Matthew Ferrara, Philosopher
 

Dear FHFA: Sue Yourself, not Banks

The U.S. government proposes to sue the nation’s largest banks for fraud that led to the housing crisis. Why stop with the banks? Others in the housing industry were surely involved. Better yet, why doesn’t FHFA just sue itself?

Of course, we’re joking about suing the housing industry (well, there might be some merit…). But we’re serious about this blame-game lawsuit. Is it possible that banks weren’t perfect during the feeding frenzy housing boom? Sure, we’ll stipulate that. But so were the ratings agencies, who are monopolies under government law. So were many REALTORS, who happily took overpriced bids on one hand, while saying, “Yeah, we know it’s a bubble,” on the other. And let’s not forget consumers, who eagerly played along with the entire shell game.

That’s how irrationally exuberant bubbles work, don’t you know?

But to say that banks defrauded investors – as sophisticated as Fannie Mae and Freddie Mac – seems a stretch. If organizations of their scale, with their resources, overseen by a government regulator didn’t catch them “in the act” then who could have? Certainly not the everyday borrower who gladly accepted his $1 million dollar pre-qualification letter on his teacher’s salary.

It doesn’t matter that we’ve seen tons of evidence that Fannie Mae and Freddie Mac actually promoted “marginal” lending practices, as we’ve written about here, and here, and here. It has become a Cracker Jack box joke that Barney Frank said he’d “like to roll the dice a little more” to marginal borrowers. We reported that Fannie Mae’s own former Chief Credit officer Edward Pinto said:

…from the time Fannie and Freddie began buying risky loans as early as 1993, they routinely misrepresented the mortgages they were acquiring, reporting them as prime when they had characteristics that made them clearly subprime or Alt-A….Market observers, rating agencies and investors were unaware of the number of subprime and Alt-A mortgages infecting the financial system in late 2006 and early 2007. Of the 26 million subprime and Alt-A loans outstanding in 2008, 10 million were held or guaranteed by Fannie and Freddie, 5.2 million by other  agencies, and 1.4 million were on the books of the four largest U.S. banks… [emphasis added]

 

We spent over $700 billion “to promote financial stability” under TARP, fearing a banking system collapse on the scale of the 1930s. Since then, we’ve lowered interest rates to levels not seen since 1945, devastating the dollar, driving up energy and food costs, all in an attempt (misguided, but let’s continue) to support an economic and housing recovery. Today, nearly 9 our of every 10 mortgages is purchased by a GSE (read: backed by taxpayers). Still, the housing market struggles. Foreclosures in some states could take a decade to clear the courts. And too many real estate agents are glad to just “hang on another year.”

Against this backdrop, does it make any sense to now sue the nation’s largest banks, and some European ones, for $200 billion. Not to mention the threat of putting a few hundred executives in jail?

Wow. Great idea to restore confidence in government and the markets.

Of course, some people, including some REALTORS I’ve seen commenting online, think this is great. Go get the banks, they say. They caused this whole problem, they rationalize. Banks aren’t lending, so punish them, they demand. One wonders if some in the housing industry understand how they get paid.

Let’s stipulate there is a fraud case to be made (but only if we sue all those homeowners who haven’t been paying their mortgages for the last three years, too). The scarier argument that should worry real estate brokers most is the “banks aren’t lending” line. For the facts, check the Federal Reserve website, indicating revolving credit lending up 8%, non-revolving credit lending up 7.5%. Even in places where mortgage lending has slowed or become more stringent, do we really have to ask why?

It’s hard to blame banks for not wanting to lend into a still-declining market. Pile on the threat of government punishment and it’s little wonder that banks would rather seek to lend to the next iPad manufacturer in China, rather than risk the wrath of such luminaries as Frank and Dodd.

In fact, Bank of America has started doing that last week. On August 31, BoA contacted the National Association of REALTORS to let them know they were exiting the correspondent mortgage lending business. BoA protests (methinks a bit too much) that the move is designed to improve customer service and manage lending oversight. But we suspect the real reason is that BoA is planning a post-lawsuit exit strategy from the housing market. You don’t walk away from $138 billion in correspondent lending business deals in the middle of a recession without a serious reason. And that is: when every new loan becomes new fodder for government lawyers and investigators, and the risk of C-suite executives is jail time if their employer makes home loans, it’s time to move in a different direction.

And that means banks purposefully exiting the mortgage business.

That might seem like a big guess, but is it? When a big bank closes off the hundreds of little third-party mortgage brokers from its pipeline, it’s not a sign they are just hoping to control quality. They are trying to control quantity. It’s a global economy, remember? Banks can make money all sorts of ways. Gold mining, for example, or shale deposits, or investments in growing industries in the Baltics, South America or Australia. Plus China and India. It’s only the U.S. housing industry that thinks it’s a big player for banks; but that’s because they still think all business is “local.”

Big banks might one day decide: Leave the housing market to the community bank lenders. We’re sick of the CRA, FHA, HUD and other strings that pull us in one direction, then noose and hang us in the other. They’ve already left the reverse mortgage business. And they’ve left the college lending business, after it was nationalized by the U.S. government last year. Banks are in the business to make money and at lower risks. If every time there’s a housing problem the alphabet-soup of government falls scalding upon them, they eventually learn to avoid getting near the stove.

The traditional wisdom against this kind of thinking is that banks make too much money in housing; they’ll never exit. These days, I’m not sure any traditional wisdom counts. Put a few big bankers in jail and see what that does to mortgage qualification standards. Force the banks to take $25 billion in TARP money each, let them pay it off with interest, then hit them with a few billion dollar lawsuit, and you’ve just done what any mob boss dreams of doing.

And there’s always the community banks, right? Those corner-banks that everyone seems to love – as opposed to the evil “big banks” out there. Well, consider this: All of the 7,000 community banks combined only comprise 21% of the banking business. Last year, only eleven community banks were chartered nationwide. Once FHFA sues the big banks out of the business, or merely causes them to significantly decrease their participation in mortgage lending, won’t we all be glad to know that Ike Godsey is still around to lend us a few dollars from the general store’s till?

And this is how we’re supposed to help the housing market recover. Right.

  • Personally I’m glad to see the “big banks” leave the residential mortgage world. They have terrible customer service, lousy follow up & even worse cross marketing agreements that only seem to hamper rather than help. They all LOVED the big profits when they could make them & then bemoan & ask for bailouts for business THEY solicited. The big banks wanted so badly to get in on the real estate bandwagon when times were booming but now that times get tough they go running to their lobbyists to sheild them. They can’t say there was a ratings service, actuary or someone saying that the boat was getting too full of water. They profess to be conservative in their methods to alleviate risk but wouldn’t listen to the nay-sayers because if they didn’t make the loans then someone else might & beat their positions globally. Profit comes at a cost, it’s called liability. You reap what you sow.

    Corporate profits do not create jobs, they’ve realized that they can do more with less and reap huge profits while doing so. Increase in the GDP creates jobs. It’s a difficult situation though. How to get one to flow into another. Just as the big lenders created the problems with MERS, no one wants to be the one holding the hot potato.

    Were investors misled? Possibly. Perhaps the market for ratings services needs more autonomy from the lenders they provide services for. Just like the accounting scandals of the last decade. How can ratings services be autonomous from those they provide services for when they are also the ones paying the bill due without some sort of fiduciary responsibility. So I do say, yes, sue the banks for the faulty investment advice but also allow those same banks to then go after the ratings services that “played ball” with them to recommend these investment vehicles.

    At the end of the day it’s always going to be the public at large that is done the dis-service by these large politically active lenders that have the money to influence lawmakers to do all possible to lessen their responsibility. They consistently do not comply with congressional inquests, mis-represent positions in testimony and yet no one ever really holds them to account because they’re “too big to let fail”. Yes, in today’s global economy the effects would be far reaching, but until lawmakers are willing to be statesmen rather than election motivated nothing will really be done.

    It’ll be a feast for lawyers & lobbyists but at the end of the day, joe public will still be the worse for wear.

  • Scott:
    Thanks for your very well thought out reply! I agree with you on a number of points: The larger banks really do deliver a lousy experience – both before, during and after, especially if there’s a problem period like we’re in now. Community lenders may have better service. The trouble is, they only make up about a fifth of the market. Also, remember that in the “last” great recession, many of the smallest banks were the ones to disappear (in the 1930s the banking crisis was precipitated by the fact that there were ONLY small banks and they couldn’t sustain themselves; ergo the push for larger networks of banks over the last 75 years).

    On the other hand, I absolutely agree that the banks should have been left to fail. It’s the best medicine for bad practices: Failure. It would also have taken the ratings agencies down – investors (consumer, retail and institutional) would have taken their lumps, and we’d be far from that by now. It doesn’t matter if people lost their money in one fell swoop, or slowly over a 5-10 year recession like we’re doing now. It’s gone and the bailouts were bandaids.

    The real question is whether the lawsuits make any sense. If the public was afraid of bank failures, so we propped them up, AND let’s remember that most paid them back BUT now we’re going to sue them for an average of $6-10 Billion each, plus throw some people in jail, how does any of this help uncertainty, fear and risk? It’s a feel-good witch-hunt for class warfare, in my mind. And right now, we don’t need more class divisions. We need American cohesion, to pull ourselves out of this morass.

    Lastly, I’m not so very sad for “Joe Public” because he wasn’t certainly complaining when he took out his fantasy equity loans, to buy cars, potato chips and vacation homes. He didn’t protest when his $50,000 salary qualified him for a $1 M mortgage, did he? We might disagree on whose fault it is, but I really have no sympathy for the consumers who enjoyed the champagne bathtubs along the way. It’s people – perhaps like me – who qualified for four times what he borrowed, but didn’t over-reach, and put 20% down (that’s gone and NEVER coming back) and lived carefully while his neighbors drove un-paid-for luxury cars – and who is now paying the tax bill while so many sit back and not pay their mortgage (but don’t have the decency to move out). That’s the American citizen I feel bad for: The one who did it all the “right way” and is now bearing the burdens of his “me, me, me” brethren.

    But that’s a whole other story!
    Appreciate your comments! Thanks for stopping by.
    – MF

  • I also agree. Greed/ignorance/intolerance/lack of due dilligence cannot be rewarded. For the average person who worked hard to gather up a legitimate downpayment & purchased within their means then yes, help save them. But we all shouldn’t have to finance “strategic defaults” or those who took “liar-loans” to get the home they “desire”. I also don’t have compassion for the people that financed their lifestyles from the equity in their primary residences. A primary residence is a place to keep your stuff & keep them out of the weather & a roof over your bed. Unfortunatly too many businesses convinced too many people to take unsecured debt & secure it with their home equity.

    I also detest the latest movement where people don’t want to have to face the consequences of their decisions & decide to short sale or default simply because they tried to game the system with “liar-loans”, negative amortization loans or even “interest only” loans. The lenders did absolutely play a part in this, by marketing to marginal people to begin with. They should be forced to stand by their commitments. Unfortunatly most of the biggest lenders will simply be paying off these judgements with lower cost “loans” from bailouts rather than having anything ever really cost their bottom line.

    I do find it amusing that all of a sudden one major lender (big red) is looking to limit their exposure to the residential mortgage market now that they are getting called on past pratices and also shutting off “affiliate lending programs”.  Ultimately it now seems that the big lenders took the lead & lions share of the profits from the real estate boom of the last 10 years to the detriment of local banks & now it seems those very local banks will be the savior for the majority of homebuyers now.

    I remember a time when a savings account paid 4-5% interest & even checking accounts paid interest of even a modest amount. Now it’s far less than 1% interest paid, the banks all have huge fancy headquarters & corporate executives get fat compensation packages never tied to the long term stability of the institution.  People do need to go to jail if only to stabilize & make others realize that this unrealistic push for profits does have consequences.

    It used to be that your banker was a very conservative individual or company that through shrewd investments made a profit, now it’s damned it all for the quick buck, let the govt. & society pay the consequences.

    Large lenders dealing with record foreclosures & short sales bemoan the volumn of work on their desks, with record unemployment they don’t have any excuse for not having the workforce to handle the workload. This is another reason why I don’t have any sympathy for the lenders. Further example of costs of being “in the real estate business” that they routinely want to ignore.

    No one knows how this all will flesh out at the end of the day but there does have to be consequences for the big paydays & profits that were made. No avoiding that. If I get sued then any commission I made is fully liable and even more so. Why aren’t the lenders facing at least the same liability?