Who Is to Blame for the Mortgage Ponzi Scheme?

Villains in the Mortgage Mess? Start at Wall Street. Keep Going.
By Kathleen Day
Sunday, June 1, 2008; B01
Washington Post

Yes, the executives at Countrywide Financial Corp. planned a top-dollar shindig at a ski resort earlier this year, just after the bank's multibillion dollar losses on subprime mortgages required a shotgun marriage to Bank of America. (A Wall Street Journal story forced them to cancel the party.) And sure, Bear Stearns chief executive James E. Cayne was off playing golf last summer as two of his investment bank's hedge funds collapsed under gargantuan subprime losses. (He's been dumped.)

But so far, the current mortgage meltdown hasn't featured the crasser displays of the 1980s savings and loan fiasco, when executives partied hearty -- one banker famously dressed up as a king and served lion meat to his guests -- as they created a mortgage industry mess that cost taxpayers more than $500 billion.

As a reporter for this newspaper, I covered the savings and loan debacle in depth and later wrote a book about it. Watching the current crisis unfold, I see much of the same behavior that led to the "S&L Hell" of two decades ago. Indeed, some of the fixes for the last problem led directly to this one. Once again, too many people had access to other people's money with too little oversight. Once again, the White House, Congress and federal bank regulators failed to police the financial services industry because they mistook deregulation for a system without any reasonable rules. And now as then, our saga is chock-a-block with people and institutions deserving special mention in the Suprime Hall of Slime.

But make no mistake: Today's crisis dwarfs the S&L fiasco. The eventual cost to taxpayers of this scandal is likely to make yesteryear's culprits look like pikers.

The short version of how we got here: Lenders, fat with money made cheap by the federal government, aggressively coaxed millions of borrowers to take out unaffordable mortgages. They lent this money without assessing whether borrowers could repay it. They assumed, in fact, that most wouldn't be able to and would have to refinance into new, equally unaffordable loans. This process would produce an endless cycle of fees for the lenders -- but only if home prices rose, fairy-tale-like, forever.

On what planet would that be an acceptable business plan?

Here's a longer version of how this happened, with a nod of recognition to the many actors who made it possible.

First and foremost: Wall Street. In the 1990s, after the S&L blowout -- and bailout -- an innovation called securitization took hold on Wall Street to spread risk among many investments and investors. The idea was to insulate mortgage lenders from the ravages of sharp interest-rate spikes that could catch them holding low-interest mortgages even as depositors demanded high-interest returns on savings -- the very thing that had sparked the savings and loan industry's turmoil.

By the end of the millennium, securitization in the housing market was a huge, well-greased mass production line. Mortgage finance giants Fannie Mae and Freddie Mac -- companies chartered by Congress to finance home lending -- bought home loans from banks, then bundled hundreds of them together to secure a bond, called a mortgage-backed security. Wall Street investment bankers bought the securities, which then traded freely in the bond market. For a fee, Fannie and Freddie guaranteed the mortgages behind every security against default, so they required lenders to assess each borrower's ability to repay a loan -- a prudent practice known as underwriting.

Fannie and Freddie's underwriting rules are the gold standard by which lenders evaluate the creditworthiness of "prime" borrowers, people whose strong credit histories make them a low risk and therefore eligible for the lowest borrowing charges.

Fannie and Freddie competed fiercely with each other to create these bonds at the best price, paying less and less for the loans they bought from banks. Securitization became so efficient that it shaved profits in the prime market paper-thin. In response, by 2000, a market had sprouted to lend to "subprime," or higher-risk, borrowers, who could be charged more for loans. Many of these individuals had been denied access to credit for decades because of their skin color or the neighborhoods they lived in -- a process known as redlining for the magic-marker boundaries lenders drew on maps to show which areas were off limits. (Subprime didn't turn out to be a boon to minority home ownership, however; many minority families have ended up as the biggest victims in this mortgage mess.)

Wall Street firms were also eyeing the subprime market. They began buying and bundling subprime mortgages into "private-label" mortgage-backed securities. But Wall Street didn't guarantee the loans it bought, so it had no financial stake in assessing borrowers' creditworthiness. Which meant that lenders didn't have to care, either.

Wall Street investment banks soon became crazy for loans to people with impaired credit, who could be charged more for a mortgage because of the higher chance of default. Absent any rules, including any preventing lenders from mislabeling borrowers a high risk, subprime lending standards slipped, and mortgage signings on a car hood in the driveway became a not uncommon sight. (this section greatly understates the role of the Wall Street Banks who were the instigators, the ringleaders, the primary moving force behind this Ponzi Scheme - Jesse)

Banks and mortgage lenders. They hardly needed persuading to get on the bandwagon. Lenders had just gone through wildly profitable 2003, when falling interest rates ignited a boom in refinancing -- and refinancing fees -- among prime borrowers. Wondering how to keep it going, lenders realized that they could expand it into the subprime market by qualifying borrowers with loans carrying a low teaser rate -- in the 8 to 9 percent range for a subprime loan -- then refinance them into another loan before unaffordable higher interest rates in the double digits kicked in. And if they could steer unsuspecting prime borrowers into subprime loans, they could even inflate the subprime market itself. So lenders paid mortgage brokers a kickback for steering borrowers into higher-priced loans.

Lenders also slashed downpayment requirements from 10 percent to 5 percent and even to zero. They quoted monthly payment figures that didn't include taxes and insurance to dupe borrowers into believing that their payments would be lower if they refinanced. If lenders didn't evaluate borrowers' credit at all, they could deem them a higher risk and charge more. Brokers and bank officers often didn't bother to tell borrowers that providing income and job verification would lower the loan's cost considerably. In fact, a majority of subprime customers -- 61 percent in 2006, by one count -- could have qualified for less expensive conventional loans.

To those who say that these folks knew what they were getting into, ask yourselves this: Would six of every 10 people knowingly pay more for a product than they had to?

In 2005 and 2006, the height of the market, most subprime loans had high prepayment penalties and deceptively low teaser rates. Borrowers were told that, before the rate increased, they could refinance into another loan, again with a teaser rate that would adjust after two or three years. Lenders made sure that the new loan would be bigger so that it could cover the fees they paid themselves, including thousands of dollars in prepayment penalty fees that borrowers weren't aware of but had to pay before they could retire the first loan and get a new one. Eventually, the new loan would be financed by another, even bigger loan, which could be approved only if the borrower's house kept appreciating, which everyone assumed would happen.

The private-label, subprime bond market grew from $18 billion in 1995 to nearly $500 billion in 2005. Wall Street sold subprime everywhere: to public and private pension funds, foreign governments and financial conglomerates, even fishing villages in the Arctic Circle.

Then the unthinkable happened: In 2006, home appreciation slowed. That slowed refinancings, which revealed that much of the appreciation had been caused by the breathless refinancings in the first place. As the higher double-digit rates that lenders must have known borrowers couldn't afford kick in, delinquencies, defaults and foreclosures are exploding. Credit Suisse predicts 6.5 million foreclosures over the next five years.

Here are the other culprits to finger in this sordid tale.

The White House. A few sounded the alarm early on. In 2000, during the final months of the Clinton administration, Treasury official Gary Gensler, while commending banks for making more prime loans to people and communities that had been underserved, noted that subprime lending had also expanded, with some troubling accompanying trends, including a worrying increase in foreclosures.

Eight months later, George W. Bush became president. The new administration paid no attention to the developing crisis. On the contrary. In 2001, the Department of Housing and Urban Development barred class-action suits on complaints about kickbacks that brokers receive to steer borrowers into pricier loans. At the same time, Bush, heralding the subprime market for opening doors to home ownership, said that it didn't need more rules. (He should have talked to his dad, who, as vice president under Ronald Reagan, saw the same mistake being made during the S&L scandal.) (or his brother Neil who was knee deep in the S&L scheme - Jesse)

The Maestro. In 1994, Congress gave the Federal Reserve Board authority to write the rules for all mortgage lenders. In the past 14 years, the Fed has done next to nothing. Its most comprehensive attempt to impose order came five months ago, when it proposed a new set of rules so anemic that on some issues, such as prepayment penalties, they are worse than the status quo.

In recent months, dozens of news reporters and bloggers have blamed former Fed chairman Alan Greenspan for the mortgage mess, saying that he made money too cheap by keeping interest rates too low for too long from 2003 to 2004. "Those who argue that you can incrementally increase interest rates to defuse bubbles ought to try it sometime," Greenspan said recently. He has a point.

But what he does deserve blame for -- big, big blame -- is failing to exercise his power as rule-maker for the mortgage industry. Subprime lending could have continued, but with a few safety rules, such as "Don't cheat people." During a go-go free-for-all, Greenspan could have been the adult at the party.

Reckless speculators, with special mention for Angelo R. Mozilo. No lender better epitomizes bad behavior than Mozilo, the always tan and dapper chief executive of Countrywide. He continued to sell abusive subprime loans last year, even as the market unraveled. The Justice Department recently launched an investigation into his company's lending practices. Under public pressure, Mozilo agreed earlier this year to forgo at least $37.5 million in severance pay triggered when the company agreed to be sold to Bank of America. Still, he left with a pension and retirement package worth tens of millions.

Congress. Why, with all this outrageous behavior under its nose, did the Senate last month overwhelmingly approve billions of dollars in tax breaks to industry but offer little to folks facing foreclosure? The answer: money. The financial services and real estate industries are far and away the largest federal campaign donors, giving more than $247 million in the 2007-08 cycle alone. Between 1999 and the end of 2006, as the subprime mess festered, the mortgage industry and its trade groups spent $187 million lobbying Congress, effectively blocking any efforts to ban abusive practices at the national level.

Fannie and Freddie. For the most part, they didn't buy the most abusive subprime mortgages from lenders because the loans didn't meet their standards. But they did buy private-label subprime bonds for their own investment portfolios to boost profits. From 2004 through 2006, these congressionally chartered companies bought a third of the $1.6 trillion in private-label bonds that Wall Street firms issued. This helped legitimize the market, giving pension funds and foreign governments additional (albeit false) comfort that these securities were safe.

Bush regulators have also allowed Fannie and Freddie to count these securities toward federally set goals for encouraging mortgage lending to low-income borrowers. As it turns out, the increase in home ownership, especially among minorities, that Bush has repeatedly touted as one of his presidency's main goals has been a bust: Yale economics professor Robert J. Shiller points out that foreclosures have pushed the national home ownership rate back to nearly the 67.5 percent it was when Bush took office, and it's likely to fall further. Minority families, which received a disproportionate share of subprime loans, will bear the brunt.

The enablers. The story would be incomplete without special mention of the credit-rating agencies, especially Standard & Poor's, Moody's and, to a lesser extent, Fitch. The firms, which had a conflict of interest because they were paid by the same folks who were issuing the securities, okayed subprime deals without sufficiently kicking the tires to make sure they held at least a little air. Wall Street didn't guarantee the mortgages it bought against default, so buyers of private-label mortgage-backed securities bought private insurance, which insurers sold based on the credit-rating agencies' stamp of approval.

Clearly, some of the so-called credit crunch we now find ourselves in isn't a crunch at all but a return to sobriety. It means that money's not so cheap and won't be available at all for reality-defying investments, at least until this debacle fades from memory.

Meanwhile, the Bush administration, which has repeatedly balked at the idea of any government help for borrowers facing foreclosure, has let the Fed underwrite a $30 billion bailout of Bear Stearns and extend an open-ended line of credit to the other investment banks that created the subprime bubble. Among the collateral it said it would accept are . . . private-label mortgage-backed securities.

Yes, we taxpayers now own this stuff.

dkathleen30@yahoo.com

Rough Economic Seas Ahead as the Storm Intensifies

The breadth and volume of the market has been narrow. We remain in a bearish posture on US financial assets that we took roughly around the market peak in October of 2007, and will stay guardedly bearish until the banking crisis is settled.

We are quite certain that it is not behind us yet, not by a long shot. There is another bigger shoe to drop, although that may not occur until the next president takes office, and the Republicans deliver the coupe de grace to the US public. We are also in an economic recession, and the length of the downturn could extend well into 2009 with the damage intensifying if the Fed fails to bring off its gambit of bailing out the banks without triggering a rather nastier bout of inflation, much worse than we are already experiencing.

The pundits' argument on Fox News is that there is "$3.5Trillion" cash on the sidelines, and that this money must go somewhere to seek a return, and the only logical place to get the best returns is in equities.

Oh really? Lets take a look at the actual returns for past year.




There is a significant amount of disinformation being tolerated in the corporate news media these days, and the integrity of many of our institutions are in question. Naive citizens become agitated by the emotional side issues, and we'll expect that to become worse as the national elections approach. Sometimes it borders on hysteria, even among normally intelligent people. This is fed in particular by some news channels, and it is probably best to avoid them as they are a form of pollution to the rational mind.

Signs of the times. We are experiencing a sea change, and traumatic disruptions may become more severe and frequent, especially for those unable to see past the change and understand it in context.

The experience is not dissimilar to other times of historic change and trauma. The experience of Germany and the US between the World Wars comes to mind. The character of the people will be tested. Let us hope we maintain a perspective, and come through this as gracefully as is possible.


'Permabear' Peter Schiff's Worst-Case Scenario
By Kirk Shinkle
May 30, 2008
US News and World Report


Economic punditry tends to fall broadly into glass-half-full or half-empty categories. Then there are those who see a cracked glass, teetering on the edge of a table just moments from a shattering fall. Enter Peter Schiff, the permabear president of brokerage Euro Pacific Capital and coauthor of last year's Crash Proof: How to Profit From the Coming Economic Collapse.

Schiff spent the past decade urging brokerage clients to jump ship from the American economy ahead of what he views as inevitable pain caused by a toxic cocktail of lax monetary policy, wayward spending, and tougher competition from all corners of the globe.

Even with some pain already felt as America's economy stumbles, Schiff saw nothing but downside in a recent chat with U.S. News. You'll want to buckle up for some characteristically apocalyptic talk from one of the gloomiest market watchers around. Excerpts:

Say something positive about the U.S. economy.
There's nothing good to say about our situation. The policies both the Fed and government are pursuing are making the situation worse. We've been getting a free ride on the global gravy train. Other countries are starting to reclaim their resources and goods, so as Americans are priced out of various markets, the rest of the world is going to enjoy the consumption of goods Americans had previously purchased. This is a natural consequence of this phony economy. If America had maintained a viable economy and continued to produce goods instead of merely consuming them, and if we had saved money instead of borrowing, our standard of living could rise with everybody else's. Instead, we gutted our manufacturing, let our infrastructure decay, and encouraged our citizens to borrow with reckless abandon.

So what are you doing about it?
I'm getting my clients' money outside of the United States as fast as they can send it to me. I've been recommending that to my clients for close to 10 years. You've got to own resources and energy. I was saying oil was going to $200 a barrel in 2002. I've been buying gold, silver, industrial metals, and all kinds of stocks. My main theme is the global economy will survive and the U.S. economy is a disaster. Everything is about how you benefit from the increased purchasing power and rising standard of living in the rest of the world.

OK, where are the best non-U.S. markets this year?
I still like Singapore, Hong Kong. Asian markets are the place to be. I like resource markets like Scandinavia. I'm spreading my chips around the world. I'm just avoiding the United States.

What are your best or worst calls through this downturn?
I've been bearish on bonds. U.S. bonds have lost a lot of real value but not nominal value. I still think that's going to be proven to be correct. While the housing bubble was inflating, I was telling people to rent. I was telling people to get out of tech stocks in 1998 and 1999. They kept rising, but then they collapsed, and I turned out to be right. The reality is I don't think I've been wrong on anything.

Most people disagree with that sort of pessimism. If you're staying in the United States, how do you invest?
If you want to be in U.S markets, you avoid anything connected with the American economy. You avoid retailers, the home builders, the financials—anything having to do with consumers buying something or paying back the money they borrowed. If you want to invest in U.S. markets, stick with exporters and resource companies. I've been saying that for five or six years; I haven't gotten anything wrong. We shorted subprime mortgages. I have clients that made 10 times their money. We've never sold an oil stock. We've never sold a gold stock.

Why don't you think soaring oil, grains, or commodities prices are the next bubble?
These prices do not constitute bubbles. They simply constitute the repricing of goods to reflect the diminished value of our money. The way you can tell there's not a bubble is that these markets are clearing. People are buying food and eating it. They're buying gasoline and using it. Speculators aren't buying gasoline and warehousing it in big facilities because they think the price is going to go up. At the same time, we've increased the supply of money dramatically, and the Fed is increasing it even faster now to deal with the bursting of the housing bubble. The only thing that can happen is for prices of commodities to rise to reflect the equilibrium of a greater supply of money. It's not even that oil prices are going up. Oil prices are staying the same. What's happening is the value of money is diminishing, so we need more units of currency to buy the same amount of oil or wheat or corn or whatever.

How about some predictions?
• I think the stock market is headed lower. Gold is going to be $1,200 to $1,500 by the end of the year. That puts the Dow at a less-than-10-to-1 price ratio to gold. Right now, it's about 13 to 1. That's another 30 percent drop in the real value of stocks by the end of the year if you price them in gold. The Dow was worth 43 ounces of gold in 2000. It'll get to 10 by the end of the year and continue to fall from there.

• Oil prices had a pretty big run and might not make more headway by the end of the year. But we could see $150 to $200 next year. I don't think oil will hit $250 because there will be enough destruction of demand in the United States to keep it from doubling. The big problem for us is if the Chinese substantially allow their currency to rise. It could increase at least fivefold against the dollar over the span of a year or two. That reduces the price of oil by 80 percent for 1.3 billion Chinese. Consumption would go through the roof, and that will drive prices through the roof for us.

• At a minimum, the dollar will lose another 40 to 50 percent of its value. I'm confident that by next year we'll see more aggressive movements to abandon the dollar by the [Persian] Gulf region and by the Asian bloc. That's where the stuff really hits the fan.

You're a Ron Paul adviser. He's out of contention, so who wins the election, and what happens then?
The Obama presidency will be like the Jimmy Carter presidency on steroids. I'm pretty sure it's Obama because the economy will be so bad into the election that as damaged a candidate as the guy is, I don't think a Republican could beat him. I think Ron Paul could've had a slim chance because he was different enough.

So how bad do you think this economy will get?
The other problem we'll have during those years is civil [unrest]. There will be a big increase in crime. People are going to be hungry. People are going to be cold. There's a sense of entitlement in this country, and when a lot of people used to having things suddenly don't, everybody looks for someone to blame.

Really?
We're going through a very rough period in our history. In many ways, it's going to be worse than the Depression.

The Dow Jones Industrial Average Deflated by Gold

Deflated by gold, the Dow Jones Industrial Average has been in a bear market since 2001.

US Dollar Long Term Chart with Commitments of Traders as of May 27 COB

US Dollar Weekly Chart with Moving Averages

Gold price to rise long term: China central bank official

SHANGHAI, May 29 - International gold prices are likely to rise further in the long term due to dollar depreciation, rising demand and global political and economic uncertainty, a researcher at China's central bank said.

Worries about global inflation, a possible worldwide economic slowdown and geopolitical instability will also bolster the metal's price, Wang Yu, director of the gold and foreign exchange market division of the People's Bank of China, told an industry conference.

"My personal conclusion is that international gold prices will remain volatile in the short term, while from a long-term perspective there is a possibility for -- and room for -- prices to increase further," she said…