The Mortgage Crisis – Now With Extra Crime

Maybe you have been hearing something in the news about the banks halting foreclosures and the “robo-signature” problem. It’s the latest chunk of fraud to squeeze out the hind end of the banking industry.

First, a few basics. If I get a mortgage with Bank A, and Bank A sells my mortgage, risks, benefits, and all, to Bank B, there are signatures involved. It’s a transfer of a contract, after all. Somebody in authority at Bank A has to place a notarized John Hancock on the mortgage so as to say “Yup, this now belongs to Bank B,” and the same is required from someone in authority at Bank B, saying “Yup, now we own it.” This can happen multiple times, with my mortgage changing hands over and over.

Let’s suppose I stop paying my mortgage. The mortgage holder can go to court to foreclose on my mortgage and evict me. Fair enough.

With all the backfield motion, fakes, and handoffs during the mortgage securitization boom, this process got confused in several ways.

First, the chain of ownership got fuzzy. The mortgages passed through investment banks into REMICs, Real-Estate Mortgage Investment Conduits. A REMIC is basically a huge bundle of mortgages. Then investors would buy sub-groupings, called tranches, of these mortgages. Various tranches were rated according to their risk. Some investors with a taste for high risk and high return bought what were essentially junk tranches, while more conservative investors bought highly rated ones. Here’s where it gets weird.

The ownership of the mortgages didn’t really transfer to the investors. The REMIC held them, and if a mortgage defaulted then the junk tranche owners were first in line to take the hit. This worked as long as there wasn’t too much defaulting going on. When the tsunami hit and homeowners started going down in windrows a few started asking questions about who actually owned their mortgage, and therefore had the right to foreclose on them. The REMICs kinda did, and the investment trusts kinda did, because, after all, they paid for them. But nobody can assign a particular mortgage to a particular investment trust. Confused yet?

The investment banks that handle the mortgage backed securities are supposed to review each foreclosure case to make sure that a) the mortgage is actually in arrears, and b) all the paperwork is in order. Duplicating the rush and rule breaking on the way into the crisis, the banks had people signing thousands of foreclosure documents without looking at them. Some homeowners got foreclosed accidentally even though they had kept up payments. The whistle blowers turned out to be the title insurance companies, who are insuring that there is a clear title and solid chain of ownership. No such luck, and foreclosure sales stalled.

Another little problem that has popped up is multiple sales of the same mortgage. (On the ever-useful site Naked Capitalism) Either by negligence or design, particular mortgages were sold to multiple buyers. It’s a great living if nobody finds out. Again, this complicates the ownership issue.

Enter the foreclosure mills. These are law firms specializing in foreclosing. Again, fair enough, somebody has to do the dirty work. Next problem: Because of all the mysteries of ownership and missing paperwork, these firms got into the forgery business. Again, Yves Smith at Naked Capitalism covered this. Apparently there is a company called DocX that has a published price list for forged mortgage documents, and banks have been ordering one from column A and two from column B, like good accessories to felony.

The upshot of all this? Nobody is sure exactly who owns what and who owes what to whom. Without nailing that down foreclosures can’t go forward and foreclosure sales can’t go forward. The whole process of working out the financial crisis can’t go forward. There is also the erosion of trust in land titles. One of the foundations of finance in this country is credit based on collateral. The confusion and outright fraud involved in the housing bubble damages the credibility of the whole market.

So what should we do? I offer the following with no confidence that our corrupted government will do what is right and necessary for the general welfare. It isn't actually all about corruption. Our politicians navigate wearing ideological blinders and act according to mythological economic theories.

It all goes back to a simple saying I came up with for debunking the oxymoronic idea of a free market. "No rules, no trust. No trust, no transaction." The investment banks wanted to get away with stuff, break rules, bypass safety steps, and generally flail about like Joe Cocker. That works for a limited time. Now we face massive loss of trust and the resultant freeze on transactions. It is chilling.

Ok, trust. Trust requires three things, in this case. 1) Prosecute the crooks 2) Mitigate the fraud perpetrated on homeowners 3) Rebuild the chain of title in an equitable way.

1) Prosecuting the guilty is the easy part - arrest everybody in the mortgage investment business and let the courts sort them out. The loan originators handed out mortgages to anyone with a pulse and conned people with decent credit ratings into time-bomb subprime loans. On the other end the banks held their noses and collected their fees as they passed on the stinkers to investors.

2) I don’t subscribe to the “blame the deadbeat homeowner” theory. I don’t know what relationship other people have with their banks, but I can’t demand a mortgage. I have to ask for one, and the loan officer behind the desk is supposed to find out if I am a good credit risk and say “no” if I’m not. Any ding-dong can apply for a mortgage, but the responsibility for due diligence lies with the bank. From the late 90s through the collapse in 2007 the banks were doing no such thing. They were flooding the market with low interest capital and progressively lowering their lending standards to rope in more suckers on both ends.

Mitigating the fraud means restructuring the loans, both in terms of price and interest. 1997 was the last year that housing prices corresponded to reality, that is, compared to median income. There would have to be geographically adjusted price modifications, because not all areas inflated the same. Look at a graph of the Case-Shiller index and you'll see that the hockey stick curve has to return to the historical mean. Returning home prices to their inflation adjusted 1997 level is just speeding up what is inevitable. It will mean an average 40% haircut for the banks, but my heart bleeds. All those interest-only, interest rate bomb, and balloon payment mortgages also need to be turned into 30-year, 5% interest, dull vanilla mortgages.  Making $400,000 mortgages into $220,000 mortgages at 30/5% means a lot of people won't need foreclosing. Better for the banks to have 60% of something than 100% of nothing. The problem is that these crooks are like that guy who shot a dummy deer (set out by the VT Fish and Game) from his truck, out of season, and still had the balls to ask if he could keep the deer. They want 100% of everything, despite their fraud and stupidity. Sorry, you get 60%. That would give the mortgage backed securities actual value.

3) Rebuilding the chain of equity will involve some legwork, due to those notes separating from the mortgages at the REMIC stage. Nevertheless, there are houses and home buyers on one end and investors on the other. I'd be inclined to just take over the dozen or more biggest banks (in terms of CDO exposure) and start doing the paperwork. Start assigning individual mortgages to specific tranches based on predicted risk, regardless of the actual state of the mortgage. Essentially do it results-blind. A junk tranche would end up with a lot of NINJA loans, most of which predictably went south and some of which miraculously are still being paid. Point 2, above, would help. Rebuild the chain between the homeowners and investors and let the chips fall. It isn't a flawless solution, but we'd end up with someone holding the note on each mortgage, good or bad. People who bought into lower rated tranches would tend to get a shittier batch of loans and more cautious investors would get better ones.

Did I mention prosecuting all and sundry for fraud? Let me reemphasize that. Orange jumpsuits for everybody.

As I said, I don’t expect the government to do any of this. Congress, with an eye on campaign donations, will try to wangle something in between craven public obeisance to the banks and halfhearted regulatory fixes. The Obama Administration, caught between public opinion and the private convictions of the former (?) bankers in their midst, will dither. In 2011 another round of mortgage rate resets will hit. At some point several major banks will be revealed as completely insolvent and keel over, forcing the government, finally, agonizingly too late, to take them over. Housing prices will continue their march towards 1997 and beyond.

We’re in this hole for another few years. Get used to it.

Milo Minderbinder

Milo Minderbinder is a character in Joseph Heller’s satirical novel Catch-22. He is a strange combination of a rigidly rule-based thinker and a completely amoral and greedy entrepreneur. The book centers around the activities of an American bomber squadron during World War II, and Milo is the mess officer. He expands a scheme to get fresh eggs for the officer’s mess into a trans-national enterprise. I have been thinking about the character of late, and how prescient Heller was in creating him.

One trigger was reading about automated computer stock trading. Computers loaded with complex algorithms track the tiny second-to-second movements in a stock price and buy and sell the stock multiple times to accrue tiny percentages on huge volumes. A faster than usual automated sale by a mutual fund triggered the “flash crash” last May, when New York Stock Exchange plunged hundreds of points and recovered in a few hours. Minderbinder started out by buying eggs in one country for a penny each, selling them for a few cents more elsewhere, buying them again, and then selling them to the officer’s mess. He eventually put in an order for all the cotton in Egypt, but couldn’t get rid of it because everyone he tried to sell it to had an outstanding order to sell it to him.

That buy-sell-buy-sell aspect aside, I am struck by what a confusing mess the stock market has become at a time when more and more people have based their retirement on their retail holdings in the market. The fixed benefit pension is nearly gone, replaced by casino gambling dressed up as investment. And so we all follow the ups and downs of the Dow Jones Average, the S&P 500, and our own 401k portfolios. Minderbinder co-opted objections to his various betrayals of the Allied cause by giving everyone a share in “M&M Enterprises.” His justification for any exploitation of his comrades is “everyone has a share!” We, too, have been co-opted into the service of corporate agendas, however corrupt, short-sighted, and ultimately destructive, because our comfort in retirement depends upon investor confidence. We can’t rein in the psychopathic idiocy too much, because the Roth IRA is looking a bit shaky and we don’t like the taste of cat food.

Ok, so Kellogg, Brown, & Root had U.S. troops risk (and lose) their lives guarding empty tanker trucks. KBR fraudulently made money per mile trucking “sailboat fuel” up and down the highways of Iraq. Even so, we can’t just declare KBR beyond the pale and yank its corporate charter. Imposing a well deserved corporate death penalty would shake the market, but we all have a share. When Minderbinder hires his own squadron’s planes out to the Germans to bomb his own airfield, the authorities finally prosecute him. He hires a good lawyer and goes free when he points out how much profit was made by the venture. Well done, Milo. Lloyd Blankfein salutes you.

On the subject of playing both sides, Minderbinder strikes again in Afghanistan. A recently released study by the Senate Armed Services Committee shows that the security contracting (mercenary) firms hired to protect U.S. and NATO facilities are in turn hiring members of the Taliban and followers of various side-switching warlords. Those warlords and gunmen are making payoffs to the Taliban and associated insurgent groups. Hey, we’re paying people to shoot at our own soldiers. It’s that legendary American generosity at work.

One M&M scheme reeks of the economist’s fallacy of monetary equivalency. I’m thinking of cost/benefit analyses of occupational safety and anti-pollution measures. You know, where losing a spouse or child is calculated into a dollar value based on lost earnings? Minderbinder needed the CO2 cartridges from the life vests aboard the bombers, so he took them and replaced them with notes of apology and share certificates in M&M enterprises. That is roughly what passes for good business ethics these days.

Catch-22 is an ageless book. I’d recommend it or the very fine (though different) movie version. Heller wrote it in the 1950s, the heyday of hyper-patriotism, hyper-militarism, and the blind worship of capitalism. Wait a sec… 

Solar Financials

Here is something that peeves me greatly. Let’s say I want to buy an SUV, a three ton chunk of rolling steel, which:

• Loses thousands of dollars of value the instant I stick the key in it
• Will cost me thousands of dollars a year to own and operate, thus increasing my financial risk
• Will depreciate dramatically over ten years to a fraction of its purchase price

I can walk into a bank, fill out a simple form, deliver up a W-2 form, and if my credit is good, walk out with something in the range of $30,000.

If I want to buy a solar energy system, be it a photovoltaic system producing electricity or a solar hot water system, I will face problems. The solar system will:

• Depreciate slowly
• Produce a tax free return on investment, decreasing my financial risk
• Last 25 years or more
• Increase the value of my home by more than the cost of the system

The bank, however, will stiff me. Either I will have to go through the hassle of getting a home equity loan or else I will have to pay the high interest rate of an unsecured loan. No EZ loan terms for solar. Why is this? It is due to a lack of failure.

Untold thousands of people have failed to pay off their car loans and have had their cars repossessed. The banks understand the process, the residual value of the car, and the probability of default, so they can plan and manage their risk accordingly. The same goes for houses. Due to long experience, banks understand the foreclosure process and deal with it. There is no such body of experience with renewable energy systems. Therefore, such systems have no value as collateral to the banks. So it was explained to me by a patient but implacable loan manager.

At one time there were no cars, so there was a time before car loans. It follows that there must have been some bank somewhere that was the first to loan someone money to buy a car, using the car itself as collateral. I’m still looking for the first bank to make that momentous step for a solar energy system. A few large solar installation companies have each raised some money and put together their own in-house programs, but commercial banks are stuck in the past.

If solar loans could be as easy and cheap as car loans the market would expand by a factor of ten.

One thing that might end the impasse is a program of loan guarantees. The state or the Feds could devise standards and back loans that acknowledged solar panels as collateral. This would give banks some data points for calculating risk and, with the occasional failure, an understanding of repossession and resale value. I have proposed the idea to a couple of Vermont state legislators and I encourage you to do the same.

 Another peeve of mine in the realm of solar is the inevitable question, “What’s the payback?” People want to know how many years it will take for a solar system to earn back its purchase price. There are a number of answers to this.

The direct answer for photovoltaics for homeowners in Vermont runs around 11 to 19 years, depending on installation cost, initial electrical price, and how fast the price of electricity goes up. Business owners have access to more grants and tax breaks, so they would get a faster payback. Solar hot water can easily pay back its costs inside of ten years, and often within eight. People generally express dissatisfaction with these numbers.

The facetious but pointed answer is, “What’s the payback on your granite countertop? Formica will hold up a mixing bowl at a fraction of the price.” Insert the name of another expensive home or life accessory in place of “granite countertop” if you wish. We often buy things for reasons other than financial return. We buy many things that are money-sucking black holes. Your electric water heater offers no payback – you just keep pouring money into it.

The more productive response is, “What’s the payback on other options for that chunk of money?” If someone has cash on hand or ready credit, how do other options compare with energy enhancements, and at what level of risk and taxation? The range of simple return on an investment in renewable energy, using the numbers above, varies between 5.26% and 12.5%, assuming that the price of energy stays flat for a decade or two. (Dream on.) Price hikes only make it better. The returns from renewable energy are essentially risk free (covered by homeowners insurance) and tax free. Where can you find a near-zero risk investment that returns even 5% these days, or any investment this side of crime that returns over 10%? I should note that investments in energy efficiency can beat these numbers and should be your first consideration. Again, these are tax-free and risk free returns.

So what’s the payback on that CD or money market account right now? Not much better than that granite countertop, I’d imagine. Neither of these options does anything for the environment, either. Put your money where your mouth is and you’ll be putting it where your financial interests are.

The Value Bucket

The other day I was driving through one of those highway commercial strips. The Librarian was riding shotgun. More accurately, she was riding Freshly Baked Peach Pie, if what the passenger is holding is the determinant. We passed a Kentucky Fried Chicken franchise. The sign out front touted “The Value Bucket.” The Librarian noted the sign and observed, “It’s crappy, and you don’t want to think about where it came from, but it’s cheap and there’s a lot of it.”

We agreed that this was an excellent metaphor for much of what Americans consume. To torture another metaphor, fried chicken is just the tip of the iceberg (lettuce).

Consider clothing, although much of it lacks even the virtue of being cheap. The majority of it is made to fall apart, sewn by underpaid, overworked, abused people. Same goes for all those bits of consumer electronics, from ear buds to desktop computers. Also small consumer goods in general, from table lamps to blenders. We’ve all got closets full of this junk, some of it still partially functional. Closets full? Those self-storage places seem to have sprung up everywhere in the past decade. No doubt they are full of sawdust-and-glue furniture, old televisions, area rugs outgassing formaldehyde, and other wretched plastic detritus.

Just as well that those televisions are in the storage bin. Otherwise the two-dimensional screens would be displaying one-dimensional plots and characters interspersed with zero-dimensional corporate propaganda – by which I mean both commercials and “news.” Television offers us a Value Bucket even more greasy, rancid, and overflowing than the dumpster behind KFC.

By contrast, I’ll share the advice my father gave me when I turned eighteen, which was drinking age back then. We went to a local bar, ordered drinks, and he offered the following: “If you only learn one thing from my mistakes, learn this – never drink cheap booze. If you have just a little bit of money, buy a very little bit of the very best you can find. You’ll have just as much fun. Your head will thank you and your stomach will thank you.” The Minor Heretic has followed this advice, with rare exceptions, to this day. It goes beyond alcohol, however. It is decent advice for consumption in general.

I suppose it is futile to advise most Americans to drink a couple of decent quality beers instead of a six-pack of that dilute cat urine they call light beer, or eat fewer calories of better food. Recommending small efficient cars instead of four-wheeled dirigibles or compact, well designed houses instead of 5,000 square foot McMansions is shouting against the hurricane. Our tastes have expanded to fill the available space and won’t contract until nature puts its foot down. By nature I mean not only our overstrained biosphere, but also the declining deposits of minerals and fossil fuels and our own overfed, overstressed bodies. We’ll gorge today and repent in the intensive care unit.

The Librarian and I fled the strip and ended up at the house of some old friends. We ate pizza topped with their own produce and baked in their stone oven and accompanied it with their home made wine. We followed it with the aforementioned peach pie. It wasn’t expensive food, except in the cost of time and care. Those last two factors are the key to understanding the Value Bucket dilemma. We have been robbed of time by a corporate economy bent on extracting more work for lower wages. We have been propagandized into caring more about quantity than quality, and to accept shoddiness as a fact of life.

Still, I count among my friends many holdouts against speed and volume. We’re fighting a delicious battle against the forces of the Value Bucket. Join us.

Churchill on Empire

Your Minor Heretic enjoys reading historical first person narratives. Not necessarily full autobiographies, but travelogues and accounts of singular events and places, limited in scope. The journals of travelers bring a fresh eye to scenery and people. The lens of a century’s distance adds perspective.

I recently read Winston Churchill’s account of his early years, including his successful pursuit of danger in Cuba, northeast India, Egypt, and South Africa. My Early Life, subtitled “A Roving Commission,” covers his childhood and education, but hits its stride as he strives to go where the bullets fly. He has some instructive experiences fighting the Pathans (Pashtuns) of what was the northeastern corner of India and what are now the tribal areas of Pakistan. He describes a warlike people, happy to absorb the advanced killing technologies of the Europeans but annoyed by road building, central government, and the restraint of laws other than their own tribal codes. This sounds familiar, but I was struck by a passage from his Cuban adventure.

Churchill was just commissioned as an officer in the 4^th Hussars in 1895 when the fighting between the Spanish army and Cuban rebels heated up. He and another young officer resolved to go see some fighting, just for the experience. Strings were pulled and they joined the Spanish general staff in Cuba as observers. After giving an account of much confused and pointless marching about in the jungle, Churchill writes the following about the Spanish:

“We did not see how they could win. Imagine the cost per hour of a column of nearly 4,000 men wandering round and round this endless humid jungle; and there were perhaps a dozen such columns, and many smaller, continuously on the move. Then there were 200,000 men in all the posts and garrisons, or in the block-houses on the railway lines. We knew that Spain was not a rich country as things went then. We knew by what immense efforts and sacrifices she maintained more than a quarter of a million men across 5,000 miles of saltwater - a dumb-bell held at arm's length.

…In these forests and mountains were bands of ragged men not ill supplied with rifles and ammunition … to whom war cost nothing except poverty, risk and discomfort - and no one was likely to run short of these. Here were the Spaniards out-guerrillaed in their turn. They moved like Napoleon's convoys in the Peninsula, league after league, day after day, through a world of impalpable hostility, slashed here and there by fierce onslaught.”

The relation to our present situation in Afghanistan, substituting arid mountain for humid jungle, is all too obvious. Spain soon lost Cuba to the rebels and the newly imperial United States.

Churchill wrote long chapters about his experiences fighting the Pashtuns. His conclusions could be summarized as “we killed and were killed, destroyed houses and crops, spent inordinate amounts of money, and ended up at the status quo ante.” His summation of a chapter on the British expedition into the Mamund Valley is as follows:

“When however we had to attack the villages on the sides of the mountains they resisted fiercely, and we lost for every village two or three British officers and fifteen or twenty native soldiers. Whether it was worth it, I cannot tell. At any rate, at the end of a fortnight the valley was a desert, and honour was satisfied.”

 There we come to the crux of it: “honour was satisfied.” Our present situation in Afghanistan is untenable. The Afghan government is corrupt, inept, and unreliable. The Afghan National Army, such as it is, lacks cohesion, leadership, training, and motivation. The Afghan National Police are known mostly for their cruelty and corruption. Our so-called allies in Pakistan are playing us for money as they cooperate with the Taliban. The resentment against our presence among ordinary Afghans grows, along with the understanding that we won’t outlast the Taliban. The situation cries out for a long overdue departure. But honor must be satisfied.

Several generations of Americans remember the footage of the overloaded helicopters leaving the rooftop of the U.S. Embassy in Saigon. That humiliation still rankles. It was a militarily, politically, and socially untenable situation, but many still blame failure on those who opposed the war.

The Obama Administration faces the dilemma of a lab rat forced to cross an electrified grid to get food. Sit and starve or go eat and get shocked? Stay and be blamed for failure or go and be blamed for failure? It’s a prime situation for the maladaptive passivity of learned helplessness. In this case the passivity is manifested as yielding to the delusions of eventual victory within the Pentagon.

Back to Cuba: As it turned out, the loss of empire actually benefited Spain economically. The massive financial resources it had invested abroad came home, begetting a boom in industrial development. If the U.S. spent even a fraction of our war budget on energy efficiency, renewable energy, education, public transit, and infrastructure in general, we would launch out of the present recession.

As a final note I have to add an excerpt from the Itinerary* of one Dr. Alexander Hamilton (not the famous one). Hamilton, a physician, went on a trip from Maryland to New Hampshire and back in 1744. While traveling through Pennsylvania he remarks on their government:

“Their goverment is a kind of anarchy (or no goverment), there being perpetual jarrs betwixt the two parts of the legislature. But that is no strange thing, the ambition and avarice of a few men in both partys being the active springs in these dissentions and altercations, tho a specious story about the good and interest of the country is trumpt up by both; yet I would not be so severe as to say so of all in generall.”

* See: Colonial American Travel Narratives, Edited by Wendy Martin, Penguin Classics, ISBN 0 14 03.9088 X