In my last post, I reviewed Part 1 of Bill Black and Randy Wray’s series on “Foreclosing the Foreclosure Frauds.” In Part 2, Bill and Randy answer three typical objections to their plan:
— “. . . while there were some bad apple lenders, much of the fraud was committed by borrowers. . . “ and so their proposal would reward fraudulent borrowers, while punishing duped banks;
— “. . . . the biggest banks are too important to take into receivership” (“too big to fail”);
— “It isn’t possible to resolve a ‘too big to fail’ institution.”
They deal with the area of “borrower fraud” first and say the following which I’ve reformatted slightly for emphasis:
There was fraud at every step in the home finance food chain:
— “the appraisers were paid to overvalue real estate”;
— “mortgage brokers were paid to induce borrowers to accept loan terms they could not possibly afford”;
— “loan applications overstated the borrowers’ incomes”;
— “speculators lied when they claimed that six different homes were their principal dwelling”;
— “mortgage securitizers made false reps and warranties about the quality of the packaged loans”;
— “credit ratings agencies were overpaid to overrate the securities sold on to investors”; and
— “investment banks stuffed collateralized debt obligations with toxic securities that were handpicked by hedge fund managers to ensure they would self destruct.”That homeowners would default on the nonprime mortgages was a foregone conclusion throughout the industry — indeed, it was the desired outcome. This was something the lending side knew, but which few on the borrowing side could have realized.
Black and Wray go into more detail than this on how homeowners were “fraudulently induced” to get nonprime mortages by lenders and their agents manipulating loan to value ratios, income to debt ratios, and “liars loans” maximizing lender’s and CEO’s income. They detail how speculators were the only borrowers who knew how to manipulate the system, while ordinary borrowers had to be walked through the financing process by lender’s and agents committing fraud.
They next explain how big banks and mortgage services extracted big fees, “misplaced” mortgage payments and generally tried to make life difficult for borrowers, so that they would be driven into default and the banks would end up with the homes and an opportunity to go through the whole process again. Unfortunately for the banks, they crushed the real estate market, and created toxic waste securities, creating questions about the value of those securities. Judges questioned foreclosures because of paperwork problems and multiple banks trying to foreclose on the same homeowner. Employees of banks and servicers began to provide “. . . depositions exposing fraud and perjury,” and evidence that in most cases mortgage-related notes were never conveyed to the trusts in charge of the securities. “Without the notes, billions of dollars of back taxes could be due, and the foreclosures violate state law. Finally, the Attorneys General of all fifty states called for a foreclosure moratorium.” Black and Wray’s prescription for all this is:
We suggest an immediate moratorium on foreclosures and a requirement that all notes be produced by purported holders of mortgages within a reasonable length of time. If they cannot be found, the mortgages — as well as the securities that pool them — are no longer valid. That means that the homeowners are not indebted, and that the homes are owned free and clear. And that, dear bankers, is a big, big problem. It is also the law — without evidence of debt, there is no debtor and no creditor.
About letting some borrowers who certainly weren’t fraud victims off the hook, they argue that “worthy borrowers” can’t be separated from fraudulent borrowers, and also that we lack resources to prosecute a large number of fraudulent borrowers even if we could separate them out. They estimate that if we tried to prosecute all borrower frauds and used all our resources for this we’d only “. . . . prosecute less than one-tenth of one percent of those frauds.” It makes no sense to use limited judicial resources to go after borrowers where it would be almost impossible to prove intent to defraud, especially when the “. . . . losses that the fraudulent nonprime lenders caused are vastly greater than the losses caused by fraudulent borrowers.” In addition:
On the other hand, we can infer a lender’s fraudulent intent because it is financially sophisticated and has expertise in lending. An honest mortgage lender would not make “liar’s loans” because absence of proper underwriting inherently produces loans that are expected to default. Yet, in 2006 just about half of all mortgages originated were liar’s loans. Banks happily advertised specialization in “no doc” and NINJA loans. There can be no question about intent — the intent was fraud, plain and simple. Fraud on the part of credit raters is equally easy to infer — we have the internal emails that document intent to defraud securities purchasers by “pay to play” schemes. And the fraud committed by the investment banks that pooled the mortgages is also well documented. These entities committed tens of thousands and even millions of frauds each. For obvious efficiency reasons, that is where our judicial resources ought to be directed.
There is one other consideration that biases the case in favor of borrowers. . . .
. . . What is important to understand, however, is that the financial sector is largely culpable for the generation of speculative frenzy, the creation of the “financial weapons of mass destruction”, and the transformation toward financial fragility that finally collapsed in 2007. In the aftermath we lost 10 million jobs and millions of homeowners lost their homes. The “collateral damage” inflicted by the SDIs is now endangering tens of millions of American families — most of whom played no role in the speculative euphoria. Almost half of American homeowners are already underwater or on the verge of going under. In short, it was Wall Street that turned our homes over to a financial casino — and so far virtually all the losses have been suffered on Main Street.
They also point out that in addition to the balance of morality being on the side of homeowners, at the aggregate level the President must consider that the benefits to the majority of Americans of national moratorium on foreclosures clearly outweigh the costs imposed on the relatively few. Also, closing the control frauds would benefit honest bankers by eliminating the race to the bottom in underwriting, while “downsizing the financial sector is critical to restoring it to a size that is commensurate with the needs of the economy,” because the excessive capacity of the financial sector has led to efforts to create bubbles as an outlet for that capacity. And they finish their argument about where justice should focus in the foreclosure mess by saying:
The cost of not closing control frauds, by contrast, can be staggering. The business practices that maximize the fictional reported income (e.g., making “liar’s loans to people who cannot repay their loans) maximize real losses and hyper-inflate financial bubbles. Control frauds destroy wealth at a prodigious rate. The one thing we certainly cannot afford is leaving the control frauds under the control of fraudulent CEOs.
Against the second, and third TBTF objections, they say that the doctrine has always been “unproven, dangerous, and counter to the law”, and that very large institutions have been successfully resolved in the past. TBTF destroys incentives, competition with smaller institutions, and “encourages risk-taking and fraud,” while “. . . it subverts the law, which requires that insolvent institutions must be resolved.” And their final point focuses on a developing reality transcending the TBTF objections:
As we write this piece, the markets are taking it upon themselves to begin to close down the control frauds — with homeowners fighting the foreclosures and investors demanding that the banks take back the toxic waste. Unfortunately, following the market solution will be a long-drawn-out and costly process — both in terms of tying up the judicial system but also in terms of the uncertainty and despair that will persist. At the end of that process, the banks will have to be resolved. No matter how much the politicians dislike it, they will end up with the banks in their hands — either now or later. Taking them now is the right thing to do.
Bill Black and Randy Wray provide strong arguments for the view that both the weight of morality and true pragmatism, are on the side of a national foreclosure moratorium; taking the big banks into receivership and resolving them, if necessary; prosecuting the systematic fraud that occurred on the lender and agent side of the real estate sales, financing, and foreclosure processes, and handing property over to owner-occupiers, where debtor-creditor relationships are now null and void due to lack of evidence of debt. Their proposals about how to deal with the foreclosure crisis are the right thing to do because they get us closest to actually healing the financial system for the future, while achieving as much justice as it is possible to get in this situation.
In addition, it will help greatly to heal the political system, since the big banks clearly have had a baleful influence on the economic stimulus bill, credit card reform, health care reform (where they strongly supported the insurance companies), finreg reform (where they weakened the Consumer Financial Protection provisions in the bill , did all they could to block TBTF provisions), and currently are strongly supporting the austerity and social security privatization proposals that will harm so many less less well off Americans. The truth is that for the vast majority of us, the big banks represent not just neutral economic institutions facilitating business and private savings, but malevolent political institutions that act against the interests of most people every day and distort American society in ways that are making it unrecognizable as America. The big banks must be broken up before we are all mere chattel to a financial Ruling Class.
A final note: To see how good the program Bill Black and Randy Wray outline in their series is, it helps to compare it with “progressive” economist Robert Kuttner’s recent proposal. It is:
Part one will investigate just how many of the nation’s mortgages and bonds backed by the mortgages are not legally valid. We will devise a way of turning these into proper loans, but only as part of a broader program of relief to homeowners.
Part two will provide a more effective system of refinancing mortgages than the present HAMP program, so that people who took out mortgage loans in good faith and then found themselves under water, can keep their homes. This is not a handout, this is justice. Ordinary people will get no more than bankers got — and no less.
Part three will determine which banks are insolvent as a result of this latest banking mess. Those banks will be restructured, under the new authority of the Dodd-Frank Act, and will be returned to sound operation so that they can serve the credit needs of Americans. No taxpayer money will be required.
There’s some justice for homeowners in this, something of a “bailout” for them, and a willingness to find invalid loans and resolve insolvent banks, but there’s almost no emphasis on investigating the frauds, enforcing the law, and providing justice for those who acted criminally in the process, as there is in the Black/Wray proposal. Bob Kuttner’s outline may go as far as inside the beltway opinion on the foreclosure mess by “serious” village commentators is willing to go, but it’s way out of touch with what I think people around the country really want to see. It ignores the needs of justice almost entirely.
In recent posts, I’ve mentioned the importance of the Administration serving justice rather than short-run “pragmatism” on a number of occasions. Bob Kuttner evidently doesn’t understand and feel that need, as Bill Black and Randy Wray do. Perhaps he can get a little more into the spirit of what’s needed by taking a look at Rusty1776’s very moving recent post, “On Wheels of Fire” at FDL.
(Cross-posted at FireDogLake and Correntewire.com).