Weve Foreclosed On Ourselves

Terrance Heath

Faced with a foreclosure fiasco of astounding proportions — as chronicled by my fellow bloggers, Zach Carter and Richard Eskow —  in which banks practically kick down doors to foreclose on homes even when they can’t prove ownership of the mortgages, President Obama fretted that a foreclosure moratorium would help people who "don’t deserve it." He needn’t have worried. Since the housing bubble popped and sent the economy into free-fall, the government has been helping people who don’t deserve it.

Of course, I mean the banks and financial institutions bailed out by the very taxpayers they are throwing out of their homes, without being able to prove they have the right to do so. Reading the stories of what has gone on makes it hard to imagine how this has gone on without so much as a ripple of outrage. It’s simple: the banks — and I believe they know this, and count on it — have their biggest allies in the American people themselves.

The roots go all the way back to the beginnings of the current economic crisis. Moral hazards were ignored when the time came to bail out the very Wall Street institutions whose actions helped bring about the economic crisis, with its accompanying waves of job loss and foreclosures. Then those moral hazards were slammed right back into place when a foreclosure aid for Main Street was first considered. The loudest dissent against foreclosure aid came from the local level.

As the Bush administration and Congress consider proposals to ease the home foreclosure crisis, local governments across the country have been lending money to imperiled homeowners and confronting some opposition

Some of these municipal and state efforts have met resistance from people who consider the assistance undeserved and adamantly oppose anything that resembles a taxpayer bailout.

…The goal of these programs is not just to keep people from losing their homes, but also to limit broader economic fallout, including plummeting property tax revenues and widespread declines in home values. Still, they pit what some government officials say are practical economic solutions for the common good against individual ideals of fairness and personal responsibility.

The opposition may be rooted in “this ancient notion of deserving versus undeserving, and you’re undeserving if you made a bad decision,” said Nicolas P. Retsinas, the director of the Joint Center for Housing Studies at Harvard University.

While the negative reactions have not stopped the assistance efforts, it has put some local officials on the defensive and forced them to try to sell the programs to the general public, not just to the intended recipients.

The result has been three years of failed policy, resulting in foreclosure prevention efforts so careful not to help "people who don’t deserve it" that they ended up helping almost no one. A first $50 billion attempt to stem foreclosures was a bust, initially helping only about 9% of those who needed help most. It reached only about 160,000 of the 3 to 4 million it was supposed to reach. That’s perhaps because the administration merely encouraged banks to adjust mortgages, but did not require them to do so. It should surprise no one that the banks exploited the fine print, and let people slide into foreclosure because it was far more profitable than adjusting mortgages.

A second $75 billion pass, in the form of the Home Affordable Modification Program, was hardly any better. Even the administration admitted that potentially thousands of homeowners were denied mortgage modifications. The result was that banks were allowed to play "extend and pretend"  — extending the painful process by pretending to offer hope of mortgage adjustment until homeowners fell into foreclosure anyway.

Despite being warned for months about trouble in the mortgage servicing industry, the administration did little. Those with the power, authority and duty to act to prevent the collapse were warned of the disaster that would be brought on by what was happening in subprime mortgage and derivatives markets, yet this administration failed to act on warnings about mortgage servicers. Instead of acting aggressively to help homeowners by requiring modifications or allowing homeowners to escape foreclosure through bankruptcy courts, the administration stuck to admonishing, cajoling and pleading with a financial sector for whom self-regulation had already worked so well.

As "the 14th Banker" pointed out, banks and government officials have taken the position that homeowners are fully to blame for their predicament, and the "paperwork issues" just need to be ironed out for them to get what they deserve — foreclosure. It’s a profitable position for banks, and perhaps even for campaign coffers, but not necessarily one that assures a just outcome.

We live under the free market paradigm and that is simple free market — and contract law — cause and effect.

But, what if the borrower was defrauded in either a legal sense or a moral sense at the inception of the contract? That may not make the contract unenforceable, but does it make the enforcement inequitable? Does it erode this moral high ground that lenders are claiming?

Perhaps we need to be more discriminating here. Some time ago I posted on asymmetrical information in regard to one type of transaction. But suppose that there was asymmetrical information at the time the mortgage was originated? According to Dealbroker, Jamie decided on October 2006 to get J.P. Morgan out of Subprime. According to the article, the JPM team decided that quality control had slipped at the originator level. What might this mean? I suspect "quality control" is a euphemism for rampant fraud. So lets just say that October, 2006 is "Day Zero."

So is there any difference in the way we should look at someone who purchased a house on Day Zero minus One versus Day Zero Plus One?

Perhaps before Day Zero, the general conditions in the market were that everyone was wrong. Everyone thought prices would continue to rise. Everyone thought the rising prices would mitigate the imprudent loan processes and structures, the no-doc loans, the 97% loans or 120% home equity loans. At Day Zero plus One, that changed. The caution light should have come on and the relationship of the professional banker to the client should have included caveats about the investments that were being made. This is idealistic, I admit.

But, someone should investigate when JP Morgan and every other bank changed their policies in regard to loan to value, income verification, product recommendations to customers, instructions to bankers, incentives to bankers, etc. If banks knew in the executive suite or the research department that the fundamentals were turning ugly, and still kept making loans and shoving them into government guarantee programs or selling them to investors, then there is no moral high ground. The information asymmetry was used to make more money. In a moral sensibility, the contract should be looked at what it was, a gamble by both parties. If at this point in time the stupidity of the lender has allowed the contract to become unenforceable, then that is the lender’s problem. Too bad, so sad.

As the "reformed mega-banker" points out, the situation above would put bankers and buyers on on level moral ground. It seems clear, from their actions that the banks knew that "the fundamentals were turning ugly" and kept right on selling and then betting against subprime mortgages. Citi, for example, "went negative" on subprime mortgages in 2006 yet continued to pump them out. Goldman Sachs "made a killing" betting against subprime mortgages in 2007, yet continued to sell mortgage-backed securities to its client. We have ample anecdotal evidence to suggest that some homebuyers were unethically tricked in into adjustable rate mortgages that put them at risk of foreclosure; and that blacks and Latinos were steered into subprime mortgages more often than whites, even when they qualified for other types of loans. We know that some homeowners are driven into foreclosure by job loss and the recession.

We know that banks have denied loan modifications for reasons forbidden by Treasury department guidelines. We know that disorganization at banks has caused mistaken foreclosures. We know now that "robo-signing" has led banks to foreclose on homes even when they cannot prove they own the mortgages in question, and thus may have no legal right to foreclose.

Yet, even as Congress tries to bailout predatory lenders by making it easier for them to get away with unethical practices that have been recently exposed, and tweaking the rules in favor of financial institution whose behavior should spark investigations and perhaps even criminal proceedings instead.

Why then do we assume the moral high ground belongs to the financial institutions in every foreclosure? Why doesn’t all the above cause more outrage at the actions of financial institutions and government officials than homeowners who have been exploited by the former and abandoned by the latter? The reasons aren’t all that different from two years ago.

Yet, this dissent is happening against the backdrop of cities struggle to cope with vacant homes, foreclosed and abandoned by subprime borrowers, attracting crime, blighting neighborhoods and further destroying home values. Local budgets are impacted to the point where schools are bracing for cuts as the housing crisis eats away at funding. Meanwhile governors turn to Washington for infrastructure funding — to repair roads, bridges, and water systems — only to be rebuffed by President Bush, who prefers the same "wait and see" approach Alan Greenspan took to the development of the current crisis. (And who, by the way, wants to take millions of dollars from the states, for the federal government, in the form of mineral royalties that could fund infrastructure in the states.)

Sound familiar?

The hesitation to bail out subprime borrowers who were either "speculators" or "should have known better" is a reflection to some degree of the success of the ownership society myth. Even as they are drowning in the very same waters as subprime borrowers, prime borrowing members of the middle class cling to the conservative idea that some people shouldn’t be rescued. Some people should be left to drown, and they can be identified by their lack of economic resources.

This is not happening to a few people who "deserve it." It’s happening to all of us. There is no way to separate the lambs from the goats. If my neighbor goes into foreclosure and his house stands vacant, the value of my house goes down, and my neighborhood becomes a less desirable place to live, and perhaps a more dangerous one given the problems that come with having vacant houses standing in a community.

In the midst of the hand wringing over bailing out the "wrong" people, what’s forgotten is that the subprime crisis has long since metastasized and spread to the suburbs, where families who believe themselves safely ensconced in the middle class, who’ve borrowed on the equity in their homes, find themselves sitting in houses now worth less than they’re paying for them. And the "wealth" that their homes supposedly represented, which in reality was merely credit (debt masquerading as money), has disappeared, or become much harder to access.

One of the illusions of the ownership class, for those who aspire to join it, is that they ceased to be one of "those" people, who got themselves into trouble by living beyond their means — pretending to a class they don’t belong to, getting ideas above their standing, etc. — even as they borrow against the credit-based "wealth" in their homes to finance everything from vacations to retirement to college tuitions.

What will happen when, or if, they realize that they never really joined the ownership class, and that they weren’t even close?

If the economy, along with our communities, are overwhelmed by the unimpeded waves of foreclosures, it will not be just because of a financial sector that sparked the tsunami or government officials who failed to stop it — but because we are apparently content to watch one another drown, effectively foreclosing on ourselves.

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