens in Washington, cutting off the relationship between public servants and the public, not unlike the way effective cult leaders convince members to fear their families.

In any Ponzi scheme, everyone is a little bit culpable, but on the spectrum of negligent naivete, trusting that housing prices would continue to rise forever is arguably a lot more forgivable than trusting an unlicensed mutual fund that claims with no documentation to be delivering a steady unchanging 10% annual return. Which is why in any Ponzi scheme, you differentiate the victims from the unwitting accomplices by determining who lost and who profited from the arrangement. There was so much fraud in the mortgage crisis that no one’s earnings were truly earned, and everyone’s profits were fictitious. And yet one group has walked away with billions, and the other have lost their homes.

My hope is that by this point DeMarco is familiar enough with the contentions of the eighteen lawsuits he’s filed to comprehend the magnitude of the malefaction at work here, and, understanding that his previous notions of causation of the issue in controversy were misguided, change his agency’s role in it. But he’ll probably get replaced, first.

Also read part one of this series, How Ed DeMarco finally cried fraud.

Comments
22 comments so far | RSS Comments RSS

A teaser rate is not fraud. Misleading a borrower about the truth of how a teaser rate works, will reset, etc. is fraud.

Posted by jaham | Report as abusive
 

It is absurd to suggest that Alan Greenspan would condone of Madoff’s actions – I can see why you are “underemployed”

Posted by jaham | Report as abusive
 

Maureen you rock! And “causation is irrelevant to the issue in controversy” continues to summarize the entire real estate mess. Keep telling it the way it really is! Great article! Thanks!

Posted by ClintWolf | Report as abusive
 

Incredibly well thought-out and written, Ms. Tkacik. One of the best analyses of this sordid portion of the mess that I have seen in the mainstream media. Kudos! Never mind jaham. He thinks in one color, and his ideological blinders cut him off from 70% of the facts around him.

Posted by BowMtnSpirit | Report as abusive
 

This is very interesting, but your thesis is somewhat obscured by the shrill rhetoric and unnecessary adjectives. If you wrote things like “Greenspan’s ideology” instead of “Greenspan’s bankrupt nonsense ideology”, your article would be easier to read and wouldn’t feel so much like a college term paper dashed off at the last minute.

Still, it’s fascinating and important stuff. I hope you emerge from underemployment and write more.

Posted by bruce1963 | Report as abusive
 

Alan White’s analysis of the foreclosure fanaticism seems compelling to me. But in addition, without that Government support of banks that are “too big to fail” the capital investment by the Fed to prop them up would have been even bigger.

We all saw how the credit markets have dried up and how dependent we are on overnight borrowing. I can see why these banks were supported. We need the liquidity they provide. However, it seems clearer than ever after your article, Ms Tkacik, that the government’s support should have led to breaking these banks up.

Fannie Mae and Freddie Mac seem to be actively covering up the systematic inflation of housing prices and the underlying causes. But deregulation and the dismantling of the Glass–Steagall Act and the derivative markets that colluded to make easy money from naive home buyers are greater evils. The whole system has been set up to create an oligarchy that is too big to fail.

The cost of the moral hazard has simply not been at play here. The hands are still in the cookie jar. They’re just reaching for different cookies.

Posted by LEEDAP | Report as abusive
 

Great article! As someone who is 100′s of thousands of dollars upside down (no second just a ton of fraudclosures where I live) it is nice to read something truthful and sensible. Too bad our politicians cant figure this out, or I should say refuse too. Obamas new refi plan is a joke. It doesn’t fix the problem. After they way we have been treated by the banks and governments if were left underwater (even with a refi) we will just walk away when we need to move. Principle reductions are the only justifiable fix.

Posted by CAS100 | Report as abusive
 

Maureen, why are you underemployed? If I were head of the SEC I’d hire you right away. And if you don’t like to work for the government, your considerable talent is such that employers are just dumb not to hire you or partner with you.

Keep ‘em coming…

Posted by TomKi | Report as abusive
 

People knew what they were signing when they put in for those mortgages. They should now have to take the consequences for their actions. The big mistake in this entire debacle is that the “suspect” loans were mixed in with good loans without due disclosure about the risks. Several suits have already been filed over this, and the corporations who bundled these need to be held accountable.

Both corporations and individuals should be held responsible for their decisions. This is the only way to restore trust to the entire system.

Posted by stevedebi | Report as abusive
 

Maureen, just get an editor and you are golden. These ideas, what you have produced here is outstanding. Smart and deep, like Taibbi, good luck and thank you Reuters.

Posted by shrink2 | Report as abusive
 

I believe you’re referencing the adjustable loan 1% one year teaser rate in the mortgage note. It never happens. The the date is changed to adjust the moment escrow closes. My guess is it’s only there to make the loan easier to approve.

Never brought up is the loan application form 1003. For some, it’s signed in blank since the mortgage broker states they need time to go over the numbers to get the lenders approval. It’s called a loan application, so like a job application, the borrower see’s no harm. But that’s the last they ever see of it. It’s suppose to resigned again at closing in front of the notary but it doesn’t make it since the broker is to provide it. Getting a copy from the Title company should point this out by the dates signed. This was all fraud and nice job on the reporting Maureen.

Posted by GetRealsoon | Report as abusive
 

these pieces put forth so much solid, valuable information and obviously represent the fruits of a great deal of heavy lifting rarely done by the average msm hack. but this last part! “dealing with the aftermath of Madoff by ordering a hit out, etc…” its like watching your favorite softball player hit a homer, and touch third base only to keep running towards the fence, hop it and jump on the back of a waiting pick up truck.

Posted by stillwaters | Report as abusive
 

“cluelessness, incuriosity, faulty reasoning and fraudulent economic logic’ seem to be characteristics that can be used to describe most people these days. How do you expect the leaders to be any better?

Posted by NeilK | Report as abusive
 

Just a wonderful, wonderful analysis.
Thank you so much for your work and insight!

Posted by fresnodan | Report as abusive
 

Well analyzed article. Keep up the good work.

In a way , aren’t we all underemployed?

Posted by commansense | Report as abusive
 

Maureen, I see that some don’t understand the term “underemployment” can also refer to over qualification.

I have been mystified by the anxiousness of banks to foreclose being a victim of their greed myself; that was until I found out about the sweet deal they have with the FDIC indirectly financed through us, the tax payer, where the FDIC on many of their “Loss Share Agreements” reimburse the bank that buys the “bad loan” 80% of the loss based on the “original loan value” (not what they bought it for = 60% of loan value). They actually make a handsome profit by foreclosing!

You see, I refinanced my home through Countrywide “Prior” to B of A take over. I did not refinance because I was late. I did so as a means of reducing the interest rate and to avoid the upcoming “reset” looming. But when B of A took over, they saw the “old” interest rate and started claiming I was late. Wrong! I have all the paperwork and provided it to them. They quickly reversed the late fee, but then sold the loan off to be serviced by Residential Credit Solutions (RCS). After RCS took over, they too accused me of now being late in making sufficient payments for the “past year”!

After making payments for almost a year at an agreed upon rate by Countrywide, RCS decided to “REFUSE” my payments any longer and started foreclosure proceedings! That’s right, they sent my check back, and wouldn’t accept any more! They’re explanation “Countrywide did not modify the loan correctly”!

From that point on, I spent “double” my mortgage payment on non-recoverable Attorney fees for the “morality” of the whole thing even though the mortgage is worth 390,000 on a home now worth 190,000.

I finally ran out of money two years later (there goes that savings) and took over to fight this thing myself (pro per). I submitted my complaint complete with 300 pages of physical evidence of me never missing a payment, a summons, and then an application for TRO and OSC. (I now respect what attorneys do! It was as hard as my Masters Degree Thesis).

I now have in writing an ORDER AFTER A HEARING enjoining their foreclosure with a judge expressed disappointment to the bank’s attorneys who represented FNMA and RCS regarding their clients miss behavior.

Here is a quote “Plaintiffs’ application for a preliminary injunction enjoining the sale of real property located at 5618 Miners Circle, Rocklin, California 95765, is granted. Plaintiffs have shown a reasonable likelihood that they may be entitled to some relief. The evidence submitted by plaintiffs indicates that they entered into a forbearance agreement with Countrywide Home Loans, Inc., and subsequently received a loan modification by which their mortgage payments were lowered. However, Residential Credit Solutions later refused to acknowledge the modification and informed plaintiffs that they were in default beginning during the forbearance period, when plaintiffs were expressly not required to make mortgage payments.
Accordingly, IT IS ORDERED that defendants Federal National Mortgage Association, Quality Loan Service Corporation, and Residential Credit Solutions, Inc., and each of them, and all persons and entities acting in concert with them or subject to their direction and control, are hereby enjoined during the pendency of this action from proceeding or causing to proceed the sale of the property commonly known as 5618 Miners Circle, Rocklin, California 95765.

The case goes on, but I’m not sure what I’m fighting for anymore. You can’t sue for punishment, only what you lost. And I’ve lost nothing but debt if I give up now! On the other hand, I could win my loan back and have a sense of justification.

Posted by Doug.kelley | Report as abusive
 

Maureen,
A) The 99% are not the victims of the mortgage meltdown. The 35% are. The renters of America have been destroyed by the entitlement mentality of the ownership society.

B) It is not at all obvious that government should provide massive mortgage relief. This solution is always presented by people who believe that homeowners are superior Americans who deserve protection from their own mistakes at the expense of people who have less than they do. We should not transfer the costs of this folly to anyone who did not participate.

C) Teaser rates are not fraud. Most of these borrowers knew exactly what they were doing. They ignored the possible consequences.

D) No mortgage reductions should have occurred without an ex post facto assessment of taxes on all real-estate capital gains achieved over the last 10 years. If we’re going to reduce losses from the bubble, we also have to reduce the winnings.

Posted by mollyknight | Report as abusive
 

“In any Ponzi scheme, everyone is a little bit culpable, but on the spectrum of negligent naivete, trusting that housing prices would continue to rise forever is arguably a lot more forgivable than trusting an unlicensed mutual fund that claims with no documentation to be delivering a steady unchanging 10% annual return.”

No, it is not more forgivable. Both are equally foolish assumptions, but mortgage holders receive far more benefits than mutual-fund investors, which makes any hubris and over-extension on their part less forgivable.

Mutual-fund holders do not receive a basic necessity along with their investment. They do not receive tax breaks to help pay for the investment. They do not receive $250,000 tax-free on capital gains. They do not have government-sponsored entities such as FHA, Fannie and Freddie supporting their investment choices.

Posted by mollyknight | Report as abusive
 

Hi Maureen Tkacik
Great piece.. most home owners are not aware that adjustable rate mortgages where made for hi income earners basing their income on market influences..and indices and Upward mobility and future CEOs. CEO position are not plentiful but finite. The bigger question now is who benefits mostly from a gov who can’t pay the bills?? Ans: Bond holders.!! yes.. refinance .. at affordable rates is the ans so long as it is a fixed rate. FHA has a program called a Streamline process when refinancing. Gov can create rush to refinance if it wanted to.

Posted by s404n1tn0cc | Report as abusive
 

mollyknight: If various companies involved in the mortgage securitization chain claimed to mortgage-buyers that a property was worth $500,000, and only going up, (which was a typical pitch when selling a teaser rate mortgage to someone) when they knew, in fact, that there was a housing bubble, prices were artifically inflated, and the property’s value was about to drop like a rock, then how is that not fraud?

If banks reselling these trash mortgages to investors neglected to mention this teaser rate issue, how is that not fraud?

If Ratings Agencies ignored the teaser rate issue, in order to keep getting massive profits from the banks who payed them to rate these investments higher than they deserved…. how is that not fraud?

If companies advertised investment products full of this trash to retirees as good, solid investments, how is that not fraud?

“Oh but i dont want my taxes raised to pay for deadbeats”. Your taxes already went to deadbeats – they are called Goldman Sachs, JP Morgan, etc. A large percentage of that money went to prostitutes, alcohol, cocaine, alimony, and sports memorabilia. (The Zeroes, The Asylum, Inside Job, Street Fighters, The Other Guys). Mortgage Relief would mean taking the money from those deadbeats, and saying that the artificial ‘value’ they manipulated into the housing market 2000-2008 would be wiped away. That $200000 tag they stuck on a 1000 sq ft bungalow is going to get lowered to $100000 and they will have to eat back their imaginary, fraudulent profits by selling off one of their yachts.

if i understand correctly.

Posted by decora | Report as abusive
 

stillwaters,

Your comment is by far the best thing I’ve read here:

“its like watching your favorite softball player hit a homer, and touch third base only to keep running towards the fence, hop it and jump on the back of a waiting pick up truck.”

Posted by dedalus | Report as abusive
 

Well analyzed

Posted by Arbrene-Hussain | Report as abusive
 

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