...Opps

Finally. . .

2012-02-28T19:44:00.001-08:00

I've been noticing in the last few weeks a small number of articles where the SEC is settling with some banks for their CMO chicanery. Here's some more good news. . .

From HousingWire: Wells Fargo, Goldman receive Wells notices over MBS disclosures
Goldman Sachs disclosed the Wells notice in its 10-K, while Wells reported the notice in its 2011 annual report to shareholders.

The notice from the Securities and Exchange Commission concerns "the disclosures contained in the offering documents used in connection with a late 2006 offering of approximately $1.3 billion of subprime residential mortgage-backed securities underwritten by GS&Co.," Goldman said in its regulatory filing. "The firm will be making a submission to, and intends to engage in a dialogue with, the SEC staff seeking to address their concerns."

At Wells Fargo, the Wells notice also relates to the bank's disclosures in mortgage-backed securities offering documents.
Goldman Sachs disclosed the Wells notice in its 10-K, while Wells reported the notice in its 2011 annual report to shareholders.
The notice from the Securities and Exchange Commission concerns "the disclosures contained in the offering documents used in connection with a late 2006 offering of approximately $1.3 billion of subprime residential mortgage-backed securities underwritten by GS&Co.," Goldman said in its regulatory filing. "The firm will be making a submission to, and intends to engage in a dialogue with, the SEC staff seeking to address their concerns."

At Wells Fargo, the Wells notice also relates to the bank's disclosures in mortgage-backed securities offering documents.
The notice from the Securities and Exchange Commission concerns "the disclosures contained in the offering documents used in connection with a late 2006 offering of approximately $1.3 billion of subprime residential mortgage-backed securities underwritten by GS&Co.," Goldman said in its regulatory filing. "The firm will be making a submission to, and intends to engage in a dialogue with, the SEC staff seeking to address their concerns."
At Wells Fargo, the Wells notice also relates to the bank's disclosures in mortgage-backed securities offering documents.
At Wells Fargo, the Wells notice also relates to the bank's disclosures in mortgage-backed securities offering documents.
The earlier Goldman settlement was related to CDO derivatives (Collateralized Debt Obligations). Now the SEC is investigating the securitization of the underlying MBS.

Wells Fargo and Goldman Sachs received Wells notices over mortgage-backed securities disclosures, according to regulatory filings.

Published: February 27, 2012 3:00 a.m.Citigroup accused of defrauding feds
Bob Ivry | Bloomberg NewsNEW YORK – Citigroup, which this month admitted breaking FHA rules and paid a fine, also violated regulations for home loans sold to Fannie Mae and Freddie Mac, according to a whistle-blower’s complaint.
The bank “defrauded, falsified information or misled federal government entities” by selling or securing insurance for mortgages with defects such as improper appraisals and paperwork errors and not reporting them as required, Sherry Hunt, a Citigroup quality-assurance vice president, said in a complaint unsealed last week. It was filed in August under the False Claims Act in federal court in Manhattan.
For Citigroup, the third largest U.S. bank by assets, the high defect rates could be costly. It might be forced to buy back substandard mortgages sold to government-controlled Fannie and Freddie, which buy or guarantee most U.S. mortgages. Under this month’s settlement with the United States on FHA loans, Citigroup will pay $158.3 million. The Justice Department reserved the right to pursue criminal and other charges related to mortgages originated or underwritten by Citigroup and not insured by the Federal Housing Administration.
“Everyone is a little bit guilty for not keeping an eye on the processes and doing what we should have been doing,” Hunt said by phone from Silex, Mo. “Managers have to take ownership of their area, know what’s going on and make sure they’re doing the right thing.”
Last year, Citigroup repurchased 6,600 loans from government buyers, an 89 percent increase from 2010, according to a presentation on its website. The bank set aside $1.2 billion to buy back defective mortgages as of the end of 2011 – the most ever, and up from $969 million in 2010.
“We take our quality assurance processes seriously and have pro-actively undertaken process improvements to ensure that they are as strong as possible,” Sean Kevelighan, a Citigroup spokesman, said in an email.
Andrew Wilson, a spokesman for Washington-based Fannie Mae, and Chad Wandler, a spokesman for McLean, Va.-based Freddie Mac, declined to comment.
Hunt said New York-based Citigroup knowingly vouched for the quality of loans that were “deficient” in income documentation, had incomplete borrower job histories, appraisal problems, errors in closing paperwork, missing credit reports and miscalculated maximum mortgage amounts, among other flaws. The failures continued into last year, Hunt said.

HSH Nordbank Sues Barclays Over Mortgage Backed Securities
HSH Nordbank AG, a regional German lender that was bailed out during the financial crisis, sued Barclays Bank Plc in New York over the purchase of $122.7 million in residential mortgage-backed securities.
Barclays made “misrepresentations and omissions” in offering materials about characteristics of the mortgage loans underlying the securities, including the percentage of properties occupied by the owners, Hamburg-based HSH Nordbank said in a complaint filed yesterday in New York State Supreme Court in Manhattan.
Pools of home loans securitized into bonds were a central part of the housing bubble that helped send the U.S. into the biggest recession since the 1930s. The housing market collapsed, and the crisis swept up lenders and investment banks as the market for the securities evaporated.
A phone call to the press office at Barclays headquarters in London after normal business hours seeking comment on the lawsuit wasn’t answered.
The case is HSH Nordbank AG (BARC) v. Barclays Bank Plc, 650508/2012, New York State Supreme Court (Manhattan).

DEALS & DEAL MAKERS
FEBRUARY 29, 2012

Mortgage-Bond Deal Draws a Fine

As Other Firms Are Targeted, State Street to Pay $5 Million to Settle Massachusetts Charges

By JEAN EAGLESHAM

Massachusetts's securities regulator is conducting a wide-ranging investigation into the Wall Street

mortgage-bond system that helped fuel the financial crisis.

Secretary of the Commonwealth William Galvin said his office is investigating "how banks misled buyers" in the multibillion-dollar deals.

"We're actively investigating a number of deals, a number of entities," Mr. Galvin said in an interview.

In the first enforcement action to result from the probe, the state regulator Tuesday fined State Street Corp. over its role as investment manager for a deal called Carina CDO Ltd.

Carina was a $1.56 billion collateralized debt obligation created in 2006, as Wall Street's CDO system was at its height. CDOs are deals based on pools of subprime mortgages and other loans, slices of which are sold to investors.

State Street failed to tell investors that Illinois-based hedge-fund firm Magnetar Capital LLC had helped to set up Carina, while also betting against $142 million of the underlying assets, the Massachusetts regulator said.

"The investigation established that State Street knew that Magnetar was shorting some or all of the portfolio but allowed the hedge fund to participate in meetings to discuss portfolio composition" and to recommend assets, it said.

When Carina collapsed in November 2007, with losses to investors of about $450 million, Magnetar was "able to reap a windfall" from its net short position on the deal, the regulator said. A spokesman for Magnetar declined to comment.

State Street, which agreed to pay penalties totaling $5 million to settle the civil securities fraud charges, said in a statement that it neither admitted nor denied the Massachusetts regulator's findings.

Deutsche Bank AG structured the Carina deal. Mr. Galvin said Deutsche is one of a number of firms under investigation by the Massachusetts regulator.

A spokesman for Deutsche declined to comment.

The Massachusetts enforcement action follows a blueprint already used by the Securities and Exchange Commission for a handful of civil enforcement actions over similar mortgage-bond deals.

The Massachusetts settlement reveals new details about the influence exerted by Magnetar, alleging the hedge fund helped to craft some 26 CDOs while betting against the underlying assets.

Deutsche Bank created Carina at the request of Magnetar, and involved the hedge fund in discussions with State Street about which assets to select for the deal, according to the settlement agreement.

It quotes an internal email sent by a State Street executive in June 2006 as Carina was being put together.

"It seems a large U.S. hedge fund has asked DB [Deutsche Bank] to structure a deal," the email said.

"Smells like a lay-up to me but we need to respond very quickly," the message added.

Magnetar got the chance to affect the name of the deal, which was taken from a constellation in the southern sky, according to the court filing.

It quotes a State Street email from June 2006 saying the bank had asked a Magnetar executive "if he has a preference for the name of the CDO. The owner of the firm is an astronomy buff…so [he] would like to see the deal named after a constellation."

Officials of the hedge fund attended meetings with representatives of State Street and Deutsche at State Street's Boston offices as the deal was being put together, according to the Massachusetts regulator. It quoted from an email sent by a State Street employee to a Magnetar executive in July 2006 promising to "keep you posted on my progress" on Carina.

Magnetar hasn't been accused of wrongdoing by any regulator. Its role in a number of mortgage-bond deals has been scrutinized by the SEC, according to people familiar with the matter.

The hedge fund has previously said it wasn't betting against the housing market and didn't "select" assets in the CDOs in which it invested.

The SEC is investigating whether investors in a $1.6 billion mortgage-bond deal called Delphinus CDO 2007-1, created by Mizuho Financial Group Inc., were told about Magnetar's input into the deal, The Wall Street Journal has previously reported. Mizuho said last month it had "been asked by the SEC to provide related documents and information, and it's currently dealing with it."

Write to Jean Eaglesham at jean.eaglesham@wsj.com

FASB 157

2012-02-27T07:36:00.001-08:00

One of the bad bargains the federal government made in the wake of the 2008 Financial Crisis was giving permission for banks and investment houses to literally make up values for the imploded CMOs they owned. If you notice, bank stocks trade at decade lows simply because no investor wants to buy a business who's balance sheet is complete fantasy. This was done to help the banks recover their solvency, but it's effect to this point has been to maintain their zombie existence.

FASB Sold Out; Expected Results Followed

By Barry Ritholtz - February 27th, 2012, 7:09AM

In the height of the financial crisis, the Financial Accounting Standards Board were pressured to pass FASB 157(“Fair-value accounting”).
Banks were complaining that some of their holdings were difficult to value, thinly traded, tough to mark. So 157 passes and it allows the accountants at banks to mark these to a model rather than the last trade.
Derided as “Mark-to-Make-Believe” it leads to this unfortunate situation: The same models that led to the unfortunate money-losing purchase decision in the first place are now being used to actually value these holdings. regardless of the obvious flaw in the model in the first place.
As these bad buys plummet in price, investors in banks have no insight into the loss potential — they are hidden from view, along with the true financial condition of the company. This sort of accounting fuckerywould never be tolerated in a nation where investors mattered more than insiders and bankers. Instead, it rewards the incompetent and allows near insolvent banks to pretend they are solvent, thereby allowing the granting of huge bonuses.
Almost three years later, we see the results of the Accounting Board’s move. The large bailed out banks remain weakened. Like all wounded animals, they are very dangerous. They have institutionalized fraud, made forgery a business expense. ZIRP exists for the primary reason of allowing these banks to rehabilitate their faulty balance sheets. Savers get punished.
The same could have been accomplished much more quickly and cheaply through prepackaged bankruptcies. That would have required an uncorrupted Congress, an honest Accounting board and a willingness to allow capitalism in America. Instead, we had foisted upon us a convoluted form of Socialism for Financiers.
If you want to know why the Fed has maintained zero interest rates, you need only look at who remains employed at banks, at who gets blamed for their failure. The record low approval rating of Congress at least imply that the public isn’t utterly blinded by the scam.
All to save the asses of a few reckless, incompetent bankers. Something is very, very wrong with this system . . .

PERMALINK | COMMENTS (11)
Category: Bailouts, Legal, Really, really bad calls, Regulation.

Ritholtz weighs in

2012-02-26T07:33:00.000-08:00

Barry's been quieter than I'd have liked on this, especially in relation to his hair on fire over the 2008 Financial Crisis (he wrote a book about it). Featuring a beautiful "I told you so" at least this gets in front of the clowns and jokers who read the Washington Post this morning.

The bigger issue is the economics of criminality. Most people who get caught committing crimes are punished. Commit a felony — if you run a bank — and your shareholders pay a monetary fine. Violating the law has merely become the banker’s cost of doing business.

Thus, the robosigning agreement has allowed the mass production of perjury. It has gone unrecognized and unpunished. It has made perjury a business expense, like travel or office furniture. The same reckless approach to giving loans to unqualified people was institutionalized, leading to another reckless approach to foreclosing homes.

We still don’t know who ordered these crimes, who is responsible for this, whether they still are in their jobs — or whether they are in a position of authority to do the same thing again.

You go, Barry. . .

The Robosigning Deal is a Useless Embarrassment

By Barry Ritholtz - February 26th, 2012, 9:00AM

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My Sunday Washington Post Business Section column is out. This morning, we look at the yet another bank giveaway, the awful robosigning foreclosure settlement.
The print version had the headline The robosigning deal is a useless embarrassment, while the online version is titled Foreclosure settlement a failure of law, a triumph for bank attorneys.
As I noted oh so many times before, once we bailed out failing banks, there is a strong incentive to protect rather than police them. This deal is a perfect example.
Here’s an excerpt from the column:

“Before the settlement, we learned that nearly every aspect of the robosigned documents was false. None of the details were ever reviewed. The signatures attesting to the review of the documents were fabricated — made by someone other than the person whose name was on the document. Neither person — the supposed signatory to the document nor the hired forger — ever validated the facts of each case. All of the safeguards put in place to make sure foreclosures were done correctly and legally were bypassed. Even the notary stamps were bogus — they were not real, and not signed by a notary to validate that the signer and the signature matched.
How did this happen? Instead of a careful review, people were hired to rubber-stamp hundreds of foreclosure documents an hour. Former burger flippers were paid $8 to $10 an hour to violate the law, file false affidavits and commit perjury. Some of the information was correct, but much of it was wrong — and none of it was verified for court purposes.
And now we have this grand settlement.
What will the impact be?
Economically, it will have no effect. The dollar amount is small relative to the U.S. economy. Indeed, the total impact of the settlement is less than one ten-thousandth of annual gross domestic product.
Then there’s the “math.” The number touted is $26 billion, but that’s wildly misleading. At most, it’s $6 billion, paid out by a consortium of banks. The other $20 billion is for capital write-downs for delinquent homeowners that were going to happen anyway. These were homes that the banks anticipated taking a $50 billion-to-$100 billion hit on. Only now, they get a tax benefit for it.”

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The dead tree version of the paper has a nice layout:
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click for ginormous version of print edition

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Source:
Foreclosure settlement a failure of law, a triumph for bank attorneys
Barry Ritholtz
Washington Post, February 26 2012
http://www.washingtonpost.com/foreclosure-settlement-a-failure-of-law-a-triumph-for-bank-attorneys/2012/02/23/gIQAe7feaR_story.html
RoboSign Washington Post, February 26 2012 (PDF)

PERMALINK | COMMENTS (4)

Quote of the day

2012-02-25T07:30:00.001-08:00

Among the fundamental principles of any functioning justice system is the following: Don’t lie to a judge or falsify documents submitted to a court, or you will go to jail. Breaking an oath to tell the truth is perjury, and lying in official documents is both perjury and fraud. These are serious criminal offenses, but apparently not if you are at the heart of America’s financial system. On the contrary, key individuals there appear to be well compensated for their crimes [...]
Indeed, at stake in the mortgage settlement are fundamental and systemic breaches of the rule of law – perjury and fraud on an economy-wide scale. The Justice Department has, without question, all of the power that it needs to prosecute these alleged crimes fully. And yet America’s top law-enforcement officials have consistently – and now completely – backed off.

Simon Johnson "Too Big To Jail"

Oh, heck, the whole thing is too good to leave off. . .

Too Big to Jail

Simon Johnson

2012-02-22

WASHINGTON, DC – Among the fundamental principles of any functioning justice system is the following: Don’t lie to a judge or falsify documents submitted to a court, or you will go to jail. Breaking an oath to tell the truth is perjury, and lying in official documents is both perjury and fraud. These are serious criminal offenses, but apparently not if you are at the heart of America’s financial system. On the contrary, key individuals there appear to be well compensated for their crimes.

As Dennis Kelleher of Better Markets has argued, the recent so-called “robo-signing” settlement – in which five large banks “settled” their legal liability for carrying out fraudulent foreclosures on mortgages – is a complete sell-out to the financial industry.

First, there was no serious criminal prosecution – meaning that no one will be charged with a felony, and no one will go to jail. In terms of affecting executives’ incentives, this is the only thing that matters.

Even the terminology used to frame the discussion is wrong. Kelleher, an attorney with extensive experience in private practice and the public sector, tells it like it is: “‘robo-signing’ is massive, systematic, fraudulent, criminal conduct.” Alternatively, as he points out, we could just call it “lying, cheating, and stealing.”

Second, the civil penalties in this settlement – a form of fine – are minuscule relative to the size of the companies involved. As Shahien Nasiripour, one of the best reporters on this issue, dryly put it: “None of the five lenders have said they expect to incur a material charge due to the settlement.” In other words, from a corporate perspective, the penalty is a trifling affair.

Third, such fines are, in any case, paid by the companies’ shareholders, not by their executives or board members (all of whom carry insurance). In the rare cases in which fines have been levied on individuals, either their insurance policies picked up most of the bill, or the penalties were trivial relative to the cash compensation that they received while committing their crimes – or both.

As if all of this weren’t bad enough, the banks reportedly will be able to use government money to write down the value of mortgages, which amounts to subsidizing them to pay their own meaningless fines.

The Obama administration and its allies have worked hard to sell its roughly $20 billion settlement with the banks as one that will have a meaningful impact on the housing market. But nothing could be further from the truth. As Kelleher points out, the United States has “more than 10 million homes under water” (the outstanding mortgage exceeds the house’s value). “Twenty billion dollars doesn’t make a dent in that: one million homes at $20,000 loan forgiveness is it.”

In fact, the Obama administration’s settlement with the mortgage lenders is consistent with its track record on all of its policies related to the financial sector, which has been abysmal. But it is also puzzling. Why would the administration continue to bend over backwards to be lenient towards top bankers under these circumstances?

I honestly do not believe that the administration’s stance reflects any form of corruption – payments made to individuals or even to political campaigns. And, in this case, it does not even appear to reflect the lobbying power of big financial players. That power certainly explains why the Dodd-Frank financial reforms enacted in 2010 were not stronger, and why there is now so much opposition to effective implementation of that legislation (for example, there is currently a huge fight around the “Volcker rule,” which would limit proprietary trading by megabanks). But mortgage lenders’ criminal activities are another matter.

Indeed, at stake in the mortgage settlement are fundamental and systemic breaches of the rule of law – perjury and fraud on an economy-wide scale. The Justice Department has, without question, all of the power that it needs to prosecute these alleged crimes fully. And yet America’s top law-enforcement officials have consistently – and now completely – backed off.

The main motivation behind the administration’s indulgence of serious criminality evidently is fear of the consequences of taking tough action on individual bankers. And maybe officials are right to be afraid, given the massive size of the banks in question relative to the economy. In fact, those banks are bigger now than they were before the crisis, and, as James Kwak and I documented at length in our book 13 Bankers, they are much larger than they were 20 years ago.

Top bankers want to make a lot of money. They also want to stay out of prison. Political leaders can huff and puff as much as they want, but, without a credible threat of poverty and time behind bars, bankers have no reason to comply with the law. For them, it’s all about the trade – and you can be the sucker in public policy as easily as you can be the sucker in an individual loan agreement.

The message to bank executives today is simple: build your bank to be as big as possible – and then keep growing. If you manage to become big enough, you and your employees are not just too big to fail, but also too big to jail.

The Obama administration has just made everyone else the sucker.

Yale School of Management explains it all for you

2012-02-19T06:43:00.002-08:00

...about the Financial Crisis. Not light reading but at first glance, pretty comprehensive.

http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1983316_code17513.pdf?abstractid=1974662&mirid=1

Commercial paper (CP) has been an important security for the financing of industrial firms for many decades. In the traditional CP market, highly rated firms can quickly issue debt with minimal transactions costs, and typically cover the risk that investors will suddenly disappear by obtaining a backup line of credit from a commercial bank. Demand for CP is high enough that financial intermediaries have increasingly made use of the market to finance long‐term financial assets, in which case the debt is known as “asset‐backed commercial paper”, or just ABCP. When CP is used this way, financial institutions can bundle mortgages, credit‐card receivables, and other loans into off‐balance‐sheet vehicles. Like the related structure of securitization, such vehicles can be more transparent than full bank balance sheets, which can then enable lower funding costs. More cynically, such vehicles can be used to move assets off balance sheets in name only, allowing banks to save on regulatory capital.

Whatever the reason, by July 2007 there was approximately $1.2 trillion of ABCP outstanding. With the majority of this paper held by MMFs, the ABCP market was deeply connected with more familiar parts of the financial system (Covitz, Liang, and Suarez, 2011).

Covitz, Liang, and Suarez describe the unraveling of this market in great detail, drawing the analogy between a “run” on an ABCP program and a traditional bank run. Conceptually, an ABCP program would suffer a “run” if lenders – equivalent to depositors in a bank – are unwilling to refinance CP when it comes due. Mechanically, the authors define a run as occurring in any week where a program does not issue any new paper despite having at least ten percent of its CP maturing. If a program is unable to issue new paper, then it must either rely on backup support from the program sponsor (typically a bank or group of banks), or it is forced to sell assets.

STOCK stopped?

2012-02-19T06:31:00.001-08:00

SATURDAY, FEBRUARY 18, 2012

Can Rep. Bachus and His Money-Crazed Congressional Colleagues Be Stopped from Insider Trading?

By Lynn Parramore. Cross posted from Alternet.

Back in the Gilded Age, venality was the rule in Congress. Bribes were as common as tobacco pipes. Lawmakers fattened their bank accounts through insider deals, with the needs of ordinary people an afterthought. Nelson Aldrich, a powerful Republican who served in the Senate from 1881 to 1911, was that corrupt era’s political poster boy, serving on the Finance Committee and using his position to invest in railroads, sugar, rubber and banking deals that made him rich.

Sound familiar? It should. We’re well on our way to repeating that money-crazed chapter in American history as a growing list of legislators use their office to play the game, “Who Wants to Be a Multi-millionaire?”

Last week we learned that Rep. Spencer Bachus, R-Alabama, Chairman of the House Financial Services Committee, is under investigation by the Office of Congressional Ethics – the first such case involving a member of Congress. The probe comes at a time when America’s ethics alarm bells are ringing loudly. In the business world, trading on insider information is a crime punishable with prison time, but Congress operates in a different – and very lucrative — universe. Recently, the House and the Senate have been debating legislation to stiffen rules on insider trading by lawmakers in the wake of a “60 Minutes” report and a book focusing on the topic, Throw Them All Out, by Peter Schweizer of the conservative Hoover Foundation. But the legislation, known as the STOCK Act, appears to be stalling.

For the public, the debate centers on several questions. Should members of Congress get to trade on and make money from inside information that can seriously sway the markets? Are elected representatives serving the interest of their constituents, or are they serving their bank accounts? And just how do we stop them from abusing their office through insider trading?

More Than Just Luck

A big sign that something is rotten in Washington is that members of Congress who play the stock market do much better on average than the individual investor.

Back in 2004, a study* considered by academics to be the baseline work in the field was published by researchers at four universities. These researchers, Alan Ziobrowski of Georgia State among them, found that during the boom years of 1993-’98, a majority of US senators were trading stocks — and they were beating the market by 12 percentage points a year on average. Corporate insiders, on the other hand, only beat the market by 5 percent, and typical households underperformed by 1.4 percent. Interestingly, there were no differences found between Democrats and Republicans. (See Gail Chaddock’s report on thestudy in the Christian Science Monitor.)

12 percent is a statistically shocking number, way beyond luck or just being smart. Nobody does that well. Not George Soros. Not Warren Buffett.

The 2004 study sent chills through Congress as members realized they were under scrutiny. And yet legislators have gone right on lining their pockets using insider information. In the executive branch, you’re expected to divest yourself of assets when you take office or put your investments into what are known as “blind trusts.” But legislators consider inside dealmaking their divine right. They typically go right on playing the stock market and often neglect to bow out when they have a financial interest in an issue they are legislating. Disclosure statements they have to release are pretty much a joke – they’re incomplete, and they are difficult and expensive for the public to obtain. A reporter requesting documents has to disclose his or her information in the request, which is then sent straight to the member, a move which can be intimidating to those asking questions.

Lawmakers Gone Wild

Remember the frightening days of 2008, the year when Wall Street was crashing and Congress was debating a rescue package? Most of us were scared stiff of losing our savings. But not lawmakers. That’s when the trading fever really caught them again. The influential Rep. Bachus was in the room back in September 2008 when the bank bailout was underway. Through briefings from Secretary of the Treasury Hank Paulson and Federal Reserve Bank Chairman Ben Bernanke, he found out ahead of the public that the markets were going to crash big-time, and he decided he would make some money in the deal, betting against the entire market in what’s called a “short option.” He also sold his shares in General Electric (whose stock price subsequently collapsed), getting out at a profit.

“These meetings were so sensitive that they would actually confiscate cell phones and Blackberries,” Schweizer noted on “60 Minutes.” “What we know is that those meetings were held one day and literally the next day Congressman Bachus would engage in buying stock options based on apocalyptic briefings he had the day before from the Fed chairman and treasury secretary. I mean, talk about a stock tip.”

The Alabama legislator’s funny idea of what he’s supposed to be doing in Congress scandalized the public back in 2010 just as he was named chair of the Finance Services Committee, which oversees banks, financial markets, housing and consumer credit. His succinct summary was breathtaking in its open embrace of corruption: “Washington and the regulators are there to serve the banks.” He forgot to mention that he was also there to serve his portfolio.

OCE investigators are currently examining whether Bachus violated Securities and Exchange Commission laws that prohibit individuals from trading stocks and options based on “material, non-public” inside information.

He may be the worst, but Bachus is by no means alone in his shenanigans. The activities of Sen. Dick Durbin (D-Illinois), Sen. John Kerry (D-Massachusetts), Rep. Jim Moran (D-Virginia) have been under scrutiny as examples of legislators making possible insider trades during the financial crisis. Speaker of the House John Boehner (R-Ohio), and former Speaker Nancy Pelosi (D-California) have also been cited for questionable dealings.

The STOCK (Stop Trading on Congressional Knowledge) Act

Over the years, a version of the STOCK Act has been tossed around and never passed. Members of Congress (surprise!) have not been enthused about applying securities laws to their own trading.

But earlier this month, as the public cried foul, both the House and Senate suddenly seemed open to approving versions of the STOCK Act, and President Obama has vowed to sign such legislation as soon as it hits his desk.

Problem solved? Not so fast. Insider trading is quite difficult to prove. When I spoke to Professor Ziobrowski, one of the researchers on the 2004 study, he observed that you’d pretty much have to have a suspicion ahead of time before you could even make a move against someone. He further noted that there are myriad ways of passing on information, from lunches to golf games, that are nearly impossible to trace. Unless conversations are taped, proving insider trading is difficult at either the corporate level or Congressional level. And what, exactly, qualifies as insider information? If a legislator comes out of meeting sensing which way the wind is blowing on new regulations for the banking industry, for example, does that qualify? The potential for gray area is vast and you can bet that legislators will be taking advantage of this when and if they are indicted.

Then there’s the dismal swamp of the political intelligence industry. Before the 1970s, representatives of various industries would hang around Washington hoping to get a heads up on legislation that might affect business. This tip-collecting then became organized into a formal industry, with players often getting a seat in the room when bills are being discussed and shaped. The result is what you might expect – a system of horse trading where political tips and business tips get circulated to the benefit of everyone except the public. A political intelligence operator gets his or her tip, which could come from a member of Congress or, even more likely, a staffer, and then sells it to a big financial firm. The firm may then offer thanks in the form of donations or insider deals on IPOs and such. There are gargantuan amounts of money involved, and that’s why last week, the political-intelligence industry was breathing a sigh of relief when Republicans chucked a provision from a STOCK bill that would have forced these firms to register their activities like lobbyists.

Finally, any laws that bar members of Congress from insider trading that do not include their staff are also likely to be exploited. “The Capitol Hill reality is that staff go into business, too, either for themselves or with the connivance of their bosses,” political economist Thomas Ferguson told AlterNet. “Any rule that doesn’t close that loophole shouldn’t be taken seriously. We also need disclosure for spouses, since they are also clearly players in many cases.”

Leveling the Playing Field

The most important aspect of the STOCK Act may be the disclosure rules. Various waiting periods for disclosure have been floated in versions of the bill, some calling for disclosure of transactions within 90 days, others stipulating a 30-day period. Such waiting periods are considered by financial experts to be a huge loophole. Professor Ziobrowski thought that members of Congress should be held to the same time-frame as corporate insiders, who must disclose transactions within 48 hours. After two or three days, he pointed out, “The smoke has cleared and the information on the transaction is of little use to the public.”

But what if the public could observe members betting their money in real time? In such a scenario, you, as a market participant, could make a judgment call on the implications of transactions made by lawmakers. If you see all the members of the Health Committee getting rid of their pharmaceutical stocks all at once, you might not know why they’re doing it, but you may suspect that something bad is going to happen for those stocks.

Giving the public a view of what members of Congress are trading would level the playing field. It would, of course, communicate both good and bad financial information to the markets. If traders had seen that Rep. Bachus was shorting the market the day after his meeting with Paulson and Bernanke in 2008, trading activity may have gone quite differently that day.

Some members of Congress, including Senate Majority Leader Harry Reid and Senate Minority Leader Mitch McConnell, have been trying to weaken the STOCK Act. That leaves the possibility of either no law at all or a law that’s useless. “What really concerns me is that we’ll get something passed here, but it won’t do much good,” said Professor Ziobrowski. “They can make something illegal, but if you don’t have the proper tools to uncover the crime, what good is it?”

The American public is strongly opposed to insider trading. But if members of Congress are being asked to basically police themselves through the passage of a new law, it will be difficult to get something with real teeth. Still, keeping the topic front and center in the public mind is a good way to give members pause the next time they decide to violate their ethical duty to the public and use their office to enrich themselves.

*The study, “Abnormal Returns from the Common Stock Investments of the U.S. Senate, Alan J. Ziobrowski, Ping Cheng, James W, Boyd, and
Brigitte J. Ziobrowski, was published in the Journal of Financial and Quantitative Analysis (Dec. 2004).

The machine

2012-02-19T06:21:00.000-08:00

Machine created to feed Wall Street

Many of the problems in the modern loan servicing business can be traced back 30 years to the invention of the mortgage-backed security.

In the early 1980s, the wizards on Wall Street learned they could convert humdrum home loans into financial instruments — a process known as securitization — enriching themselves as investors gobbled them up. By the early 2000s, securitization was standard practice among all of the largest lenders.

Most home loans are bought by Wall Street banks or by Fannie Mae and Freddie Mac, bundled together and placed into pools of 5,000 or more. They are then sliced up and sold as securities. Mortgage servicers bid on the rights to manage these loan pools before they are sold to investors.

Often, the servicer is a branch of the same Wall Street bank that created the investment. Bank of America, which acquired Countrywide’s notoriously troubled loan portfolio (along with its legal headaches), is the biggest servicer, managing 12.5 million loans.

The basic job is straightforward: servicers collect payments and pass them along to the trust that represents the investors. They are also responsible for handling foreclosures. In exchange, servicers typically collect one-half of 1 percent of the value of the outstanding loans each year in fees.

For a $200,000 loan to a borrower with good credit, a servicer might collect about $50 per month, with income dipping slowly as the balance of the loan drops. Servicers also make money from the “float” — interest earned during the short time the servicer holds the loan payment.

During the boom years, from 2002-2007, when few loans defaulted, profits soared, with margins averaging about 20 percent. Lenders with big servicing arms made piles of money from originating loans, packaging them for sale to investors, and then at the back end, from collecting fees from investors to service the loans.

Eventually, the wheels came off. Securitization encouraged lenders to stop caring whether the loans they were making were sound. Mortgage giants like Countrywide approved as many loans as possible knowing that Wall Street would purchase them, no matter how toxic.

The bankers, in turn, packaged the securities and sold them with gold-plated ratings to investors such as large pension funds and foreign banks. When the lending market dried up, so did new servicing contracts. Defaults and foreclosures soared.

But rather than hire and train enough employees to personally manage troubled loans in a way that minimizes foreclosures and encourages loan modifications, servicers entrusted management of troubled loans to old computer software that legal experts say isn’t up to the task.

The end result is a system with little accountability and a whole lot of angry homeowners.

It is impossible to know how many loans have been subject to wrongful fees and accounting errors, but foreclosure war veterans say the number is high.

Jay Patterson, a forensic accountant who has examined hundreds of mortgage loans in bankruptcy or foreclosure, said that “95 percent of these loans contain some kind of mistake,” from an unnecessary $15 late fee to thousands of dollars in fees and charges stemming from a single mistake that snowballs into a wrongful foreclosure.

http://www.iwatchnews.org/2012/01/27/7985/raging-against-foreclosure-machine

I left my heart. . .

2012-02-16T09:10:00.003-08:00

Interesting report about how San Francisco did in a few months what the Federal government couldn't manage in years. Namely a review of publicly available mortgage transaction for errors and fraud. This from Credit Slips

Why No Investigation?

posted by Adam Levitin

Here's a bombshell: the San Francisco City Assessor commissioned a serious audit of foreclosure documentation filed in the past few years. The audit examined 400 foreclosures. It found problems with 85% of them, often multiple problems. What's more, some of the problems are pretty serious as they implicate not only borrowers' rights, but the integrity of mortgage-backed securities and the property title system.

The San Francisco City Assessor's audit also serves as a benchmark for evaluating the Federal-State servicing settlement. The San Francisco City Assessor managed to accomplish in a few months what the Federal government and state Attorneys General weren't able to do in nearly a year and a half with far greater resources at their disposal: perform a credible investigation of foreclosure documentation with serious implications about the securitization process in general. That's a lot of egg on the face of Shaun Donovan, Eric Holder, Tom Miller, et al. The SF City Assessor report shows that it really wasn't so hard for a motivated party to undertake a serious investigation. And that raises the question of why the largest consumer fraud settlement in history proceeded with virtually no investigation.

The lack of investigation was the compelling criticism that led the NY and DE AGs to stay out of the settlement for quite a while. I've never heard an answer as to why no serious investigation. As the SF City Assessor's audit shows, the documentation is all a matter of public record. It's not that hard to do, especially if you have the resources of the federal government. So the resources were there. The capability was there. So why no investigation? The answer has to lie with lack of motivation. Were the Feds and AGs scared of what they would find if they delved too deeply into the issue?

I hope that members of Congress will question the Attorney General and HUD Secretary the next time they show up to testify on the Hill. The issue is also worthy of a GAO or IG examination.

Now to be fair, there was a federal bank regulator review of some 2800 foreclosures and state banking supervisers did some sort of audit of Ally Financial's practices (the results of which are not public). But these audits are only as good as what they were looking for. If the focus was on narrow robosigning--the mindless signing of documents without verify the statements therein--that's a really different audit from what the SF City Assessor did.

The robosigning itself and similar lack of internal controls are the small potatoes. There are much more serious things in the SF City Assessor report.

First, the SFCA audit compared assignments in the public record with those that were represented to MBS investors in SEC filings. Anyone who's been following this blog knows that this is the securitization fail problem. And the SFCA audit finds evidence aplenty of this. Curiously, the OCC foreclosure review protocols don't include this sort of examination. Hmmmm. Wouldn't want to find out that we've got a massive securitization fail problem. That could trigger another financial crisis. So let's not look into it. If we ignore it, then Levitin and Yves Smith and others can just keep howling into the wind.

Similarly, the SFCA audit does a cross check between MERS records and foreclosure filings. As alleged in the DE AG suit against MERS, these records often don't match. That's a problem. Let me rephrase that: this is a HUGE problem. MERS is a self-privatization of part of a real property title system. Whatever one thinks of self-privatization of property records (reversing an Anglo-American tradition of government recordation that goes back to at least Richard I in 1194), the unreliability of the MERS system is just disasterous for real property title. As Judge Young said, MERS is the "wikipedia of land registration systems". The SFCA audit makes that seem like a generous comparison, as Wikipedia is often more accurate. Pretending the problem doesn't exist isn't going to make it go away.

The SF City Assessor report is yet another indication of how thoroughly rotten the Federal-state settlement is. While I'm on the topic, though, let me add in another one: the Federal-state settlement has folded into it a settlement between HUD and Bank of America for BoA embezzling from the FHA. The price tag for this was $1B, which seems to be double counted as part of BoA's contribution. That's appalling. Lee Farkas went to jail for a smaller fraud on the FHA. Think anyone from BoA is going to be in the pokey?

Let me suggest this: when a federally-chartered entity commits insurance fraud on the federal government, it should lose its charter and FDIC insurance. National banks exist by the grace of the federal government. That grace can be removed. Oh wait, we can't do that to BoA--it's too big to fail! Stripping BoA of its charter for defrauding the government just does not compute in the bank regulator mindset, which ignores that a federal banking charter is a privilege, not a right.

So there we have it. Once again, the federal government is held captive by the banks. The Too Big to Fail problem isn't a financial risk problem--it's a political problem, as too-big-to-fail means too big to regulate. The administration has had three chances to deal with too-big-to-fail: the bailouts, Dodd-Frank, and now the mortgage crisis, and it has shyed away every time. It's hard to think of a greater failing of this Administration.

Yes, the Administration did pass Dodd-Frank, which has important reforms in it, like the CFPB. But on what is really the most important financial regulatory issue--the need to end the political power of the banks, which will otherwise always be used to stymie effective financial regulation (or the administration of justice as we see here). Successful financial reform requires political reform, and breaking up the large banks is the only way we will see that political reform happen.

Note by way of comparison how the Feds brought the hammer down on Milken and Drexel for creating a junk bond bubble through a daisy chain of S&Ls (and a corrupt life insurer) that financed the destructive corporate raiding of the 1980s (and resulted in the creation of the CDO!). Drexel wasn't Too Big to Fail, and Milken wasn't from the same social millieu as many of the regulators. He wasn't their classmate, he wasn't white shoe, his lawyers hadn't been the regulators previous, and the regulators weren't looking for future employment with DBL. And he went to jail.

Today TBTF is a get-out-of-jail free card. But I want to emphasize that TBTF isn't the only thing going on here. Part of the problem, I think is a social one, as our political leadership is part of the same social milieu as our financial leadership and unwilling to call out criminal acts by their peers. The white shoe firms who were having their lunch eaten by Milken had no such qualms.

In the end, despite lack of investigation, 49 AGs signed onto the federal-state deal. Some of them signed on because they were able to narrow the scope of the release and get some level of federal buy-in and support for investigations on the securitization side of the bubble. In other words, for them, this settlement is conceived of as a first step, and signing on was part of a bargain. I hope it turns out to be a wise bargain, but thus far, the settlement seems an awful lot like Swiss cheese--it's got plenty of wholes and smells ever worse with time.

February 15, 2012 at 11:44 PM in Financial Institutions, Mortgage Debt & Home Equity, Too Big to Fail (TBTF)

You are prey . . .

2012-02-15T08:49:00.001-08:00

In the post of the day, Uncle Barry spells it all out for you on the subject of Banks, fractional reserve banking and the illusion that your money is safe.

MFGlobal Reveals You Are A Bank Counter-Party

By Barry Ritholtz - February 15th, 2012, 7:30AM

The esteemed former Fed Chairman, Paul Volcker, introduced a very simple regulatory concept that bears his name: The Volcker Rule. It was part of the Dodd-Frank regulatory reforms passed after the financial crisis of 2008-09.
There has been enormous pushback against what should be a simple piece of prophylactic rules on proprietary trading by depository banks (see this Jamie Dimon commentary as an example). Why? The profits of speculation goes to banks, driving bonuses and compensation; but the ultimate risk of loss lay with the FDIC and taxpayer. If the banks blow up, someone else besides the banker pays.
Privatized gains, socialized losses.
I want to take a few moments to briefly explain why this rule is so important to taxpayers, especially following the collapse of MF Global and the loss of billions of client assets.
Recall the basic facts of MFG: Management engaged in leveraged speculations with monies — whether it was their own or clients became irrelevant as the losses were so great as to wipe out much more capital than the bank actually had. Billions in losses meant MFG was insolvent and was wound down. On the winning sides of those trades were folks like JPM and George Soros. It is neither their duty nor obligation to verify whose money is on the other side of the trade — the clearing firms make sure the trade settles.
Those trade settlements are the only possible outcome. Why? Imagine a burglar robs a house of cash, goes to a casino and loses the money playing Roulette. The Casino settles that bet, it clears — and the burgled homeowner can never recover the money. Exchanges work the same way. They simply cannot validate the capital sources of every transaction. In the case of MFG, he money wasn’t even burgled — it was simply entrusted to an entity that became so insolvent thru excess speculation that even money in “Segregated accounts” was highly compromised.
And therein lay the dirty little secret of modern banking: THERE IS NO SUCH THING AS A SEGREGATED ACCOUNT. It is simply a helpful way to think about money and banking; it does not exist in the real world.

Consider your basic bank account — checking, savings, passbook, etc. We go through massive contortions to create an illusion that your money is yours, that its safe and sound in a bank with your name on it, in your own virtual safe deposit box. But that is simply not the reality of modern banking. What you perceive as “your money” is little more than an electronic journal on the banks accounting ledgers.

Fractional reserve banking means that the $100 you deposit is lent out — only $10 of your $100 is kept in reserve. Under normal circumstances, with thousands of depositors and millions of dollars, the banks have no trouble giving customers who ask for their money back the full amount at anytime. But it is not as if your money is sitting in an account waiting for you — you merely have a claim on those monies, and that claim is insured by the FDIC, and backed by taxpayers (theoretically).
You are, in fact, a counter-party to your bank.
In the old days, banks were boring. 3-6-3 banking meant borrowing at 3%, lending at 6%, be on the links at 3pm. It was simple. Banks were a utility, making reliable steady money, so long as they didn’t do anything too stupid to screw it up. Glass Seagall, the depression era legislation, prevented them from engaging in the sort of risky Wall Street speculation that caused so much trouble over the years. Think MFGlobal to get a better understanding of what is involved.
Thanks to the sheer ideological idiocy of Phil Gramm, enabled by the corruption of former Treasury Secretary Robert Rubin and the hubris of former Treasury Secretary Larry Summers, Glass Steagall was repealed. Thus, banks could be as stupid as they want to be — and you get to foot the bill.
What does all this have to do with the Volcker rule and MF Global? It is quite simple: Today’s post Glass Steagall repeal Bankers engage in leveraged speculation that potentially could blow the bank up. They did it to themselves with sub-prime mortgages; have no doubt that someone is working on the next ‘financial innovation’ whose losses will be even bigger and better than RMBS and CDOs.
When the next bank blows up — note I said when and not if — their depositors will become counter-parties. Those depositors are you, just like MF Global’s. Only, you as counter-part are not first in line with a claim on the monies — the folks on the other side of the trade get first dibs.
So this bank blows up, the trades settle, the counter party banks/brokers get paid, and whatever is left (if anything) goes to depositors. The FDIC will make good up to $250,000. FDIC’s budgets comes froma small fee on banks. If the losses are great enough, it will exceed their budget and so the taxpayer than fills int he difference.
The risks and rewards are to use a big word “asymmetric.” Hit a home run as a trader or banker, collect a huge bonus. Lose it all and then some, and the taxpayer is on the hook. Anyone who fails to see the simple math of this either spends their days shilling for banks or are acting as CEO mouthpieces.
Privatized gains, socialized losses.

PERMALINK

The fine print

2012-02-13T20:25:00.000-08:00

Yves has her hair on fire again as details dribble out about the AG Bankster scam, and this is just the executive summary:

VII. Release of Claims
The proposed Release contains a broad release of the banks’ conduct related to mortgage loanservicing, foreclosure preparation, and mortgage loan origination services. Claims based onthese areas of past conduct by the banks cannot be brought by state attorneys general or banking regulators.

The Release applies only to the named bank parties. It does not extend to third parties who mayhave provided default or foreclosure services for the banks. Notably, claims against MERSCORP, Inc.or Mortgage Electronic Registration Systems, Inc. (MERS) are not released. Securitization claims, including claims of state and local pension funds, and including investor claims related to the formation, marketing or offering of securities, are fully preserved. Other claims that are not released include violations of state fair lending laws, criminal law enforcement,claims of state agencies having independent regulatory jurisdiction, claims of county recorders forfees, and actions to quiet title to foreclosed properties. Of course, the Release does not affect the rights of any individuals or entities to pursue their own claims for relief.

At first glance it seems to be what we've already read described, but the language of the first sentence is so broad as to exempt the banks from pretty much everything they did wrong relative to their mortgage loans, not merely robosigning. The last sentence generously concedes that individuals can go after the banks on anything they like, just the state AGs are castrated. Be sure and let me know how those individual suits work out. . .

There is still nothing about exactly whose mortgages get worked over, the banks own, or the MBS that were engineered from the bank mortgages that private individual and entirely blameless owners.

And about that web site. For some reason the Justice Department is distancing itself from it, so I suppose that means it was set up by the Five Banksters. . .

MONDAY, FEBRUARY 13, 2012

Bizarre Department of Justice Disclaimer for Mortgage Settlement Website

Dave Dayen pointed out how peculiar that the mortgage settlement propaganda website, www.nationalmortgagesettlement.com, is a .com and not a .gov. And it turns out the Department of Justice disavows its content (hat tip April Charney):

"We're sorry, we broke the law . . ."

2012-02-12T10:07:00.000-08:00

The reviews are in and the Obama administration gets a C- on the robosigning settlement with the 5 Banksters.

There has been a lot more heated reaction than I thought there would be. The problem I have with all of it is that somehow the criminal issue of massive document fraud has been equated with the vast number of troubled mortgages held by homeowners. There's no cause and effect here, one did not cause the other and punishing the banks by letting them repair their balance sheets via a more orderly and measured rate of foreclosures doesn't seem to be comparable to the Banksters contempt for their customers and the legal process. Where are the resignations? The bonus clawbacks? "We sorry, we broke the law, we fired those responsible and it will never happen again." Anybody read that anywhere?

Conferring Immunity from Justice, Barack Obama Becomes “The Great Vaccinator”

Posted on February 9, 2012 by Jim White

Ronald Reagan was The Great Communicator. Lyndon Johnson’s anti-poverty efforts were aimed at realizing The Great Society. Barack Obama’s presidency is moving toward greatness, as well, but not in a good way. At seemingly every turn, Obama has made sure that major crimes are met not with justice but with immunity. Obama has conferred so much immunity on so many different groups that he has earned the title “The Great Vaccinator”.

Ironically, even Obama’s major “success”, the killing of Osama bin Laden, is marred by an illegal act that this time is mingled with biological rather than legal immunity. It appears that Pakistani doctor Shakil Afridi, working with the CIA, pretended to be carrying out a house-to-house vaccination program so that he could gather intelligence on who was residing in the compound where bin Laden was found. This short-sighted action by the CIA has now put public vaccination programs in a very bad light and set back vaccination programs in impoverished countries significantly.

Even before becoming President, Obama began his quest of conferring immunity wherever justice is demanded. Once he had the Democratic nomination in his pocket, Obama abandoned the principled stand he took during the primaries (when he said he would filibuster any bill with retroactive immunity and would vote against it) and voted along with all Senate Republicans for cloture and then in favor of the bill that conferred retroactive immunity on the telecommunications companies that illegally wiretapped citizens without warrants.

After he won the election but prior to taking office, Obama then began his quest to confer immunity for one of the most egregious crimes committed by our country, the institutionalization of torture as a major tool in the “War on Terror”. As ABC published on January 11, 2009, Obama famously told George Stephanopoulos “we need to look forward”:

Mortgage settlement is great — for politicians and banks

The settlement mostly requires mortgage lenders and servicers to comply with what I would have thought was already the law, which prohibits, you know, criminal fraud.

By Michael Hiltzik

February 11, 2012

Supposedly a big part of the deal is the implementation of new foreclosure standards to end the abuses that made the deal necessary. These standards require banks seeking to foreclose henceforth to submit sworn affidavits that are accurate about the amounts owed and the legal right of the servicer to proceed, and require that the bank officers who sign them to actually examine the documents they swear to have examined.

In other words, no more "robo-signing." Assertions the banks make in court will have to be "accurate." Banks will have to give borrowers complete and accurate information about their loans, suspend foreclosure proceedings once they start working on a loan modification, apply mortgage payments promptly, keep accurate loan records and communicate effectively with borrowers.

I believe the technical term for all this is "big whoop." The provisions mostly require mortgage lenders and servicers to comply with what I would have thought was already the law, which prohibits, you know, criminal fraud. The rest is pretty much out of the best-practices manual of customer service, which benefits both the customer and the institution.

What the standards do accomplish is to expose how sad our enforcement of the law has been up to now, and how hard it will be to enforce it in the future if this is the best we can do in the face of manifestly illegal behavior. The lesson is: Break the law, and the full weight of the state and federal governments will come down on your head to make you agree not to break the law — in the future.

It may not be long before the euphoria over the settlement evaporates in the realization that the banks that made a travesty of the mortgage market are still getting a pass — not only on their cupidity in making loans to unqualified buyers, but in magnifying their cupidity through forgery, lies and the other building blocks of foreclosure fraud.

In the words of business consultant Susan Webber, who blogs expertly on financial matters under the pen name Yves Smith, "We've now set a price for forgeries and fabricating documents. It's $2,000 per loan." She observes, quite properly, that the payoff is a minuscule fraction of the costs these practices have imposed on borrowers, the court system and the economy.

FAIR GAME

The Deal Is Done, but Hold the Applause

By GRETCHEN MORGENSON

Published: February 11, 2012

The banks crowed that this settlement would help the economy and the reputation of the mortgage industry. Michael J. Heid, president of Wells Fargo Home Mortgage, characterized the deal as “a very important step toward restoring confidence in mortgage servicing and stability in the housing market.”

But it’s hard to imagine that this one settlement will be enough to restore trust in loan servicers. Given what we know about their questionable practices — how they larded improper fees on struggling homeowners, for example, and forced people to buy home insurance at three times market rates — restoring confidence in these firms will take some doing.

There’s no doubt that the banks are happy with this deal. You would be, too, if your bill for lying to courts and end-running the law came to less than $2,000 per loan file.

For most homeowners, it will barely move the needle. Forgiving $17 billion in principal “is a drop in the ocean,” Mr. Diggle said, “given that close to 11 million borrowers are underwater on their loans to the tune of $700 billion in total.” Doing the math, $17 billion in write-downs would be about 2.4 percent of the total negative equity weighing down borrowers across the nation now.

Yves Smith, the perspicacious founder of the Naked Capitalism Web site, wrote that this deal was a stealth bailout of the major banks.

Why? It will improve the value of the second liens or home equity lines of credit they own. These vast holdings — roughly $400 billion — are worthless if the first mortgages preceding them are underwater. But if the banks don’t write down the second liens alongside the first mortgages, the seconds become more valuable. A lower principal balance on the first mortgage makes the second more likely to pay.

But perhaps the largest question looming over this settlement is how it will be policed. Recent history is littered with agreements that required banks to take specific steps to make amends. All too often, the banks have skated away from their promises.

A prime example is a settlement over predatory lending that was reached by Countrywide Financial in 2008. Led by attorneys general in California and Illinois, that deal had Countrywide vowing to provide $8.4 billion in loan relief to borrowers in the form of lower interest rates and loan modifications.

It sounded good on paper. But Bank of America, Countrywide’s parent, defied many aspects of the settlement, according to Catherine Cortez Masto, Nevada’s attorney general. She sued Bank of America last summer, contending that it had raised interest rates on loan modifications even though Countrywide had promised to lower them.

Bank of America also declined to provide loan modifications to qualified homeowners as required in the deal and improperly proceeded with foreclosures while borrowers’ modification requests were pending, Ms. Masto’s suit said. Furthermore, the bank failed to meet the settlement’s 60-day requirement on granting new loan terms, allowing months — and in some cases, more than a year — to go by with no resolution, the lawsuit said.

Yves explains it all for you

2012-02-10T08:48:00.001-08:00

It's really all so horrible when you listen to Yves explain it all. It's so clear that the 5 banks literally bought their way out of massive criminal fraud in presenting falsified mortgage documents in court to get mortgages foreclosed on. Temp workers were literally being hired to write 2000 signatures a day that happened not to have been their own on mortgage documents. The banks hired these guys and have to take responsibility for them, but in this country if you break the law on a large enough scale you get to negotiate the terms of your own punishment and not even have to admit you broke the law.

The amount of self-congratulation by the Obama administration is embarrassing to watch. In return for the "get out of jail free" robosigning card the banks got, they basically cough up $5 billion. Which is a lot of money but represents less than 10% of their annual revenues in a bad year. The mortgages they will be reducing principal on are owned by other private investors, who I'm sure will not be submitting quietly to being mugged.

Worst of all is that the first step in monitoring the banks performance on this will be the banks themselves, which then gets reviewed by an actual federal monitor on a quarterly basis. Banks executives must be high-fiving their asses off on this one as the program expires in exactly 36 months and banks have had lots of experience at evading and gaming oversight.

For Obama to have participated in this is appalling to me. There are only two ways to look at this issue and they're both pretty horrible. The first is that the banks are in really far worst shape than we know, that their balance sheets are sheer fantasy and that if not allowed to blow off criminal charges for each and every falsified document they presented in court we'll find that the majority of mortgages they own are seriously tainted and possibly worthless. The losses they would then sustain would wipe them out.

The other views is simply that Obama has been captured by Wall Street. He's been convinced that his presidency and the economic health of the US economy depends on what the players that got us in this mess tell him.

So, where are the resignations of bank executives who were responsible for hiring DocX? Where is any public display of regret? How is a 10% hit in earnings going to discourage bank CEOs from continuing to break the law. Who is going to step up and say publicly to the thousands of mortgage holders that were denied due process in court, "we cheated you, we're sorry, we fired those responsible and it won't happen again?"

Taibbi repents

2012-02-10T07:08:00.000-08:00

Rolling Stone's Hunter S. Thompson echo, Matt Taibbi, is often too overheated for my tastes but he found himself on the wrong side of the robo-signing issue last weeks and admits it.

Why the Foreclosure Deal May Not Be So Hot After All

POSTED: FEBRUARY 9, 12:58 PM ET

So the foreclosure settlement is through.

A few weeks back, I was optimistic about it – I had been worried that it was going to contain broad liability waivers for all sorts of activities, and I was pleasantly surprised when I heard that its scope had essentially been narrowed to robosigning offenses.

However, now that the settlement is finalized, and I've had time to think about it and talk to people who know far more than I do about this, I'm feeling pretty queasy.

It feels an awful lot like what happened here is the nation's criminal justice honchos collectively realized that a thorough investigation of the problem would require resources they simply do not have, or are reluctant to deploy, and decided to accept a superficially face-saving peace offer rather than fight it out.

So they settled the case in a way that reads in headlines like it's a bite out of the banks, but in fact is barely even that. There will be little in the way of real compensation for stuggling homeowners, and there are serious issues in the area of the deal's enforceability. In fact, about the only part of the deal we can be absolutely sure will be honored in full is the liability waiver for the robosigning offenses.

With the rest of it -- collecting on the settlement, enforcement of the decrees, all the stuff put in there to balance the deal in the consumer's direction -- there will be an uphill battle from this point forward to get the banks to comply. The banks meanwhile have no such uphill battle. They will get the full benefit of the deal (a release from costly litigation) from the moment the ink is dry.

Really this looks like America's public prosecutors just wilted before the prospect of a long, drawn-out conflict with an army of highly-paid, determined white-shoe banker lawyers. The message this sends is that if you commit crimes on a large enough scale, and have enough high-priced legal talent sitting at the negotiating table after you get caught, the government will ultimately back down, conceding the inferiority of its resources.

I think the best summation of the settlement is probably Yves Smith's, which can be found here. The piece lists the 12 things that suck the most about the settlement. The most painful is probably #12:

12. We'll now have to listen to banks and their sycophant defenders declaring victory despite being wrong on the law and the facts. They will proceed to marginalize and write off criticisms of the servicing practices that hurt homeowners and investors and are devastating communities. But the problems will fester and the housing market will continue to suffer. Investors in mortgage-backed securities, who know that services have been screwing them for years, will be hung out to dry and will likely never return to a private MBS market, since the problems won't ever be fixed. This settlement has not only revealed the residential mortgage market to be too big to fail, but puts it on long term, perhaps permanent, government life support.

My mistake in looking at this deal a few weeks ago, when details of it first leaked out, was in focusing on how much worse it could have been, instead of thinking about how bad it still is. The only acceptable foreclosure deal had to bring about a complete end to robosigning and the other similar corrupt practices that grew up around it (like for instance gutter service, the practice of process servers simply signing affidavits saying they delivered summonses, instead of really doing it).

But this deal not only doesn't end robosigning, it officially makes getting caught for it inexpensive. Shame on me for ever thinking that might be a good thing.

The Five Families, Ally, B of A, Citi, Chase, Wells

2012-02-09T10:05:00.000-08:00

This is funny to me for some reason. The ink isn't dry on the settlement announcement and they already have a website with a graphic of a happy young white couple swinging their 8 year old daughter in front of a $400K house.

A more appropriate graphic would have been a still from the Godfather where all the capos are meeting to discuss business

After many months of negotiation, 49 state attorneys general and the federal government have reached agreement on a historic joint state-federal settlement with the country’s five largest loan servicers:

The settlement will provide as much as $25 billion in relief to distressed borrowers and direct payments to states and the federal government. It’s the largest multistate settlement since the Tobacco Settlement in 1998.

The agreement settles state and federal investigations finding that the country’s five largest loan servicers routinely signed foreclosure related documents outside the presence of a notary public and without really knowing whether the facts they contained were correct. Both of these practices violate the law. The settlement provides benefits to borrowers whose loans are owned by the settling banks as well as to many of the borrowers whose loans they service.

About the Settlement: Learn about the settlement, who is affected and what claims may still be pursued against the banks. Find links to your state Attorney General’s Office to find state-specific information and contacts.
Help for Borrowers: Learn how to find out if your loan is affected by this settlement, the timeline for relief, how you will know if you are eligible. Find links to your state Attorney General’s Office to find state-specific information and contacts.
News: Read the national news release and find links to your state Attorney General’s Web site for state-specific news.

The Servicing Settlement: Banks 1, Public 0

posted by Adam Levitin

What are we to make of the servicing settlement announced today with much hoopla? The short answer is not much. The settlement is the large consumer fraud settlement ever, but it accomplishes remarkably little in terms of either alleviating the foreclosure crisis of holding to account those responsible for the housing bubble and subsequent foreclosure abuses. As my Texas relatives say, it's “All sizzle, no steak.”

Instead, I think the settlement needs be seen as the conclusion to round one of an on-going struggle for accountability and reparations for the enormous damage the housing bubble did to the United States. Whether we will ultimately see meaningful accountability and reparations in the end is very much in question. Round two, featuring the Residential Mortgage-Backed Securities Fraud taskforce, could well be stillborn; the taskforce combines more motivated and more capable agencies, but it isn't clear of the motivated can leverage the more capable or will be bogged down by them. But as for this settlement, if this is all that we get, it’s a big nothing.

There are two big issues to parse in the settlement: what does it cover and what sort of relief does it provide. Not surprisingly, both are quite limited; the banks wouldn’t pay big dollars for a small release.

The settlement covers mortgage servicing abuses, as well as a $1 billion settlement of claims that Countrywide (BoA) was cheating the FHA. It also includes settlements of litigation by the Arizona and Nevada AGs for BoA’s violations of an earlier settlement. It also covers some origination claims on which the statutes of limitations have run or will shortly expire. The settlement apparently (and here the precise language is crucial) excludes securitization-related claims, fair lending claims, false claims acts violations, MERS issues, and criminal claims. It also doesn’t prevent homeowners or investors from bringing their own suits. So it’s really covering robosigning and overbilling in foreclosures.

Given the relatively narrow scope of this settlement, it’s not surprising that the dollars involved are quite small compared to the overall harms created by the housing bubble and aftermath. The formal price tag for the settlement is $25 billion, although it is projected to accomplish up to $40 billion in relief. Only $5 billion of that is hard cash contributed by the banks. Let me repeat that. The five banks involved in the settlement, which have a combined market capitalization of over $500 billion, are putting in only $5 billion. That’s less than 1% of their net worth. And they are admitting no wrongdoing. To call that accountability is laughable.

That $5 billion in hard cash is going to the state and federal government, only some of which will be given to borrowers. What about the other $20 billion? That’s to come in the form of $3 billion in refinancings and $17 billion in principal reductions, deeds in lieu, short sales, anti-blight measures, etc. The banks receive variable credit for these actions, depending on whether these measures are taken for loans owned by the banks or owned by others and serviced by the banks. Basically, it’s full credit if the bank owns the loan, and half credit if the bank merely services the loan. Because of this formulation, the $17 billion in principal reductions, DILs, short sales is anticipated to result in $32 billion in actual relief. In other words, it is expected that the banks will modify the loans owned by others rather than the loans they themselves own. And when a second lien loan owned by the bank is involved, it only has to be written down pari passu (at the same percentage) as the first lien loan. So from absolute to relative priority, which is a major handout to the big banks, which have large underwater second lien positions.

Or put differently, $32 billion of the settlement is being financed on the dime of MBS investors such as pension funds, 401(k) plans, insurance companies, and the like—parties that did not themselves engage in any of the wrong-doing covered by the settlement. This shouldn’t be a surprise—the state Attorneys General previously cut a similar deal with Bank of America, which promised to make up for its wrongdoing by modifying loans own by other parties.

But let’s get to the bigger problem. Whether this is a $25 billion or $40 billion settlement is really beside the point. It’s a drop in the bucket relative to the scale of the problem. There is approximately $700 billion in negative equity nationwide weighing down the housing market and the economy. Add to that legions of homeowners dealing with unemployment or underemployment and we’ve got a problem that absolutely dwarfs the settlement numbers. It’s Pollyannism to think that this settlement will have any impact on the national housing market. At best it makes some incremental improvements and helps a small number of homeowners. But at worst, it lets the banks off the hook for the largest financial crime in history.

I can’t say I’m surprised, however. There was no investigation was done prior to this settlement. That had been the sticking point for a number of attorneys general who eventually signed on to the settlement, but only once it was narrowed. But that doesn’t take away the problem that there was no investigation. If you go bear hunting without any ammo, you aren’t going to bag a bear.

To illustrate how little the settlement does for the housing market, let’s take the settlement’s most optimistic projections and assume that it really results in $40 billion of mortgage relief of various sorts. How much does that translate into per distressed homeowner? Let’s assume that the universe of distressed homeowners is limited to those underwater—roughly 11 million. So we’re talking $3,636 per homeowner. That doesn’t help a whit in terms of preventing foreclosure.

Now to be sure, the relief will be more concentrated on a subset of these homeowners. The settlement is estimated to help about 2 million homeowners, hopefully to the tune of about $22,000 each. That's certainly a lot better than $3,636, but consider that the average negative equity is about $50,000. At a very generous best, then the settlement only gets rid of less than half of the negative equity for 18% of underwater homeowners. So we're talking about a solution that has less than a 10% impact. Best case scenario is less than 1 in 10 are helped. In any case, those luck few, will be chosen not by where the relief will help the most or by who is most deserving, but by what will be most advantageous to the banks. So some lucky group of homeowners will have “won the lottery” and in some cases might avoid foreclosure. For most distressed homeowners, it’s “no soup for you!” And because fixing the housing sector is about volume, this means that there's no soup for all of us--the housing sector will remain severely depressed.

What about the argument that the settlement will help the housing market by enabling foreclosures to start up again and for banks to clear through the shadow inventory? Well, what’s causing the shadow inventory? Is it the possibility of state and federal prosecutions for robosigning? Is it lack of uniform servicing standards? Nope, and nope. The shadow inventory problem is at core the result of two problems. First, the foreclosure system only has limited bandwidth—there are only so many foreclosures that can be processed at a time. Second, the banks have their own staffing issues. And third, the bigger problem is that the banks don’t have their paperwork in order to foreclose. This servicing settlement doesn’t affect any of these problems (maybe it will encourage better staffing on behalf of the banks, but if that hasn’t happened by year 5 of the crisis, I can’t imagine it will any time soon). National servicing standards as part of a settlement in no way replace existing state and local requirements, and to the extent they supplement them, it may make things harder for the banks. The fact that a bank is in compliance with the servicing standards in the settlement doesn't mean that the bank can in fact foreclose, and litigation of foreclosure actions is private litigation, not governed by this deal. (And this leaves aside the question of bank compliance with this settlement.)

The settlement also creates really awful incentives. It has zero deterrent effect against future wrong-doing. This settlement set a price-tag for mortgage servicing abuses. If the abuses are more profitable than the cost of settlement, what rational bank wouldn’t engage in them? The early CFPB-settlement analysis that was leaked months ago envisioned $25 billion as being simply the disgorgement component, not the remedial component. Here we have a settlement with $ 5 billion in actual disgorgement and very little that’s remedial, let alone punitive (which is necessary to have deterrence).

Also announced in conjunction with the big settlement were the fines the OCC is imposing as part of its consent orders. They total $394 billion, but they are payable either in cash or in kind via relief given to homeowners as part of the OCC Potemkin foreclosure review process. Please Hammer, Don't Hurt 'Em! (Hmm, maybe the banks' theme song should be "U Can't Touch This".)

Is this really the best our government can do? I hope not. This settlement might or might not be the end of the attempt to rectify the financial crisis, but as things stand, we have a settlement in which the banks commit to follow the law and pay out some pocket change. The settlement doesn’t fix the housing market. It doesn’t create accountability for the financial crisis. It doesn’t even create incentives against future wrong-doing. But it provides the Obama Administration (and those attorney generals who just jumped in for the settlement at the last minute) with a fig leaf of political cover. It galls me is that the Obama Administration is going to trumpet this settlement as evidence that it is serious about prosecuting the crimes behind the financial crisis and helping homeowners. It was heartening to hear Obama talk about protecting the middle class in his State of the Union address. It was the right message, but the President is simply not a credible messenger. If Obama wants to run as the champion of Main Street against Romney, the Captain of Wall Street, he’s going to need to do something a lot more credible than this settlement.

The score: Banks 1, Public 0.

The towel . . .

2012-02-09T07:48:00.000-08:00

Yves throws it, reacting to the long rumored AG settlement with 5 banksters for robosigning fraud.

As we’ve said before, this settlement is yet another raw demonstration of who wields power in America, and it isn’t you and me. It’s bad enough to see these negotiations come to their predictable, sorry outcome. It adds insult to injury to see some try to depict it as a win for long suffering, still abused homeowners.

THURSDAY, FEBRUARY 9, 2012

The Top Twelve Reasons Why You Should Hate the Mortgage Settlement

As readers may know by now, 49 of 50 states have agreed to join the so-called mortgage settlement, with Oklahoma the lone refusenik. Although the fine points are still being hammered out, various news outlets (New York Times, Financial Times, Wall Street Journal) have details, with Dave Dayen’s overview at Firedoglake the best thus far.

The Wall Street Journal is also reporting that the SEC is about to launch some securities litigation against major banks. Since the statue of limitations has already run out on securities filings more than five years old, this means they’ll clip the banks for some of the very last (and dreckiest) deals they shoved out the door before the subprime market gave up the ghost.

The various news services are touting this pact at the biggest multi-state settlement since the tobacco deal in 1998. While narrowly accurate, this deal is bush league by comparison even though the underlying abuses in both cases have had devastating consequences.

The tobacco agreement was pegged as being worth nearly $250 billion over the first 25 years. Adjust that for inflation, and the disparity is even bigger. That shows you the difference in outcomes between a case where the prosecutors have solid evidence backing their charges, versus one where everyone know a lot of bad stuff happened, but no one has come close to marshaling the evidence.

The mortgage settlement terms have not been released, but more of the details have been leaked:

1. The total for the top five servicers is now touted as $26 billion (annoyingly, the FT is calling it “nearly $40 billion”), but of that, roughly $17 billion is credits for principal modifications, which as we pointed out earlier, can and almost assuredly will come largely from mortgages owned by investors. $3 billion is for refis, and only $5 billion will be in the form of hard cash payments, including $1500 to $2000 per borrower foreclosed on between September 2008 and December 2011.
Banks will be required to modify second liens that sit behind firsts “at least” pari passu, which in practice will mean at most pari passu. So this guarantees banks will also focus on borrowers where they do not have second lien exposure, and this also makes the settlement less helpful to struggling homeowners, since borrowers with both second and first liens default at much higher rates than those without second mortgages. Per the Journal:
“It’s not new money. It’s all soft dollars to the banks,” said Paul Miller, a bank analyst at FBR Capital Markets.
The Times is also subdued:
Despite the billions earmarked in the accord, the aid will help a relatively small portion of the millions of borrowers who are delinquent and facing foreclosure. The success could depend in part on how effectively the program is carried out because earlier efforts by Washington aimed at troubled borrowers helped far fewer than had been expected.
2. Schneiderman’s MERS suit survives, and he can add more banks as defendants. It isn’t clear what became of the Biden and Coakley MERS suits, but Biden sounded pretty adamant in past media presentations on preserving that.
3. Nevada’s and Arizona’s suits against Countrywide for violating its past consent decree on mortgage servicing has, in a new Orwellianism, been “folded into” the settlement.
4. The five big players in the settlement have already set aside reserves sufficient for this deal.

Here are the top twelve reasons why this deal stinks:

1. We’ve now set a price for forgeries and fabricating documents. It’s $2000 per loan. This is a rounding error compared to the chain of title problem these systematic practices were designed to circumvent. The cost is also trivial in comparison to the average loan, which is roughly $180k, so the settlement represents about 1% of loan balances. It is less than the price of the title insurance that banks failed to get when they transferred the loans to the trust. It is a fraction of the cost of the legal expenses when foreclosures are challenged. It’s a great deal for the banks because no one is at any of the servicers going to jail for forgery and the banks have set the upper bound of the cost of riding roughshod over 300 years of real estate law.
2. That $26 billion is actually $5 billion of bank money and the rest is your money. The mortgage principal writedowns are guaranteed to come almost entirely from securitized loans, which means from investors, which in turn means taxpayers via Fannie and Freddie, pension funds, insurers, and 401 (k)s. Refis of performing loans also reduce income to those very same investors.
3. That $5 billion divided among the big banks wouldn’t even represent a significant quarterly hit. Freddie and Fannie putbacks to the major banks have been running at that level each quarter.
4. That $20 billion actually makes bank second liens sounder, so this deal is a stealth bailout that strengthens bank balance sheets at the expense of the broader public.
5. The enforcement is a joke. The first layer of supervision is the banks reporting on themselves. The framework is similar to that of the OCC consent decrees implemented last year, which Adam Levitin and yours truly, among others, decried as regulatory theater.
6. The past history of servicer consent decrees shows the servicers all fail to comply. Why? Servicer records and systems are terrible in the best of times, and their systems and fee structures aren’t set up to handle much in the way of delinquencies. As Tom Adams has pointed out in earlier posts, servicer behavior is predictable when their portfolios are hit with a high level of delinquencies and defaults: they cheat in all sorts of ways to reduce their losses.
7. The cave-in Nevada and Arizona on the Countrywide settlement suit is a special gift for Bank of America, who is by far the worst offender in the chain of title disaster (since, according to sworn testimony of its own employee in Kemp v. Countrywide, Countrywide failed to comply with trust delivery requirements). This move proves that failing to comply with a consent degree has no consequences but will merely be rolled into a new consent degree which will also fail to be enforced. These cases also alleged HAMP violations as consumer fraud violations and could have gotten costly and emboldened other states to file similar suits not just against Countrywide but other servicers, so it was useful to the other banks as well.
8. If the new Federal task force were intended to be serious, this deal would have not have been settled. You never settle before investigating. It’s a bad idea to settle obvious, widespread wrongdoing on the cheap. You use the stuff that is easy to prove to gather information and secure cooperation on the stuff that is harder to prove. In Missouri and Nevada, the robosigning investigation led to criminal charges against agents of the servicers. But even though these companies were acting at the express direction and approval of the services, no individuals or entities higher up the food chain will face any sort of meaningful charges.
9. There is plenty of evidence of widespread abuses that appear not to be on the attorney generals’ or media’s radar, such as servicer driven foreclosures and looting of investors’ funds via impermissible and inflated charges. While no serious probe was undertaken, even the limited or peripheral investigations show massive failures (60% of documents had errors in AGs/Fed’s pathetically small sample). Similarly, the US Trustee’s office found widespread evidence of significant servicer errors in bankruptcy-related filings, such as inflated and bogus fees, and even substantial, completely made up charges. Yet the services and banks will suffer no real consequences for these abuses.
10. A deal on robosiginging serves to cover up the much deeper chain of title problem. And don’t get too excited about the New York, Massachusetts, and Delaware MERS suits. They put pressure on banks to clean up this monstrous mess only if the AGs go through to trial and get tough penalties. The banks will want to settle their way out of that too. And even if these cases do go to trial and produce significant victories for the AGs, they still do not address the problem of failures to transfer notes correctly.
11. Don’t bet on a deus ex machina in terms of the new Federal foreclosure task force to improve this picture much. If you think Schneiderman, as a co-chairman who already has a full time day job in New York, is going to outfox a bunch of DC insiders who are part of the problem, I have a bridge I’d like to sell to you.
12. We’ll now have to listen to banks and their sycophant defenders declaring victory despite being wrong on the law and the facts. They will proceed to marginalize and write off criticisms of the servicing practices that hurt homeowners and investors and are devastating communities. But the problems will fester and the housing market will continue to suffer. Investors in mortgage-backed securities, who know that services have been screwing them for years, will be hung out to dry and will likely never return to a private MBS market, since the problems won’t ever be fixed. This settlement has not only revealed the residential mortgage market to be too big to fail, but puts it on long term, perhaps permanent, government life support.

As we’ve said before, this settlement is yet another raw demonstration of who wields power in America, and it isn’t you and me. It’s bad enough to see these negotiations come to their predictable, sorry outcome. It adds insult to injury to see some try to depict it as a win for long suffering, still abused homeowners.

49-State Foreclosure Fraud Settlement Will Be Finalized Thursday
By: David Dayen Wednesday February 8, 2012 8:15 pm	Tweet193

Forty-nine states, every one but Oklahoma, as well as federal regulators will participate in a foreclosure fraud settlement that will release the five biggest banks (Wells Fargo, Citi, Ally/GMAC, JPMorgan Chase and Bank of America) and their mortgage servicing units from liability for robo-signing and other forms of servicer abuse, in exchange for $25 billion in funding for legal aid, refinancing, short sales, restitution for wrongful foreclosures and principal reduction for underwater borrowers. The announcement will be made on Thursday.
This settlement arises from multiple abuses found in the servicing of loans and the foreclosure process over the past several years. At the height of the housing bubble, banks sliced and diced mortgages and traded them with little regard for the rules following land recording or securitization to such a sloppy extent that they lost track of the true owner on potentially millions of homes. To cover up for this massive failure, banks and their servicing units have been found to have routinely forged, back-dated and fabricated documents at county recorder offices and state courts across the country. Furthermore, they employed “robo-signers,” who signed hundreds of thousands (if not millions) of documents and affidavits without any knowledge of the underlying mortgages. In addition, investigations uncovered massive servicing abuses, including illegal fees charged to borrowers, putting borrowers into foreclosure at the same time as they were working out loan modifications, failing to honor previous settlements where promises were made on modifications, and countless other errors that maximized servicer profits and gouged homeowners. There are also cases of wrongful foreclosures where homeowners have been turned out of their homes without just cause, and servicer-driven foreclosures, where servicers illegally added late fees and applied payments inaccurately, pushing the homeowner into foreclosure. This is but a smattering of the examples of foreclosure fraud and servicer abuse found in a series of interlocking investigations, court depositions, reviews of documents in registers of deeds offices, and homeowner testimonials.
The deal caps a 16-month process that had several fits and starts, and closed with the final holdouts, New York and California, coming to terms. The deal will release claims from state Attorneys General, but individual homeowners retain private rights of action to sue over foreclosure fraud and other abuses. As part of the settlement, states will get a fixed amount in hard dollars that would go to fund legal aid services. “This will get a lawyer for everyone facing foreclosure in the state,” said one source in an Attorney General’s office. “This will stop every wrongful foreclosure.”
Oklahoma stayed out of the deal because the state’s Attorney General, Scott Pruitt, did not believe that the banks should face any penalty.
As far as the release goes, AG offices that signed onto the lawsuit claimed it was narrowly crafted to only affected foreclosure fraud, robo-signing and servicing (which I don’t feel is all that narrow, but I’m trying to just-the-facts this -ed). The lawsuit that New York AG Eric Schneiderman filed last Friday, suing MERS and three banks for their use of MERS, was preserved fully. There was a last-minute request by the banks to dissolve that lawsuit, but it was not successful. In addition, Schneiderman reserves the right to sue other servicers for their use of MERS along the same lines as the current lawsuit.
In addition, all securitization claims, tax fraud claims, insurance fraud claims, and more will be able to be investigated and prosecuted by individual AGs and the RMBS working group, set up at the Financial Fraud Task Force, with Schneiderman as one of five co-chairs. They will be able to use all findings gathered in multiple investigations into servicing and foreclosures in their investigation. At least one of those investigations, the HUD Inspector General report, will be made public as part of the settlement. That report, according to a senior Administration official, will show a wide variety of errors among the major servicers, but the worst will show up to a 60% error rate. In one incident described in the report, an employee of one of the servicers spent two weeks experimenting with her staff to see how long it would take to process foreclosure documents correctly. They determined it would have taken at least 1-2 weeks. This employee went to their manager and reported the information. The following week, the manager told the employee they were reducing the time spent on each file from 48 to 24 hours.
This is the kind of conduct that will be released in the settlement.
Other lawsuits, like Delaware AG Beau Biden’s lawsuit against MERS, Missouri AG Chris Koster’s criminal indictments against DocX, and Nevada AG Catherine Cortez Masto’s suit against LPS and its employees would be able to go forward as well because the banks are not a party to them. However, it’s unclear whether any of those AGs will be able to work their way up the chain to indict bank officers for the same conduct; the likely answer, I assume, would be no. In California, Kamala Harris preserved the right for state officials and large pension funds to sue under the state’s False Claims Act over mortgage backed securities that later fell in value.
The status of Massachusetts AG Martha Coakley’s suit against five banks for foreclosure fraud is unknown. In all likelihood, the Nevada/Arizona suit against Bank of America for failing to follow their responsibilities in the Countrywide settlement will be folded into the deal.
In that settlement, BofA promised to deliver $8.5 billion in relief for Countrywide borrowers who fell victim to deceptive practices in the mortgage process. In reality, only $236 million was ever spent. Weak settlement terms allowed BofA to take credit merely for offering loan modifications to borrowers. And the Nevada suit alleged that BofA immediately started abusing borrowers who tried to get relief under the deal. But that suit is now gone.
State and federal regulators insist that they learned their lesson with that botched settlement and that this one has tight enforcement guidelines. A federal monitor, North Carolina banking commissioner Joseph Smith, will be employed, and he will have oversight responsibilities over the settlement. However, the monitoring process begins with a self-assessment from the banks through quarterly reports, which Smith and a committee can then review. This enforcement process is likely to take months to actually properly assess the settlement.
And then there’s the settlement price: $25 billion, divided up several ways. $3 billion will go toward refinancing for current borrowers who are underwater on their loans, as well as short sales. $5 billion will go as a hard cash penalty to the states, which can use them for legal aid services, foreclosure mitigation programs, and ongoing fraud investigations in other areas (one official close to the talks feared that much of that hard cash payout will go in some Republican states toward filling their budget holes). The federal government will get a cash penalty as well. Out of that $5 billion, up to 750,000 borrowers wrongfully foreclosed upon will get a $1,800-$2,000 check if they sign up for it, the equivalent of saying to them “sorry we stole your home, here’s two months rent.”
The bulk of the money, around $17 billion, will go to principal reduction credits for troubled borrowers. The banks will not get dollar-for-dollar credit for every write-down; reductions on loans bundled in private-label mortgage-backed securities, for example, will be under 50 cents on the dollar, and write-downs for second liens (mostly home equity lines of credit) will be more like 10 cents. Housing and Urban Development Secretary Shaun Donovan believes that they will be able to get between $35-$40 billion in principal reduction in real dollars out of the settlement. Donovan became the point person on the federal level, along with DoJ, as the Administration pretty much took over the investigation and settlement process from the states, who were led by Iowa AG Tom Miller.
But even this $35-$40 billion number, which is at best a guess since the direction of the principal reduction is mostly at the discretion of the banks, pales in comparison to the negative equity in the country, which sits at $700 billion. And the banks have three years to implement the principal reductions, drawing out the loss on their books. As the New York Times reports, banks have covered reserves for all of this, and should see major boosts to their stock price as a result of the settlement.

The five banks in the settlement — Bank of America, JPMorgan Chase, Wells Fargo, Citigroup and Ally Financial — have largely set aside reserves for the expected cost of the accord and investors are likely to cheer its announcement, analysts said [...]
The deal will not substantially reduce the debt left from the housing bust, nor will it help everyone who may have been hurt by foreclosure abuses. About one in five Americans with mortgages are underwater, which means they owe more than their home is worth. Collectively, their negative equity is almost $700 billion. On average, these homeowners are underwater by $50,000 each.
A recent estimate from the settlement negotiations put the average aid for homeowners at $20,000.
“I just don’t think it’s going to be a life-changing event for borrowers,” said Gus Altuzarra, whose company, the Vertical Capital Markets Group, buys loans from banks at a discount.

I’ve done the math on this before, and you’re talking about $20,000 (when homes are on average underwater $50,000) for 1 million borrowers (when there are 11 million underwater). If Donovan is correct about 2:1 maybe you’re at $30,000-$40,000. And the banks have three years.
There will be plenty more to say about this once we get all of the facts of the claim. In addition, this will have to go before a federal judge to sign off on the settlement. And we won’t know for many years whether this promise on loan modifications, unlike all the others, will take. But it’s going forward. And now the only hope for accountability and justice for the crimes of the financial crisis lie in some scattered lawsuits grandfathered in and Schneiderman’s RMBS working group. One thing is clear – the banks relieved themselves of a significant portion of liability at a price they believe they can easily handle.

The Banks Have Won, Homeowners Are Re-Victimized

By: Cynthia Kouril Thursday February 9, 2012 7:15 am

(photo: Lance Page/truthout/flickr)

The NY Times is reporting that NY and California have agreed to sign on the 50 state deal and that is will immunize robo-signing. If that is true, it’s over folks. The housing market is not going to recover any time soon and the court system will be permanently corrupted by forged and perjurious documents.
This settlement is an incredible breach of the social contract between the government and the governed.
On top of everything else, nobody seems to think it’s going to be helpful to the recovery of the housing market, help the economy, or do anything except bail out the banks, again. From the Times:

“I wouldn’t say it’s a panacea for the housing industry but it is good for the banks to get this behind them,” said Jason Goldberg, an analyst with Barclays.

Lucky banks.

Christopher J. Mayer, a housing expert at Columbia Business School, said the accord could give banks more certainty that they can clear their large backloads of seized homes, restoring the flow of those homes into the market.

Yeah, because it’s not like there are a shortage of homes for sale already?

About one in five Americans with mortgages are underwater, which means they owe more than their home is worth. Collectively, their negative equity is almost $700 billion. On average, these homeowners are underwater by $50,000 each.
A recent estimate from the settlement negotiations put the average aid for homeowners at $20,000.
“I just don’t think it’s going to be a life-changing event for borrowers,” said Gus Altuzarra, whose company, the Vertical Capital Markets Group, buys loans from banks at a discount.

He’s right, homeowners will continue to be sacrificed like so many lambs.
On the other hand, the banks are evidently bribing the AG’s with money to use to pay for their investigations of—the banks. And useless consumer credit education, to perpetuate the myth that this is the fault of greedy or stupid homeowners who bought more house then they could afford; rather than the reality that they were fraud victims of predatory lenders.

Happy Birthday Credit Crisis

2012-02-08T22:05:00.000-08:00

Ritholtz say's it's been five years, who am I to argue, but I just wanted to mark it's anniversary.

Here's where the dominoes started falling . . .

HSBC to Boost Loan-Loss Provisions on Bad Mortgages (Update8)

By Christine Harper and Chia-Peck Wong - February 8, 2007 05:02 EST

Feb. 8 (Bloomberg) -- HSBC Holdings Plc, Europe's biggest bank, said it's setting aside 20 percent more than analysts estimated for loan losses in 2006 because the company's U.S. mortgage business is deteriorating.

Home loans to risky borrowers in the U.S. are going bad faster than HSBC expected just two months ago, the bank said yesterday in an e-mailed statement. HSBC's London-traded shares fell as much as 2.5 percent today to 909 pence, their biggest drop in eight months, and traded down 21.5 pence to 909.5 pence at 9:45 a.m.

London-based HSBC, which paid $15.5 billion to buy Household International Inc. in 2003, initially got a boost in profit as U.S. house prices soared. Now earnings are eroding as defaults jump. Home loans to borrowers with poor credit ratings or large debt burdens are souring at a faster rate than during the U.S. recession six years ago, according to Friedman Billings Ramsey Group Inc.

``Household provided them with a reasonably strong earnings boost in the last few years but it's hurting them now,'' said Sunil Garg, an analyst at JPMorgan Chase & Co. in Hong Kong who today cut his rating on HSBC. ``It's a deterioration of the U.S. market and HSBC isn't isolated in this.''

HSBC said analysts had expected $8.8 billion in loan-loss provisions for 2006, based on the average of 11 estimates gathered by the bank. A 20 percent increase would bring provisions to $10.56 billion, more than the $8.7 billion HSBC earned in the first half.

Sub-Prime Rates

The stock has fallen 7.2 percent since Nov. 13, when HSBC first said bad debts in the U.S. were rising, making it the third- worst performer on Hong Kong's benchmark Hang Seng Index. All other banking stocks on the index rose in the period.

``There will be some doubt about whether this is the big provision or whether it's a sign of things to come,'' said Tathagata Guha Roy, who helps manage $1 billion for Alliance Trust Plc in Hong Kong.

Chief Executive Officer Michael Geoghegan and Chief Financial Officer Douglas Flint will host a conference call today at 10 a.m. London time to discuss the provisions.

Rising interest rates and falling house prices have made it harder for many Americans to repay their mortgages, leading to higher loan losses at HSBC and rivals including New Century Financial Corp. The U.S. Federal Reserve raised its benchmark rate to 5.25 percent last year from 1 percent in 2004.

New Century, HSBC's largest competitor for so-called sub-prime mortgages, said yesterday it expects a fourth-quarter loss in part because of a jump in defaults on new loans.

`Further Weakness'

``The impact of slowing house price growth is being reflected in accelerated delinquency trends across the U.S. sub-prime mortgage market,'' HSBC said in the statement. ``It is clear that the level of loan-impairment provisions to be accounted for as at the end of 2006 in respect of Mortgage Services operations will be higher than is reflected in current market estimates.''

Lenders typically charge 2 or 3 percentage points more on sub- prime mortgages than on those to the safest borrowers. Such loans made up about a fifth of all new mortgages last year, according to the Mortgage Bankers Association in Washington.

Two months ago, HSBC warned that earnings were at risk of ``further weakness'' in the U.S. because a slowdown in mortgage lending would ``constrain revenue growth.'' Today, the company said the rest of its businesses performed in line with its expectations on Dec. 5, the date of its last outlook. HSBC is scheduled to report earnings on March 5.

Household Purchase

The worsening prospects for U.S. mortgages are increasing pressure on HSBC ChairmanStephen Green to accelerate growth in Asia. HSBC gets almost half its profit from the U.S. and the U.K., where record household debt is forcing the bank to increase bad- loan provisions as well.

``HSBC has exposure to the U.S. market which is unique to banks listed in Asia,'' said Garg, who cut his HSBC rating to ``underweight'' from ``neutral.'' ``The pure Asia plays look better.''

HSBC, the world's No. 3 bank by market value after New York- based Citigroup Inc. and Charlotte, North Carolina-based Bank of America Corp., bought Household International for $15.5 billion in 2003. Acquiring the Prospect Heights, Illinois-based company, a lender to consumers with poor credit ratings, left HSBC more vulnerable to a housing slowdown.

Mortgage Bankruptcies

Irvine, California-based New Century also is restating earnings for the first nine months of 2006 and delaying the release of fourth-quarter results.

Mortgage Lenders Network USA Inc. of Middletown, Connecticut, filed for bankruptcy on Feb. 5 and Agoura Hills, California-based Ownit Mortgage Solutions sought protection from creditors in December.

During the five-year boom in housing prices, homeowners who fell behind on mortgage payments could sell their homes and pay off their loans or get better refinancing terms based on the higher value of their property. Federal Reserve Governor Susan Bies said in a Jan. 11 speech that regulators were concerned about sub-prime loans made with low down payments or limited proof of borrowers' incomes.

DocX

2012-02-07T06:59:00.000-08:00

MONDAY, FEBRUARY 6, 2012

Mirabile Dictu! Missouri Attorney General Files Criminal Lawsuit on Robosiging

“Linda Greene” has become a household word to those on the foreclosure fraud beat. And it turns out, for once, that the work of diligent investigators such as the foreclosure attorneys around Max Gardner, and investigators like Lynn Szymoniak and Lisa Epstein led to press coverage which in turn spurred prosecutors to act.

What is striking about the indictment by a Missouri grand jury is that the Missouri AG Chris Koster has decided to challenge the banks’ party line that robosigning and related abuses were mere “paperwork problems.” He’s called robosiging what it is: forgery. The 136 count indictment is for forgeries and false declarations, and the targets are LPS subsidiary and its founder and past president, Lorraine Brown. From a press release by Koster:

Today’s indictment reflects our firm conviction that when you sign your name to a legal document, it matters,” Koster said. “Mass-producing fraudulent signatures on millions of real estate documents across America constitutes forgery. When you file those documents in our state, you are committing a crime under Missouri law.
The forgery and false declaration counts each allege that the person whose name appears on 68 notarized deeds of release on behalf of the lender is not the person who actually signed the paperwork. The documents were then submitted to the Boone County Recorder of Deeds as though they were genuine…
DOCX’s role in the robo-signing process came to national attention when 60 Minutes reported that Linda Green, an employee of DOCX, purportedly signed thousands of mortgage-related documents on behalf of several different banks and in multiple handwritings. The 68 documents on which the indictments are based were purportedly signed by Linda Green, but were in fact allegedly signed by someone else.
Forgery is a Class C felony and False Declaration is a Class B misdemeanor. If convicted on the most serious count, Brown could face up to seven years in prison for each count. DOCX could be fined up to $10,000 for each forgery conviction and $2,000 for each false declaration conviction.

The open question is whether Koster intends to stop here or is using the mob prosecution strategy that Catherine Cortez Masto seems to be employing, that of going after LPS, which was the major outsourcing platform for servicers, and seeing where that trail leads.

Additional comments from Gretchen Morgenson of the New York Times:

One of the largest companies that provided home foreclosure services to lenders across the nation, DocX, has been indicted on forgery charges by a Missouri grand jury — one of the few criminal actions to follow reports of widespread improprieties against homeowners…
A grand jury in Boone County, Mo., handed up an indictment Friday accusing DocX of 136 counts of forgery in the preparation of documents used to evict financially strained borrowers from their homes. Lorraine O. Brown, the company’s founder and former president, was indicted on the same charges.
Employees of DocX, a unit of Lender Processing Services of Jacksonville, Fla., executed and notarized millions of mortgage documents for big banks and loan servicers over the years. Lender Processing closed the company in April 2010, after evidence emerged of apparent forgeries in these documents, a practice now called robo-signing.

DocX was a particularly bad actor; we’ve discussed in earlier posts how it had a price sheet for various services, including fabricating documents like mortgage note out of whole cloth. I’m surprised it has taken this long for someone to go after them. While this is clearly good news for borrowers and bad news for LPS, I doubt that anyone at the banks will feel threatened by this action. Unless this action leads to further prosecutions, it only scrapes the surface of bad conduct in the mortgage arena.

Start Schtupping !!!

2012-02-06T07:35:00.000-08:00

O.C.J. Case No. 5595

2012-02-05T07:23:00.000-08:00

The NYT has a pretty interesting story about a guy who got pissed off at the mortgage abuse he'd suffered and had the means to cause Fannie to investigate his accusations. OCJ Case No. 5595 is the result of Fannie's own investigation. An exerpt:

We have found evidence that false statements by foreclosure attorneys are being routinely made in at least two counties in Florida and appear to be occurring elsewhere. Apparently due to Mr. Lavalle's ex parte communications, two Florida judges ordered hearings to examine MERS' s role in foreclosures. During consolidated hearings that resulted in the
judges dismissing 24 foreclosure actions, three judges (including one who took the time to observe and comment) criticized MERS for routinely filing " sham" pleadings and "false" affidavits regarding its interest in promissory notes and supposed lost promissory notes. I I One
judge questioned whether large numbers of foreclosures would have to be reversed due to fraud on the court. MERS' s counsel conceded false allegations are routinely made, and the practice should be "modified." He acknowledged that foreclosure counsel used the Florida Supreme
Cour t ' s form pleading for foreclosures without critically analyzing the facts. The form contains an allegation that the plaintiff is the "owner and holder" of the promissory note. MERS is neither.

His report is here and it appears to be a smoking gun versus the boards of FannieMae. At the peak of the CMO bonanza, FannieMae was keeping the wheels greased so the money could continue to roll in, by ignoring the crimes the servicers they were hiring to process the mortgage paper. They can't claim they didn't know of the abuses they were apparently winking at.

A Mortgage Tornado Warning, Unheeded

Gary Bogdon for The New York Times

After his own experience dealing with a mortgage mess, Nye Lavalle set out to learn all he could about the mortgage industry, traveling nationwide to dig into records. In 2003, he compiled a dossier of practices at Fannie Mae. In hindsight, the problems he found look like a blueprint of today's foreclosure crisis.

By GRETCHEN MORGENSON

Published: February 4, 2012

REPRINTS

YEARS before the housing bust — before all those home loans turned sour and millions of Americans faced foreclosure — a wealthy businessman in Florida set out to blow the whistle on the mortgage game.

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Report to Fannie Mae Regarding Shareholder Complaints

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His name is Nye Lavalle, and he first came to attention not in finance but in sports and advertising. He turned heads in marketing circles by correctly predicting that Nascar and figure skating would draw huge followings in the 1990s.

But after losing a family home to foreclosure, under what he thought were fishy circumstances, Mr. Lavalle, founder of a consulting firm called the Sports Marketing Group, began a new life as a mortgage sleuth. In 2003, when home prices were flying high, he compiled a dossier of improprieties on one of the giants of the business, Fannie Mae.

In hindsight, what he found looks like a blueprint of today’s foreclosure crisis. Even then, Mr. Lavalle discovered, some loan-servicing companies that worked for Fannie Mae routinely filed false foreclosure documents, not unlike the fraudulent paperwork that has since made “robo-signing” a household term. Even then, he found, the nation’s electronic mortgage registry was playing fast and loose with the law — something that courts have belatedly recognized, too.

You might wonder why Mr. Lavalle didn’t speak up. But he did. For two years, he corresponded with Fannie executives and lawyers. Fannie later hired a Washington law firm to investigate his claims. In May 2006, that firm, using some of Mr. Lavalle’s research, issued a confidential, 147-page report corroborating many of his findings.

And there, apparently, is where it ended. There is little evidence that Fannie Mae’s management or board ever took serious action. Known internally as O.C.J. Case No. 5595, in reference to the company’s Office of Corporate Justice, this 2006 report suggests just how deep, and how far back, our mortgage and foreclosure problems really go.

“It is axiomatic that the practice of submitting false pleadings and affidavits is unlawful,” said the report, a copy of which was obtained by The New York Times. “With his complaint, Mr. Lavalle has identified an issue that Fannie Mae needs to address promptly.”

What Fannie Mae knew about abusive foreclosure practices, and when it knew it, are crucial questions as Congress and the Obama administration weigh the future of the company and its cousin, Freddie Mac. These giants eventually blew themselves apart and, so far, they have cost taxpayers $150 billion. But before that, their size and reach — not only through their own businesses, but also through the vast amount of work they farm out to law firms and loan servicers — meant that Fannie and Freddie shaped the standards for the entire mortgage industry.

Almost all of the abuses that Mr. Lavalle began identifying in 2003 have since come to widespread attention. The revelations have roiled the mortgage industry and left Fannie, Freddie and big banks with potentially enormous legal liabilities. More worrying is that the kinds of problems that Mr. Lavalle flagged so long ago, and that Fannie apparently ignored, have evicted people from their homes through improper or fraudulent foreclosures.

Until a few weeks ago, Mr. Lavalle, 54, had never seen O.C.J. 5595. He had hoped to get a copy after helping Fannie’s lawyers, at Baker & Hostetler in Washington, complete it. He didn’t.

But after learning about its findings from a reporter for The Times, Mr. Lavalle said, “Fannie Mae, its directors, servicers and lawyers appeared to have an institutional policy of turning a willful blind eye to evidence of mortgage origination and servicing fraud.”

He went on: “When confronted directly with this evidence, Fannie not only failed to correct and remedy the abuses, it assisted in continuing the frauds via institutional practices that concealed fraudulent foreclosures.”

A spokesman for Fannie Mae said in a statement last week that the company quickly addressed several issues that were raised in the 2006 report and that it took action on other issues associated with foreclosures in 2010. “We want to prevent foreclosure whenever possible, but when foreclosures cannot be avoided they must move forward in a timely, appropriate fashion,” he said.

Fannie Mae would not say whether it had shared O.J.C. 5595 with its board of directors or its regulator, then known as the Office of Federal Housing Enterprise Oversight. James B. Lockhart III, who headed that regulator in 2006, said he did not recall reading the report. “I probably did not see it as back then foreclosures were not a very big deal,” he said.

But another report published last fall by the inspector general of the Federal Housing Finance Agency, the current regulator, briefly mentioned some of the problems that Mr. Lavalle had raised. (It didn’t mention him by name.) It also faulted Fannie Mae, saying it failed to address foreclosure improprieties that had surfaced years before.

Scathing . . .

2012-02-01T17:33:00.000-08:00

This is pretty intense. . .

The author is as politely pissed off as any I've read on the subject of the Obama Administration doing almost nothing of significance to bring the banking sector to heel for their crimes involving the 2007 Financial Meltdown. In very clear and dramatic terms he contrasts the efforts made to bring the S&L Crisis criminals to justice versus current efforts.

He also paints an interesting picture of Obama co-opting the biggest critic of the AG Settlement by giving him a title and desk.

Sigh. . .

TUESDAY, JANUARY 31, 2012

Holder & Obama’s Propaganda is “Belied by a Troublesome Little Thing Called Facts”

By William K. Black

The Obama administration’s record of prosecuting elite financial frauds is worse than the Bush administration’s record, which is a very large statement. Syracuse University’s TRAC issued a report on November 11, 2011 entitled “Criminal Prosecutions for Financial Institution Fraud Continue to Fall.”

Neither administration has prosecuted any elite CEO for the epidemic of mortgage fraud that drove the ongoing crisis. This contrasts with over 1,000 elite felony convictions arising from the S&L debacle. The ongoing crisis caused losses more than 70 times greater than the S&L debacle and the amount of elite fraud driving this crisis is also vastly greater than during the S&L debacle. Bank CEOs leading “accounting control frauds” now do so with impunity from the criminal laws. They become wealthy through fraud and even if they are sued civilly they almost invariably walk away wealthy with the proceeds of their frauds.

The Obama Administration Prefers Politics and Propaganda to Prosecutions

Elite financial institutions officers engaged in fraud face a dramatically reduced risk of prosecution compared to 20 years ago when financial fraud was far less common. TRAC reports that the number of financial institution fraud prosecutions under Obama is less than one-half the number 20 years ago. Bush (II) was slightly better than Obama in prosecuting non-elite financial institution frauds, but both were pathetically bad.

The New York Times reported on January 23, 2012 that the administration rushed to try to reach a settlement with the five largest banks that engaged in massive foreclosure fraud so that it could take credit for it in the State of the Union (SOTU) address. The headline for the article was “Political Push Moves a Deal on Mortgages Inches Closer.” The administration did not deny the statements made in the article.

“But a final agreement remained out of reach Monday despite political pressure from the White House, which had been trying to have a deal in hand that President Obama could highlight in his State of the Union address Tuesday night.

The housing secretary, Shaun Donovan, met on Monday in Chicago with Democratic attorneys general to iron out the remaining details and to persuade holdouts to agree with any eventual deal. He later held a conference call with Republican attorneys general. But as he renewed his efforts, Democrats in Congress, advocacy groups like MoveOn.org and several crucial attorneys general said the deal might be too lenient on the banks.

In a bid to win support from California officials, Mr. Donovan proposed earmarking $8 billion in aid for beleaguered California homeowners, but that left other state attorneys general incensed, according to an official familiar with the negotiations.”

The NYT did not make the point, but these facts represent multiple disgraces on the administration’s part that go beyond the substance of deal. First, there is the obvious impropriety of pressuring state attorney generals (AGs) who are Democrats to approve a deal so that the President can claim credit for it in the SOTU. Second, it is disgraceful that HUD Secretary Donovan met separately with Democratic AGs. Prosecutions and suits against banks must have nothing to do with political affiliation. Holding separate meetings with AGs based on their party affiliation brings the entire system into disrepute. Third, the idea of offering California a unique earmark in order to buy AG Harris’ support for a deal is as stupid as it was offensive. The administration thinks that everything is about politics. As a former Department of Justice attorney I regret the administration’s bringing the department into disgrace. I can personally assure the nation that nothing like this ever occurred during the S&L debacle in our prosecutions, civil lawsuits, and agency enforcement actions.

Here is what Obama said in his SOTU address:

“One of my proudest possessions is the flag that the SEAL Team took with them on the mission to get bin Laden. On it are each of their names. Some may be Democrats. Some may be Republicans. But that doesn’t matter. Just like it didn’t matter that day in the Situation Room, when I sat next to Bob Gates – a man who was George Bush’s defense secretary; and Hillary Clinton, a woman who ran against me for president.

All that mattered that day was the mission. No one thought about politics. No one thought about themselves.”

The President was, of course, correct. The same logic applies to everything that government attorneys do. No one should think about politics or themselves. Political party “doesn’t matter.” Party, politics, and the pursuit of financial contributions not only matter, but are controlling for the administration in their non-pursuit of the fraudulent elite CEOs that drove the ongoing crisis.

The fact that a NYT story could reveal this outrage without the authors even mentioning the impropriety of the actions described, without the administration feeling any need to respond to the impropriety, and without any scandal demonstrates how badly we have fallen as a society. While the President was reviewing drafts of a major address to the nation that emphasized that politics should never have a role in government service two of his cabinet officers, Attorney General Holder and HUD Secretary Donovan, were devising a partisan lobbying strategy aimed at getting the state AGs to approve a disgraceful surrender to five of the nation’s largest banks. He either did not notice the contradiction or did not feel any need to end the impropriety. Have we lost our capacity for outrage?

The failure of the article to generate a scandal reflects badly on both parties. The candidates for the Republican Party’s nomination have been searching for every conceivable issue as a potential basis for attacking Obama. The administration’s conduct as described by the NYT article provides the perfect club to the Republican candidates, yet none of them will use it. Why? The Republican candidates could not oppose a settlement that, substantively, was so exceptionally favorable to the largest banks. Finance is the largest contributor to both parties. The only criticism in the article came from liberal Democrats (Senator Brown and Representative Miller).

The administration recognized that the only threat to the disgraceful settlement came from liberal Democrats. The administration devised a sophisticated propaganda campaign to counter this opposition. It bore fruit immediately. The day after the NYT story ran, the Center for Responsible Lending (CRL) issued a press release entitled “AGSettlement: Not Perfect, but Significant Reform of Mortgage Servicing.”

The press release was based on a friendly leak, presumably from the administration, of the terms of the settlement as of January 24, 2012. The settlement had two express, related substantive defects. The amount of money the banks would pay was grossly inadequate, relative to the claims being released by the federal and state governments. The third substantive defect is not contained in the written release, but it is one of the keys to the governmental surrender to the fraudulent financial CEOs who caused the crisis. The federal government does not intend to prosecute criminally the large financial firms and their senior officers who committed hundreds of billions of dollars in fraudulent mortgage originations. That figure only counts the fraudulent liar’s loans the five large banks made. The total amount of mortgage origination fraud through liar’s loans exceeds $1 trillion. The five banks’ civil liability for mortgage origination fraud is vastly larger than their civil liability for their endemic foreclosure fraud. I have explained in detail in prior articles and testimony why only fraudulent banks made material amounts of liar’s loans.

Here is how the administration successfully spun the deal to CRL.

“Banks remain accountable. While the state AGs would not be able to bring additional origination or servicing claims against the participating banks, the settlement would preserve the ability of homeowners to pursue claims against banks. Moreover, the settlement would not shield banks from prosecution related to criminal activities, claims based on mortgage securities violations, fair lending suits, or claims against MERS. Finally, the settlement would be enforceable in court by an independent monitor.”

As of January 24, the deal the administration was desperate to conclude prior to the SOTU required the state and federal governments to release civil claims for mortgage origination fraud.

The administration’s efforts to pressure the state AGs (all Democrats) to withdraw their opposition to this cynical deal to immunize expressly the largest banks from civil liability for their mortgage origination fraud and, implicitly, to immunize them from criminal liability for mortgage origination fraud failed. The administration responded to the failure through an elaborate symbolic creation of a new task force and a renewed propaganda campaign designed to neutralize liberal opposition to its proposed surrender to the largest banks. The maneuver, however, required an important substantive change in the proposed deal that reveals how bad for the public the administration’s proposed deal of January 24 was.

The administration is good at spinning, and this effort had a clever twist and a substantive change that added to its credibility. To date, the spin has been largely successful with liberal commentators. The clever twist was adding the AG leading the opposition to the surrender, NY AG Eric Schneiderman, to the newly created working group. Schneiderman has great credibility with liberals because he blocked the administration’s proposed grants of immunity to the five large banks (which were apparently far broader and included express terms raising crippling barriers even to criminal prosecutions). The administration needed Schneiderman on the task force to grant it any credibility. The need for credibility became even more intense after ScotPaltrow’s January 20 expose in Reuters (Insight: Top Justice officials connected to mortgage banks). The article revealed that U.S. Attorney General Holder and Lanny Breuer, head of DOJ’s criminal division, had been partners at the law firm Covington & Burling, which represented many of the largest banks and had provided key legal opinions to the infamous MERS (Mortgage Electronic Registration System) that has contributed greatly to foreclosure fraud.

Schneiderman apparently recognized the great leverage he had over the administration and insisted on the modification of the deal’s release of the big banks’ civil liability for their mortgage origination fraud. The administration used Schneiderman’s willingness to serve on the new task force and the reduced grant of immunity for the big banks’ mortgage origination fraud as the centerpiece of its effort to spin liberals. It promptly leaked a description of the new proposed deal terms to several liberals – and was immediately rewarded with praise from liberals. Given the fact that Holder and Breuer have no credibility with liberals, this was an exceptional achievement that has delighted the administration. Mike Lux, who has consistently and strongly opposed the administration’s earlier proposed settlement drafts, broke the story of the substantive improvements to the deal on January 27. His story explains that two sources he trusts leaked the terms of the new deal to him. He entitled his article “Settlement Release Looks Tight.” I encourage reading Lux’s entire article, but here is the key excerpt.

“Big breaking news about the long-fought over bank settlement: senior sources high up in the negotiations have outlined the terms of the legal release. Here's what I was told:
***
No release on the "vast majority" of origination claims.
No release on the "vast majority" of securitization claims, including all claims of state pension funds.
***

According to these (two) sources, the release is almost entirely confined to robosigning cases.

Now, I haven't seen the actual language, so I can't verify all this, and I don't know what the phrase "vast majority" means. I also don't know if every player in the negotiations is 100 percent signed off on it. But I have a lot of trust in my sources that this real and that they wouldn't be trying to BS me on how narrow this is. If the language is indeed as tight as my sources are telling me, this is very big news.

All along in this battle, there have been two things progressives working on this issue have been fighting hardest for: one was that we got a broad, deep, well-resourced, and serious investigation of the big financial fraud issues that have gone down in this country over the last decade; the other was that if there was a settlement, that the legal releases the banks got was drawn as narrowly as it could be drawn, as tight as a drum. That combination, in the view of New York Attorney General Eric Schneiderman and those of us fighting by his side, would create real potential of finally holding the Wall Street bankers who wrecked our economy and abused us all accountable for their actions, and for getting a serious amount of money for writing down underwater mortgages. While there are still legitimate questions in both areas, it is looking like we may be achieving both of these huge goals.

One other big question remains in all this: with a release this narrow, will the big banks actually settle? JP Morgan Chase CEO Jamie Dimon and unnamed bank lobbyists are already threatening to walk away, and are clearly really unhappy, so that isn't clear. If they walk away, though, progressives can certainly live very well knowing that they will be prosecuted aggressively by AGs like Schneiderman, Beau Biden of Delaware, Kamala Harris of California, and hopefully others, so it's a win-win for us. My view is: anything that makes Jamie Dimon and big-bank lobbyists unhappy is good for the rest of us.”

Lux obviously recognizes that there are important outstanding questions about the proposed deal. I write to add several cautions.

1. There is no reason for granting any civil immunity on mortgage origination or securitization frauds and the grant of even limited immunity for such frauds can only create future problems.

2. The state AGs do not have the resources to investigate mortgage origination fraud. It isn’t even close. Collectively, the 50 state AGs could investigate Countrywide’s frauds if they took every investigator with expertise in financial institutions and assigned them to the case for five years.

3. The state AGs are not investigating mortgage origination fraud by major lenders.

4. The new working group will not investigate mortgage origination fraud. Obama described the task force in these words in his SOTU address.

“And tonight, I am asking my Attorney General to create a special unit of federal prosecutors and leading state attorneys general to expand our investigations into the abusive lending and packaging of risky mortgages that led to the housing crisis. This new unit will hold accountable those who broke the law, speed assistance to homeowners, and help turn the page on an era of recklessness that hurt so many Americans.”

The working group will not “investigate … abusive lending” and it will not “hold accountable those who broke the law … [by defrauding] homeowners.” It will not “speed assistance to homeowners.” It will not “turn the page on an era of recklessness” – and fraud, not “recklessness” is what prosecutors should prosecute. The name of the working group makes its crippling limitations clear: the Residential Mortgage-Backed Securities Working Group. Attorney General Holder’s memorandum about the working group makes clear that the name is not misleading. The working group will deal only with mortgage backed securities (MBS) – not the fraudulent mortgage origination that drove the crisis (the only exception is federally insured mortgages).

Fraudulent mortgage originators engaged in fraudulent sales of the mortgages, mostly to Wall Street and, eventually, Fannie and Freddie. As I stressed earlier, the administration is continuing to grant de facto immunity to CEOs at the large lenders whose massive mortgage origination frauds drove the crisis. The working group’s mandate helps confirm the administration’s continued refusal to prosecute elite mortgage origination fraud.

5. The working group is a symbolic political gesture designed to neutralize criticism of the administration’s continuing failure to hold accountable the elite frauds that drove the crisis. Neither the Bush nor the Obama administration has convicted a single elite fraud that drove the crisis. This is a national disgrace and represents the triumph of crony capitalism. Remember that the FBI warned in September 2004 that there was an “epidemic” of mortgage fraud and predicted that it would cause a financial “crisis.” There are no valid excuses for the Bush and Obama administrations’ failures. The media have begun to pummel the Obama administration for its failure to prosecute. The administration could not answer this criticism with substance because it has nothing substantive to offer in prosecuting elite mortgage origination frauds. The ugly truth is that we are three full years into his presidency and Holder could not find a single indictment to bring that Obama could brag about in his SOTU address. Who doubts that Holder and Obama would have done so if they had anything in the prosecutorial pipeline? Why do Holder and Obama have nothing in the pipeline? There are three fundamental problems, and the working group has not even addressed, much less resolved, any of the three fundamental defects.

One, criminal prosecutions of elite financial criminals have to come from investigations initiated by those with the expertise and resources to detect and investigate “accounting control fraud” (the form of fraud that can hyper-inflate financial bubbles and cause catastrophic losses and financial crises). Only the federal banking regulators have this capability. The absolute essential to achieving broad success is superb criminal referrals from those regulators. The central difficulty with such referrals should be that roughly 75% of the fraudulent mortgage loans were made by entities not regulated by the federal (or state) banking regulators. They were primarily made by mortgage bankers. Sadly, that did not prove to be the central difficulty with federal banking regulators’ criminal referrals. The federal banking regulators essentially ceased making criminal referrals last decade.

Banks will not file criminals against their CEOs – the people who run the accounting control frauds that produced the epidemics of mortgage fraud. Police and detectives do not investigate elite accounting control frauds. The FBI does not patrol a beat. Unless the regulatory cops on the beat (e.g., the banking regulators) make the criminal referrals the DOJ and the FBI will never investigate or prosecute the fraud. Indeed, because accounting control fraud is inherently complex and requires specialized knowledge to recognize, the DOJ will rarely recognize accounting control fraud even when the facts are only consistent with accounting control fraud (as opposed to bad luck or optimism). Absent high quality criminal referrals from the banking regulatory agencies, DOJ may have episodic successes but it will fail utterly to prosecute any epidemic of elite accounting control fraud. Criminal referrals provide the road map that allows effective investigations and prosecutions.

Two, DOJ has not provided remotely enough resources to investigate the large accounting control frauds. Three, DOJ has adopted a self-serving definition of mortgage fraud that implicitly defines accounting control fraud out of existence. DOJ has violated the central rule of investigating elite white-collar crime – if you don’t look; you don’t find.

We have forgotten the successes of the past. During the S&L debacle, Congress responded to the S&L crisis, once the presidentially-ordered cover up of the scope of the crisis ended in 1989, by ordering and funding a dramatic increase in DOJ resources dedicated to prosecuting the S&L accounting control frauds that drove the second phase of the debacle. President Bush (II), President Obama, and Congress have each failed to emulate the policies that proved so successful in prosecuting elite frauds that caused prior crises. DOJ and the S&L regulators made the prosecution of the elite frauds a top priority by their deeds as well as their words. Contrast that with Holder’s press release announcing the formation of the working group:

“Over the past three years, we have been aggressively investigating the causes of the financial crisis. And we have learned that much of the conduct that led to the crisis was – as the President has said – unethical, and, in many instances, extremely reckless. We also have learned that behavior that is unethical or reckless may not necessarily be criminal. When we find evidence of criminal wrongdoing, we bring criminal prosecutions. When we don’t, we endeavor to use other tools available to us – such as civil sanctions – to seek justice.”

Holder was even more dismissive of criminality in his memorandum to the financial fraud task force officially informing it of the creation of the working group: “To the extent there was any fraud or misconduct in the RMBS market, we remain committed to discovering it….” This phrase indicates his doubt that there was any fraud – he is saying that they have not “discover[ed]” any fraud. That is a remarkable statement on three grounds. It is a statement made without any credible DOJ investigation. It is a statement contrary to all recent experience with financial crises. Accounting control frauds caused the largest losses in the Enron-era frauds and the S&L debacle. It is also extraordinary because other federal agencies have documented endemic fraud and charged many of the world’s largest financial institutions with intentionally selling loans they knew to be fraudulent through false reps and warranties.

Holder consistently emphasizes the lack of criminality. Indeed, since he has prosecuted no elite CEO involved in causing this crisis, he is actually saying that he believes this is our first Virgin Crisis. Countrywide and its ilk made millions of fraudulent mortgage loans – yet Holder thinks that Countrywide’s CEO was a victim of the fraud.

I have concluded that the entire working group gambit upsets me so much because it rests on such crude propaganda. Holder decided to embellish the gambit with the illusion of concrete action. Reuters reported Holder’s claims at his press conference on the working group.

“The Justice Department issued civil subpoenas to 11 financial institutions as part of a new effort to investigate misconduct in the packaging and sale of home loans to investors, Attorney General Eric Holder said on Friday.

Holder declined to provide specifics, including the names of the firms.

"We are wasting no time in aggressively pursuing any and all leads," Holder said at a news conference announcing details of a new working group to investigate misconduct in the residential mortgage-backed securities (RMBS) market, "you can expect more to follow."”

One assumes that reporters were so stunned by Holder’s audacity that they failed to challenge his claim that “we are wasting no time in aggressively pursuing any and all leads.” Let us review only the most obvious reasons why this statement is preposterous. The subpoenas are civil subpoenas, not grand jury subpoenas. There is no indication that Holder is serious even now about conducting any criminal investigation of elite banks or bankers.

The question is not whether the Working Group wasted a day or two in issuing civil subpoenas. The Obama administration has wasted three years before issuing these subpoenas. (The Bush administration wasted eight years. The total waste is cumulative.) Civil subpoenas are the most preliminary form of investigation. DOJ should have been issuing grand jury subpoenas to every lender making liar’s loans and every entity packaging liar’s loans no later than September 2004 when the FBI warned that there was an “epidemic” of mortgage fraud and predicted that it would cause a financial “crisis.”

The Obama and Bush administrations have consistently failed to “pursu[e] any and all leads.” Let us count the ways DOJ has typically failed to pursue leads against the elite officers whose frauds drove this crisis: they have not used grand juries, they have not issued civil subpoenas, they have not used electronic surveillance, they have not used undercover investigators, they have not “wired” cooperating witnesses who they have “flipped”, they have not appealed for whistleblowers to come forward, they have not called elite witnesses before grand juries, they have not convened grand juries, they have not sent FBI agents to their homes or offices to conduct formal interviews, they have not retained expert witnesses or consultants with expertise in accounting control fraud, they have not demanded that the banking regulatory agencies produce high quality criminal referrals, they have not asked those agencies to “detail” examiners and other skilled staff to the FBI to serve as internal experts, they have not trained AUSAs, special agents, and banking regulators in how to detect, investigate and prosecute accounting control frauds, they have not prosecuted where other federal agencies, after investigation, have charged that financial elites committed fraud, and they have not flipped intermediate officers and gone up the chain of command, they have not assigned remotely adequate staff to investigate and prosecute frauds, they have not assigned any meaningful number of their staff to investigate the elite frauds, and they have not made strong, consistent demands that Congress fund adequate staff to end the ability of financial elites to commit fraud with impunity. Conversely, DOJ has assigned its inadequate staff almost exclusively to non-elite mortgage fraud, has formed a “partnership” with the Mortgage Bankers Association (MBA) – the trade association of the “perps”, and has adopted the MBA’s absurd “definition” of mortgage fraud that implicitly defines accounting control fraud out of existence. How does Holder expect to get “leads” against elite frauds when he gets no criminal referrals from the banking regulatory agencies, “defines” the leading fraud perpetrators of mortgage fraud as the “victim” of mortgage fraud, conducts no credible investigation of elite frauds, takes no proactive steps to investigate (e.g., using undercover FBI investigations), makes no plea for whistleblowers to come forward with evidence on the elite frauds, and provides training for regulators, FBI agents, and AUSAs that implicitly denies the existence of accounting control fraud? I understand that he inherited a disaster and a disgrace from his predecessor, but he has made it worse.

Collectively, the Bush and Obama administration have provided de facto impunity from the criminal laws for our largest financial firms and their elite officers who drove our crisis. DOJ has had episodic successes against financial elites not involved in creating the crisis (e.g., Madoff and a prominent insider trader). These “successes” were bittersweet. Madoff conducted a Ponzi scheme that last for decades. DOJ only learned about the scheme because Madoff confessed to his family. He only confessed because the Ponzi scheme was about to collapse. The government learned of the insider trading through a whistleblower and found key facts through electronic surveillance and “wiring” “flipped” participants in the insider trading. The insider trading fraud went on for many years and likely would have gone on for many more years without the government learning of it but for the whistleblower. Both of these frauds were elite financial control frauds, so it is bizarre that Holder simultaneously takes credit for their successful prosecution while implicitly denying that control fraud could exist in elite financial institutions in the mortgage fraud context.

The Reuters story records Holder’s effort to claim that DOJ is vigorously prosecuting elite corporate frauds.

“[Holder] responded to criticism that federal enforcers have brought few marquee cases in the aftermath of the financial crisis. Holder said the department has brought around 2,100 mortgage-related cases.

"The notion that there has been inactivity over the course of the last three years is belied by a troublesome little thing called facts," Holder said.”

It is Holder whose claims are “belied by a troublesome little thing called facts.” He was responding to the factual critique that he has not indicted or prosecuted any elite banking officers of the large fraudulent lenders that drove the financial crisis. That critique is true. Holder, however, implied that it was an untrue critique by deliberately making a non-responsive response. His answer was that he has indicted 2,100 defendants in mortgage-related cases (roughly 700 annually). By 2006, lenders made roughly two million fraudulent liar’s loans. In 2005, they made over one million fraudulent liar’s loans. Prosecuting roughly 700 (or 7,000) smaller mortgage fraud cases annually is, at best, a symbolic act that cannot possibly have any material effect in slowing an epidemic of mortgage fraud, bringing to justice the elite frauds that caused the ongoing crisis, or deterring future crises. If Holder had led any elite prosecutions of the senior officers of the huge, fraudulent lenders and investment bankers that drove the crisis he would have used them to refute the criticism. Instead, he tried misdirection.

In January 1993, the GAO released a report entitled: Bank and Thrift criminal Fraud” prepared at the request of Senate Judiciary Committee Chairman Biden, who is now Obama’s Vice-President. Here are key excerpts from that report that demonstrate how real investigations and prosecutions occur:

“In 1984, Justice, along with the federal financial regulatory agencies, formed the Interagency Bank Fraud Enforcement Working Group in an effort to facilitate interagency communication and coordination between Justice and each of the regulatory agencies.

[WKB note: the key deregulatory law that created the criminogenic environment that led to the epidemic of accounting control fraud by roughly 300 S&Ls was the Garn-St Germain Act of 1982. By 1984, DOJ and the banking regulatory agencies realized (with the aid of a vigorous kick to their rears from the House of Representatives administered by Chair man Doug Barnard (D. Georgia)) that there was a fraud crisis and had formed the working group to investigate and prosecute bank frauds.]

Renamed the National Bank Fraud Enforcement Working Group, the group included officials from Justice (including the Criminal Division’s Fraud Section, the Attorney General’s Advisory Committee of Attorneys, and FBI), OTS, FDIC, occ, the Fed, NCUA, the Farm Credit Administration, the Secret Service, the Department of the Treasury, and the Securities and Exchange Commission.

[WKB note: Contrast this membership with Holder’s announcement of the members of his working group:

“The mission of the group — to hold accountable those who violated the law and provide relief for homeowners struggling from the collapse of the housing market — will be furthered through the active participation of the following members:

• Executive Office for United States Attorneys
• Federal Bureau of Investigation
• Financial Crimes Enforcement Network
• Internal Revenue Service - Criminal Investigation
• Consumer Financial Protection Bureau
• Federal Housing Finance Agency's Office of Inspector General
• United States Department of Housing and Urban Development
• United States Department of Housing and Urban Developments Office of Inspector General”]

Notice the conspicuous (except that no one I have read mentions it) failure to include any of the banking regulatory agencies – the entities that should have the expertise and should be making the vital criminal referrals. The administration will eventually be forced to add the banking regulatory agencies to the working group to quell criticism. The administration’s failure to name them originally is revealing. Any serious effort would start with the banking regulatory agencies. The more fundamental problem is, that unlike the S&L debacle, when the banking regulatory agencies led the demand for criminal prosecution of the elite frauds, the current crop of regulatory leaders under Bush and Obama have been notoriously silent and have failed to take even the most basic, essential step – reestablishing a superb criminal referral process and vigorous regulatory investigations of the largest frauds. There is no excuse for this continuing failure.]

In 1990, in testimony before the House Committee on the Judiciary, the Assistant Attorney General of the Criminal Division noted that the group had a number of accomplishments. Among other things, he noted that it produced a uniform criminal referral form….

[WKB note: this may seem a small, bureaucratic step if you have never created a system that resulted in the most successful prosecution of elite white-collar criminals. It is in fact the absolute essential place to start. The bank working groups engaged in what we would now call “continuous improvement.” The banking regulators responsible for making criminal referrals got feedback from the FBI on what aspects of our referrals were most useful and what aspects failed to meet the FBI’s needs. Our criminal referral specialists took that knowledge back to our staff and, through training and editing of draft referrals, continuously improved the quality of our referrals.]

The criminal financial institution fraud investigative workload in FBI has continued to grow. As of July 31, 1992, FBI had 9,669 investigations pending, an increase of about 46 percent from 1987. More than half of those investigations were classified as “major” fraud cases….

Table 2.1: [Number of criminal referrals filed by the banking regulatory agencies]
Federal Home Loan Bank Board/OTS [WKB note: the Office of Thrift Supervision (OTS) was the successor agency to the FHLBB.]
1987: 6,100
1988: 5,114
1989: 5,014
1990: 6,393
1991: 7,861

[WKB note: these figures do not include criminal referrals made by OTS after 1991, criminal referrals by the RTC (which resolved failed S&Ls’ bad assets), and criminal referrals by S&Ls placed into receiverships by OTS). Collectively, the federal agencies regulating S&Ls and dealing with S&L failures filed well over 30,000 criminal referrals during the S&L debacle.]

[WKB note: number of criminal referrals filed by OTS in the ongoing crisis: 0.]

Following enactment of FIRREA, the Attorney General designated criminal fraud in financial institutions a top enforcement priority. He announced but did not implement plans to address this “enormous and unprecedented challenge” by establishing task forces in 26 cities around the country modeled after the Dallas Bank Fraud Task Force. The Crime Control Act of 1990 authorized more than a doubling of available Justice resources and focused responsibility for the overall effort in Justice’s new Office of Special Counsel for Financial Institutions Fraud.

[WKB note: the Dallas Bank Fraud Task Force was staffed with nearly 100 FBI and IRS agents and other analytical support staff and 38 attorneys.]

FBI has relied on the cooperation of staff from the regulatory agencies to provide information and expertise needed for investigations.

Between October 1, 1988, and June 30, 1992, Justice charged 3,270 defendants through indictments and informations [in “major cases”] and convicted 2,603 defendants (110 defendants were acquitted, establishing a conviction rate near 96 percent). The courts sentenced 1,706 of 2,205 offenders to jail (77.4 percent).

The major difference between working groups and task forces is that task forces investigate and prosecute cases, while working groups do not.

As of July 31, 1992, FBI had 9,669 financial institution fraud cases pending, an increase of 11.3 percent over the 8,678 pending at the end of fiscal year 1991 and 45.3 percent over the 6,649 pending at the end of fiscal year 1987.

In 1989 and 1990, Congress passed two major pieces of legislation that shaped the government’s approach. The Financial Institutions Reform, Recovery, and Enforcement Act (FIRRRA) of 1989 and the Crime Control Act of 1990 (Crime Control Act) provided Justice with additional powers and resources to investigate and prosecute financial institution fraud.

The House report accompanying FIRREA reflects the belief that Title IX of FIRREA was “absolutely essential to respond to a serious epidemic of financial institution insider abuse and criminal misconduct and to prevent its recurrence in the future.”

Title XXV of the Crime Control Act [was] entitled the Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer Recovery Act of 1990….

Appropriations following FIRREA and the Crime Control Act nearly tripled the investigative and prosecutive resources that had previously been available to Justice to address the mounting volume of criminal bank and thrift fraud. The Crime Control Act also authorized additional appropriations to support more IRS resources important to fraud investigations. In addition, the act appropriating funds for the Department of the Treasury in fiscal year 1991 also authorized the Secret Service to participate in financial institution fraud investigations.

Appendix III: FBI and U.S. Attorney Resource Allocations Under FIRREA

[Additional staffing resources made available to aid the prosecution of S&L and bank frauds pursuant to the Financial Institution Reform, Recovery and Enforcement Act of 1989]

FBI: Special Agents: 219; Accounting technicians: 100
U.S. Attorney office: AUSAs: 121; Auditors: 22; Support: 120

Appendix IV: FBI and U.S. Attorney Resource Allocations Under the Crime Control Act [of 1990]

FBI: Special Agents: 289

U.S. Attorney Office: AUSAs: 228; Support: 198 [WKB note: this category included paralegals and auditors]

Table 2.4: Increased Justice Authorized Staff Positions
Fiscal years 1990 to 1992 (special agent, attorney, and other support positions)

FBI (total positions): 1621
U.S. Attorneys (total positions): 772
Criminal Division (total positions): 116
Tax Division (total positions): 65
Civil Division (total positions): 46
Total [DOJ] positions 2,620

[WKB note: these figures do not include IRS, Secret Service, Postal Service, and banking regulators working on the S&L and bank fraud task cases.]

[WKB (very long) note: in FY 2007 the FBI had 120 agents assigned to mortgage fraud cases. By FY 2009 that number rose to 300.

http://www.fbi.gov/stats-services/publications/financial-crimes-report-2009

The ongoing crisis caused losses over 70 times greater than the S&L debacle and the number of frauds in this crisis is vastly greater than during the S&L debacle. The best estimate is that there were roughly two million new cases of mortgage fraud in 2006. (The estimate arises from two facts explained at length in my prior work. Roughly one-third of all mortgage loans originated in 2006 were liar’s loans and the incidence of fraud in liar’s loans is roughly 90 percent.) Worse, DOJ formed a “partnership” with the Mortgage Bankers Association (the MBA) – the trade association of the “perps” and adopted the MBA’s contrary-to-fact definition of “mortgage fraud” in which the lender originating the fraudulent mortgages is always the victim of the fraud. Accounting control fraud is, implicitly, defined out of existence. The DOJ repeats this self-serving definition of mortgage fraud repeatedly, without any critical consideration. After the dominant role of accounting control fraud in the second phase of the S&L debacle and the Enron-era frauds we are faced with the conclusive assumption (unsullied by any real investigation or analytics) that the current crisis is the Virgin Crisis. Because they know that the lender is the victim, virtually every FBI agent has been assigned to investigating relatively minor mortgage frauds in which the lender is the purported victim. There has been no meaningful criminal investigation of any of the large fraudulent lenders. Given the pathetically low number of FBI agents assigned to mortgage frauds and their assignment to review staggering numbers of relatively small mortgage fraud cases there were never, remotely, adequate numbers of FBI agents to conduct a real investigation of Countrywide or Washington Mutual (WaMu). Each of these S&Ls made hundreds of thousands of fraudulent mortgage loans. Each of these S&Ls is substantially larger and more complex to investigate than Enron. Each of the S&L originated their hundreds of thousands of fraudulent mortgages by crafting perverse incentives for a vast network of mortgage brokers that induced them to commit endemic mortgage fraud. It took roughly 100 DOJ professionals several years to investigate Enron, so a comparable competent investigation of Countrywide or WaMu would require well over 100 DOJ professionals for several years. Any credible investigation of Countrywide or WaMu would have also required a group of OTS examiners to be “detailed” to work with the FBI investigation and serve as their internal experts. There is no evidence that either of these events ever occurred. Any purported FBI investigation of those massive shops was a sham.

The Working Group continues the sham and political symbolism at the expense of substance.Holder’s press release explained its staffing levels.

“Attorney General Holder announced that the new Working Group will consist of at least 55 Department of Justice attorneys, analysts, agents and investigators from around the country. Currently, 15 civil and criminal attorneys are part of the Working Group, along with 10 FBI agents and analysts who will be assigned to the Working Group efforts. An additional 30 attorneys, investigators and other staff around the country will join the Working Group efforts in the coming weeks. This team will join existing state and federal resources investigating similar misconduct under those authorities.”

Compare that staffing with the staffing levels we know from experience are required to be successful against elite accounting control frauds. The Working Group does not pass even the most generous laugh test. No one who has ever been involved in a successful, complex criminal investigation of a large organization could take this Working Group seriously. It lacks the capacity to conduct a competent investigation of any of the largest financial frauds – and there are scores of huge institutions engaged in MBS frauds and hundreds of large mortgage banks engaged in MBS frauds.]

The Settlement is too good, or too bad to be true

Lux notes that Jamie Dimon (JP Morgan Chase’s CEO) has expressed skepticism about whether the five large banks will continue to support the settlement now that its substance has been changed (assuming the accuracy of the leaks) to remove the “great majority” of the grants of immunity from civil liability and all grants of criminal immunity. The banks considered the earlier drafts of the deal that offered substantial immunity for mortgage origination fraud to be worth far more than the $25 billion they would pay in return to secure the immunity. Their civil liability exposure for mortgage origination fraud is in the hundreds of billions of dollars, so being released from both mortgage origination and foreclosure fraud for $25 billion would have been a spectacular win for the banks. Even if they received no express immunity from criminal prosecutions, it was clear that the administration was implicitly signaling that it would prosecute their mortgage origination frauds. By eliminating civil liability for mortgage origination fraud, the banks also would have made civil suits far less likely or even impossible and that would greatly reduce the risk that civil investigations would disclose criminal conduct that DOJ could not avoid prosecuting, particularly in an election year.

If the revised settlement has virtually no releases from civil liability for mortgage origination fraud and none for criminal actions, then it should be a no brainer that the deal no longer makes any sense for the banks. Their civil liability for their foreclosure fraud should be far less than $25 billion. It will be instructive to see whether the banks walk away from the deal or the government sweetens the deal for the banks by reducing the settlement amount or broadening again the releases from civil liability. If the banks sign the revised deal, as it is has been represented to Lux, then we will know that the big banks realize that they have such rotten skeletons in their foreclosure fraud closets that it is imperative that they settle the suits and prevent the civil suits from going forward and bringing the skeletons to light.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.

Follow him on Twitter: @WilliamKBlack

Terming out

2012-02-01T09:18:00.000-08:00

Read this a while back and wondered why no one picked up on it. The guy following this did.

A Former Treasury Adviser On How To Really Fix Wall Street

Morgan Ricks
December 17, 2011 | 12:00 am
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Any serious program for Wall Street reform should start with two words: “term out.” “Terming out” is a financial term of art, but its meaning is easily grasped. It simply means funding your business withlong-term financing instead of short-termIOUs. To a far greater extent than is commonly understood, our financial sector funds its operations with extremely short-term borrowings. These IOUs must be paid back in a day, a week, or a month. By contrast, termed-out financial firms shun borrowings that come due in less than a year. A terming-out requirement would be costly for Wall Street, but the reward would be a safer and more resilient financial system. That’s a trade we should be willing to make.

Short-term borrowings are fragile. Like a weak immune system, these fragile borrowings turn otherwise manageable challenges into life-threatening situations. Our financial system can deal with the occasional boom and bust without much of a problem. What it can’t handle—what sends the financial system and the economy into a tailspin—is a financial panic. And, by definition, a panic is about short-term IOUs.

In a panic, short-term lenders abruptly stop rolling over their IOUs. The financial sector, which relies heavily on these borrowings, then goes into cash-hoarding mode. It stops making loans and buying securities. Consequently, consumers and businesses can’t get credit on reasonable terms. They reduce their spending, and the economy stalls. The resulting slump can last for years—long after the financial sector has stabilized.

THE OBSERVATION THAT short-term IOUs are at the core of our financial troubles isn’t novel or even very controversial. A number of economists, including Gary Gorton at Yale, have been pointing this out for several years. Yet instead of addressing this issue squarely, recent financial reforms have largely been directed elsewhere.

Nor are the dangers of short-term borrowings a recent discovery. In 1873, Walter Bagehot—an English economist who was the father of modern central banking—warned his contemporaries about this very subject.“Of the many millions” in London’s financial system, Bagehot wrote, “infinitely the greater proportion is held by bankers or others on short notice or on demand; that is to say, the owners could ask for it all any day they please: in a panic some of them do ask for some of it.” He continued: “If any large fraction of that money was demanded, our banking system and our industrial system too would be in great danger.”

Bagehot’s prediction was borne out by the Great Depression. Milton Friedman famously showed that the Depression was brought about by successive waves of depositor panics. And deposits are, for banks, a form of short-term borrowing. (When you “deposit” money “into” a bank, you are, quite literally, lending the bank money.) So the Great Depression really was about short-term IOUs. According to Friedman, the Federal Reserve should have flooded the banking system with money to stop the panic. It failed to do its job.

Douglas Diamond, a University of Chicago economist and a leading theorist in this area, recently said that “financial crises are always and everywhere about short-term debt.” The recent crisis was no exception. In 2008, we witnessed massive runs on virtually all of the financial sector’s short-term IOUs, which go by odd names like “repo,” “asset-backed commercial paper,” and “Eurodollars.” This time, the public sector intervened on an awesome scale to stem the panic, with trillions in cash infusions and guarantees for the financial industry.

This rescue operation probably prevented another full-scale depression. However, taxpayers have paid a steep price for this support. Wall Street firms are quick to point out that they paid the money back, with interest. This is true, but it misses the point. Even before the crisis, the market was confident that the government wouldn’t let the financial industry default on its short-term IOUs, at least not on any significant scale. And the mere expectation of public support allows the financial sector to fund itself more cheaply up front. These are real subsidies—they’re extracted from taxpayers. Wall Street doesn’t pay the public back for this privilege.

The dollar amounts are staggering. Andrew Haldane of the Bank of England has calculated that the five largest global banks alone receive an economic subsidy of nearly $60 billion per year from implicit government support. For the full set of global banks, the figure runs into the hundreds of billions of dollars a year. And these subsidies aren’t limited to “too big to fail” firms. They flow to other parts of the financial sector, including hedge funds, through obscure channels. This state of affairs is economically wasteful—and it isn’t fair. Indeed, to state the obvious, it isn’t capitalism.

THERE’S ONE SUREFIRE way for Wall Street to avoid panics: It could vastly reduce its reliance on short-term borrowings. In other words, high finance could term out. Termed-out financial firms are immune to catastrophic runs, so they don’t die suddenly. They’re safe for bankruptcy; the collateral damage is minimal. The government does not need to, and should not, bail them out.

Financial firms won’t term out voluntarily. Short-term funding is remarkably cheap, thanks in large part to government support. But there’s nothing about the business of Wall Street that makes short-term funding essential. Investment banks and hedge funds can get along just fine with ordinary long-term financing.

To be sure, we wouldn’t want the entire financial sector to term out. Consider deposits again. These short-term IOUs are the economy’s primary medium of exchange—they function as money. Other short-term IOUs, too, have “money-like” qualities. (Hence short-term IOUs are classified as “cash equivalents” for accounting purposes.) Because we need an efficient monetary system, we really do need short-term IOUs.

But it doesn’t follow that we shouldn’t regulate their issuance. Instead, we might confine their issuance to a designated set of licensed firms. Here’s how it would work. First, licensed firms would be allowed to fund short, but they’d be required to meet strict safety standards. Second, other financial firms—those without licenses—would be free to takebig risks, but they’d have to term out.

This might seem like an unprecedented regulatory intervention. As a matter of fact, it’s not. It’s how the law of banking has virtually always worked. At its core, banking law consists of two components. First, licensed banking entities must abide by strict portfolio restrictions and other risk constraints. Second, and critically, there’s a sweeping prohibition: Entities without banking licenses are legally forbidden to fund themselves with deposits.

In its existing form, this regulatory system suffers from a fundamental defect. As we saw in the recent crisis, all of the financial sector’s short-term IOUs, not just deposits, are susceptible to destabilizing panics. Yet we don’t regulate these other short-term funding markets. The proposal, then, is straightforward. Instead of focusing narrowly on deposits, we should address short-term IOUs as a class, on a functional basis. Under this modernized approach, only safe, licensed firms would be allowed to “fund short” in large amounts. Public sector support would be strictly limited to these licensed firms, and they would pay fees to the public for this privilege.

But how would this work for big, complex financial firms, like JP Morgan and Citigroup—the quintessential “too big to fail” companies? It’s actually pretty simple. These firms consist of multiple corporate entities, grouped together under a single holding company. Under the proposed approach, licenses would be granted on an entity-by-entity basis. Those entities that met the applicable safety requirements (such as commercial banking subsidiaries) could continue to fund short. But any entities that were engaged in riskier activities, such as investment banking, would have to term out.

True, there would be costs to this approach. Wall Street would be less profitable, and capital would probably get marginally more expensive—just as the removal of corn subsidies would make corn products more expensive. The removal of a subsidy is always costly to its beneficiaries. In this case, the reward would be a much more stable financial system.

TERMING-OUT ISN’T a panacea. Financial booms and busts are still going to happen. We can’t cure every financial disease; however, we can repair the financial system’s broken immune system. By addressing the problem of short-term IOUs, we can prevent occasional financial infections from turning into life-threatening disasters.

It’s sometimes argued that there’s an even simpler and better answer: laissez faire. Why don’t we just let financial firms fund themselves with all the short-term IOUs they want, while denying them public support under any circumstances? Under this view, we should abolish the central bank’s traditional “lender of last resort” powers and let the market work.

This position has natural appeal—but it denies both theory and history. Economic theory suggests that short-term funding is unstable, and that this instability is damaging to the real economy. Historical experience confirms this hypothesis. This is what economists call a “market failure,” and it won’t fix itself.

At the same time, we should avoid the opposite mistake. Too often, it is said that we need “more” financial regulation—as though the solution were just a matter of turning up some imagined regulatory dial. This impulse is just as superficial, and just as erroneous, as the laissez faire mindset. Good financial regulation isn’t a question of more versus less. It’s a matter of design.

The terming-out proposal embodies a simple, clean design. Furthermore, it’s market-friendly. Outside the protected sphere of licensed issuers, we could let finance be finance. Finally, the proposal would put an end to our current, disastrous system of subsidies for Wall Street. Termed-out firms can go bankrupt without incident, so public support would be unnecessary. So let’s have a new guiding principle for Wall Street reform: “term out.” It’s simple, and it works.

Morgan Ricks is a visiting assistant professor at Harvard Law School. He previously served as a senior policy adviser in the Obama Treasury Department. Before that, he was an investment banker and trader.

Short term debt

2012-02-01T09:02:00.001-08:00

You are here: Home » Financial Institutions » The Fetish for Liquidity (and Reform of the Financial System)

The Fetish for Liquidity (and Reform of the Financial System)

RANDALL WRAY | 31 JANUARY 2012 14:00

By L. Randall Wray

This post first appeared at "Great Leap Forward”, my EconoMonitor blog.

In his General Theory, J.M. Keynes argued that substandard growth, financial instability, and unemployment are caused by the fetish for liquidity. The desire for a liquid position is anti-social because there is no such thing asliquidity in the aggregate. The stock market makes ownership liquid for the individual “investor” but since all the equities must be held by someone, my decision to sell out depends on your willingness to buy in.

I can recall about 15 years ago when the data on the financial sector’s indebtedness began to show growth much faster than GDP, reading about 125% of national income by 2006—on a scale similar to nonfinancial private sector indebtedness (households plus nonfinancial sector firms). The run-up of the debt ratio of households and nonfinancial business were EACH about the same size as the debt ratio of the financial sector in 2006. I must admit I focused on the latter while dismissing the leveraging in the financial sector. After all, that all nets to zero: it is just one financial institution owing another. Who cares?

Well, with the benefit of twenty-twenty hindsight, we all should have cared. Big time. There were many causes of the Global Financial Collapse that began in late 2007: rising inequality and stagnant wages, a real estate and commodities bubble, household indebtedness, and what Hyman Minsky called the rise of “money manager capitalism”. All of these matter—and I think Minsky’s analysis is by far the most cogent. Indeed, the financial layering and leveraging that helped to increase the financial sector’s indebtedness, as well as its share of value added and of corporate profits, is one element of Minsky’s focus on money managers. I don’t want to go into all of that right now. What I want to do instead is to focus quite narrowly on liquidity in the financial sector.

So here’s the deal. What happened is that the financial sector taken as a whole moved into extremely short-term finance of positions in assets. This is a huge topic and is related to the transformation of investment banking partnerships that had a long-term interest in the well-being of their clients to publicly-held, pump-and-dump enterprises whose only interest was the well-being of top management.

It also is related to the rise of shadow banks that appeared to offer deposit-like liabilities but without the protection of FDIC. And it is related to the Greenspan “put” and the Bernanke “great moderation” that appeared to guarantee that all financial practices—no matter how crazily risky—would be backstopped by Uncle Sam.

And it is related to very low overnight interest rate targets by the Fed (through to 2004) that made short-term finance extremely cheap relative to longer-term finance.

All of this encouraged financial institutions to rely on insanely short short-term finance.

Typically, financial institutions were financing their positions in assets by issuing IOUs with a maturity of mere hours. Overnight finance was common—through repos, asset-backed commercial paper, and deposit-like liabilities.

On the other hand, the assets were increasingly esoteric positions in mark-to-myth structured assets with indeterminate market values—indeed, often with no real markets into which they could be sold. Further, many of these assets had no clearly defined income flows at all—virtually by definition, a NINJA loan (no income, no job, no assets) has no plausible source of income to service the debt. That is just the most outlandish example—but many or most of the “asset backed commercial paper” had no plausible source of income to service the liabilities issued.

It was all myth. US debt-to-GDP ratios reached 500%–there was a dollar of income to service $5 of debt. It was not going to happen. The short-term liabilities of financial institutions were not going to get serviced—they would only get rolled over, so long as the myths were maintained.

As I’ve said before, it worked until it didn’t. As soon as one holder of all this crap wondered whether the Emperor had any clothes, the whole house of cards collapsed. And that largely took the form of one financial institution refusing to “roll over” another financial institution’s short term crappy IOUs.

Four years and trillions of lost dollars of wealth later, here we are.

Since 2008 we’ve had a steady stream of recommendations concerning what to do to remedy the problem. Most of the “reforms” suggested misidentify the problem, or have no political viability.

As we now know, Dodd-Frank is toothless and will do almost nothing to remedy current problems or to prevent future crises. It does have one positive effect that I’ll come back to in a later blog: many of the Fed’s bail-out actions last time around are now illegal. That is good. But as they say, where there’s a will, there’s a way. Still, so far as legislative reforms, the best we can hope for is a crash much worse than the GFC that will open the possibility for real reform.

The most popular “reforms” today are a Tobin tax on financial transactions and higher capital ratios for financial institutions. Neither of these will have any significant impact. I won’t justify my position here—but there are fairly good analyses already, especially on capital ratios. Jamie Dimon at JPMorgan has proudly announced his bank is gaming the capital ratios, by managing the “hell out of RWA”—risk-weighted assets. If anything, the risk-weighting of the Basel requirements hastened the run-up of leverage that caused the GFC, and the recent proposals to enhance capital ratios based on RWA will only bring on the next crisis because they encourage every financial institutions to maximize risk within a risk-weighting.

More radically, some like Simon Johnson recommend breaking up the biggest institutions. I confess that I concur, but would go a bit farther: close all of the “dirty dozen”—the biggest 12 banks—and investigate, prosecute and punish all of the top management. Spare no expense, pursue both criminal prosecutions and sue them for civil damages. The goal should be to at least double the success achieved in the aftermath of the S&L crisis: put at least 2000 of the top management and traders of the dirty dozen behind bars. That would include two or three Secretaries of the Treasury plus most of Obama’s closest economic advisors and even some recent White House Chiefs of Staff (Obama’s choices so far have put first Wasserstein & Co, then JPMorgan and finally Citigroup management in charge of the White House).

OK, that will not happen with an Obama administration, which is run by and for the dirty dozen. And none of the Republican candidates with the possible exception of Ron Paul is going to do this, either. So, yes, prosecuting criminal banksters is a pipedream.

Is there any other proposal on the horizon that might save us from Armageddon?

In a very interesting piece, former Treasury advisor Morgan Ricks has offered a proposal. Let me make two remarks before summarizing his idea. First, it is amazing that this comes from an insider who advised President Obama. Second, I know Morgan and can attest that he is simultaneously a very smart guy, and he is no flaming radical. His proposal is thoughtful and while it won’t be popular among the biggest banks, it comes down squarely in the middle of those who want to tweak with a bit more capital and those who want to close down the biggest fraudsters.

So here’s the idea. Morgan quotes University of Chicago’s (!!) Douglas Diamond that “financial crises are always and everywhere about short-term debt”. Now that is a very good start, a far more interesting and accurate statement than the most famous quote by a Chicago economist—Uncle Milty Friedman—that “inflation is always and everywhere a monetary phenomenon” (demonstrably false, by the way). Financial crises occur because of this conflict between the desire for liquidity by individuals, and the impossibility of liquidity for society as a whole. Think of it this way: all assets—financial or real—must be held by someone. So we cannot all get out of them simultaneously.

In a crisis, that is precisely what happens: we all try to get out, but cannot. In the GFC, holders of the very short-term liabilities of financial institutions rationally decided to get out. Note that I said “rationally”. A lot of the analyses of a run to liquidity rely on the supposition of irrationality. There was nothing irrational about the run out of short-term financial institutions liabilities in 2008. It was rational. These institutions were holding pure crap as assets. They still are. It is entirely irrational to hold their short-term liabilities because in the short-term they are all insolvent. Massively.

That is why the Fed had to lend and spend (buying trashy assets) $29 trillion to keep them in business. There were no dupes to hold their liabilities, so the dupe of last resort—the Fed, guaranteed by Uncle Sam—stepped up to the plate. I’ll have a lot more to say on that topic over coming weeks.

The point, however, is that the creditors of these institutions held essentially overnight short-term liabilities. They refused to refinance them. The suspected insolvency led immediately to a liquidity crisis. As well it should! If you know your irresponsible drunk uncle is set to go bankrupt, you don’t lend him another thousand bucks for a night in Las Vegas. He can call that a liquidity crisis; you call it good sense.

So what is Morgan’s solution? “Term out”: force financial institutions that take risky bets to finance their positions in assets by issuing longer-term liabilities. In that case, there is no easy way to “run out”. The creditors are locked in to the crazy bets made by the debtors. Maybe they’ll pay off. Maybe they won’t.

If you think about investment banks before 1999, that is essentially how they operated. They played with partner’s money, with low leverage. But then they went public and adopted a new business model: maximize share prices to funnel money to hired management. They greatly increased leverage and moved to short-term finance. Customers and share-holders alike were treated like patsies. But the investment banks made people like Hank Paulson and Bob Rubin rich—and then bought them positions in Treasury to back-stop the banks’ risky positions.

The cult of the “Greenspan put” and the “Bernanke great moderation” convinced markets that these risky short term liabilities issued by banks betting in complex CDOs squared and cubed were actually as safe as FDIC-backed bank deposits. And then when the whole darned thing collapsed, Uncle Ben and Dauphin Prince Timmy really did bail them out—to the tune of tens of trillions of dollars.

Morgan’s Solution: segregate financial institutions into two mutually exclusive summer camps. One is subject to regulation and supervision of the asset side of its balance sheet. It gets to issue insured deposits. As these are payable on demand, they are by nature short-term, and are the primary medium of exchange and means of payment that is necessary in any monetary economy. It’s a safe and sound summer camp, albeit one that is a wee bit more Jimmy Stewart than Rod Stewart.

The other camp consists of all those who are not subject to such supervision and regulation. They are pretty much free to buy any crap they feel like buying, and can screw their customers and lose investors’ money. But they must “term out”—they finance using long-term liabilities. And they cannot issue anything that looks, smells, tastes, or feels like a deposit. Think of Altamont-era Rolling Stones—an exciting and necessary experience that is not quite suitable for everyone.

This will resolve the problem of short-termism with respect to financing positions in junk. It also mitigates the complaint about excessive regulation—any institution that hates regulation can avoid it almost completely by funding long-term. It makes the payments system safe by keeping the risky operators out. And it offers a good alternative to all the debates about capital ratios and Tobin taxes.

Now, will that long-term funded and unregulated partition of the financial sector periodically crash and burn? Yes it will. I think Schumpeter called that creative destruction.

OK this is admittedly only a short introduction. I’ll provide more argument in coming weeks. Meanwhile, take a gander at Morgan’s proposal here. It achieves a separation that is something like Glass-Steagall– i.e. only the safe summer camp institutions can issue deposits. The risky summer camp institutions cannot issue deposits. There’s nothing in Morgan’s proposal that is inconsistent with Warren Mosler’s proposal for permanent ZIRP (zero overnight rate target) – and I also support that policy. We wouldn’t need the silly expectations management that Bernanke is trying to do now. And, finally, Minsky’s loose version of real bills could be consistent with Morgan’s proposal–that is more about the kinds of assets the Jimmy Stewart summer camp banks are allowed to buy: self-liquidating loans, not investment finance.