The Foreclosing of America (Part 3): Chainsaw Jim

[We pick up our story as our hard-working but underemployed young couple, fearing of their precarious financial position but confident of their future income potential, and inspired by their president's exhortation that "the more ownership there is in America, the more people have a vital stake in their country," signs a NINJA - "No Income, No Job, No Assets" - mortgage. Read Part 1 here [1]. Read Part 2 here [2].]

Shaker Heights: the place you were intimidated just to visit back in high school. Shaker Heights. How the very name once made your heart sing with joy - you, a hard-scrabble kid from Cleveland, who managed to work your way through college and a master's degree in computer science, even if the accomplishment left you with twenty thousand dollars in debt. You remember, that fall day in 2004 - Election Day! - as the happiest in your life. That day, you turned the key to your very own home: Shaker Heights.

Now: not so much. Now, in March of 2007, the very phrase name makes you shudder. On your block there are two abandoned houses - two owners whose loans had been foreclosed - and city workers have been busy mowing the overgrown weeds, boarding up broken windows, and installing alarms against squatters, lest your block start looking like some Third World slum, and the price of you and your neighbors' homes plummet further. Shaker Heights has made the New York Times: [3] city officials are "working with financially troubled homeowners to renegotiating debts, or, when eviction is unavoidable, to find apartments."

That's you.

The too-good-to-be-true deal the mortgage broker sold you was too good to be true. Late last year, just like the fine print said, your interest rate ballooned from 1.5 percent to 6.5 percent.

Almost simultaneously, your house stopped appreciating [4] - housing supply finally started outstripping demand, and you had no more equity [5] to rely upon to meet your monthly payments.

You read what the mayor of Shaker Heights said in the Times: "It's a tragedy and it's just beginning. All those shaky loans are out there, and the foreclosures are coming. Managing the damage to our communities will take years." In the five business days between June 29 and July 6, according to the outstanding reporting of local Cleveland blogger Bill Callahan [6], 236 foreclosures were recorded in the Cuyahoga County Recorder's Office - mortgages held by such distinguished houses of finance as Deutsche Bank, Wells Fargo, Lasalle, and Citibank. 356 foreclosed properties were listed for a sheriff sale for July 9.

But you can't believe you're one of them. And, having internalized Republican ideology (personal responsibility!), you presume it must be your own fault.

Like most things Republicans believe, that's wrong. You've been defrauded, and under the cover of law. The ownership society has, as the kids say, owned you. It's owned us. The crisis is systemic. In this wealthiest of countries, one presently graced by rates of economic growth Republicans are pleased to all "healthy," foreclosure rates [7] in the first three months of 2007 were at their highest since 1979 - a year when the economy was at its un-healthiest since the Great Depression. And according to the head of securitization research ("securitization": we'll be explaining what that's about below) at Deutsch Bank, "We think we're just starting to see the tip of the iceberg...that's a process that we think will happen over two years." Some people say a million and a half households will be dumped out into the streets. Others say two million. Each empty home means more supply, in a market with less demand; the inventory of unsold homes [4] in March of 2007 was 25 percent higher than the inventory of unsold homes in March of 2006; the number people selling vacant units - desperately motivated sellers, in other words - is up 40 percent. This, in turn, will send the prices of all homes plummeting. Millions of Americans rely on the value of their homes as the fuel for their very financial health. They also rely on the increasing value of their homes to keep up with their mortgage payments. This could well become Dust Bowl stuff.

It is the product of policy failure. It could have been prevented. How did it happen? And why?

********

It began with a clever man at the old investment house Solomon Brothers named Lewis Ranieri, explains the Washington Post's tough-minded financial columnist Steven Pearlstien (no relation; what kind of lunatic would spell "Perlstein" with an "a"?), "dreamed up the idea of buying mortgages from bank lenders, bundling them and issuing bonds with the bundles as collateral. The monthly payments from homeowners were used to pay interest on the bonds, and principal was repaid once all the mortgages had been paid down or refinanced." And, as I explained in Part 2 [2] of this series, "because the originators make their money from fees and from selling the loans, they don't have much at risk if borrowers can't keep up with their payments."

And therein lies the problem: an incentive structure that encourages originators to write risky loans, collect the big fees and let someone else suffer the consequences."

Next, the same old story: the capitulation of Clinton-era Democrats to right-wing fantasies about the magic of the unfettered market helped rev the engine; Republican rule in all three branches of government rocketed the anti-social practices into the stratosphere; the laws of gravity bring the whole sick system plummeting back to earth - and it all could have been prevented at any point along the way with sensible, sustained, public-spirited regulation.

According to the March 22 Wall Street Journal, in 2005, over half of sub prime mortgage issuers were under no federal supervision whatsoever. Of the rest, half come from finance companies that, because they are units of bank-holding companies, are at least indirectly supervised by the Federal Reserve, and half are regulated banks or savings & loans. Others, of course, are regulated by the states - states like California, where there are 25 examiners for 4,800 licensed lenders.

These regulators' sins of omission are profound indeed. The Journal explains: "even where federal regulators have jurisdiction, they sometimes have been slow to grapple with the explosive growth in especially risky practices." Sometimes? So long as a bank seems solvent, they did nothing. The FDIC has issued precisely four cease-and-desist orders against sub prime lenders in the past two years - the same period over which the has sanctioned one sub prime lender. The Office of Thrift Supervision disciplined not a single thrift. Its head was too dismanting his bureaucracy - driving out 20 percent of his workforce. They don't care about consumers. They parroted the conservative line: "capital markets and well-educated consumers are the best way to curb unscrupulous lending." The Journal quoted one of them, the chair of the FDIC: "Early on, regulators didn't see extensive consumer complaints and credit distress."

They didn't see them because, of course, they don't look. That's not their bag. Their concerns are elsewhere. Federal regulators once held a press conference in 2003. To symbolize their commitment to cutting red tape for bankers, they held up gardening shears. The head of Bush's Office of Thrift Supervision, James Gilleran, did them one better. he brought a chainsaw. They don't care about consumers.

Grover Norquist--or was it Karl Rove?--once famous pronounced, "personnel is policy." In other words, if you want a certain kind of government, you hire people who believe certain kinds of things. In the case of regulating housing financial regulations, it's been that old familiar E. coli conservatism story: the revolving door between government and industry, pals watching pals, foxes guarding henhouses, and in the service of that secular church the Republican Party.

Take Gilleran, the guy who brought a chainsaw to a press conference to symbolize his commitment to cutting red tape. The former superintendent of banks in California, George H.W. Bush nominated him for comptroller of currency; then the nomination was withdrawn once Clinton won (suspicious, isn't it?). Gilleran moved on to the Bank of San Francisco - and returned to his second career as a Republican fundraiser. "Texas Gov. George W. Bush's colossal $36.3 million campaign treasury was built on three pillars: a home-court advantage that allowed him to hit up Texas supporters, enthusiastic support from Republican governors, and the vast fund-raising network of his father," the New Orleans Times-Picayune reported on Independence Day of 1999. "'There's a tremendous amount of money available out there today,' James Gilleran, 66, chairman of the Bank of San Francisco, said on his way out of a packed Bush fundraiser in his city Wednesday." Two years later to the day - Happy July 4, bankers! - his nomination to head the Office of Thrift Supervision was announced.

He had already served as chairman of the San Francisco Democratic Party and of a local head of the 1988 Bush/Quayle campaign. He had already come under fire for signing fundraising letters while serving as state bank superintendent. "He says he has never been tempted to run for high office," his hometown San Francisco Chronicle reported. "'My interest has always been behind the scenes,' he explained."

"Behind the scenes." It raises a fascinating question. What with all the best-dressed Republican strategists speaking of homeownership for one and all as the royal road to permanent Republican rule, what with Bushies constantly boasting of increasing a homeownership rate [8] of 65 percent in 1996 to 69 percent in 2002 - well, might some order for all these regulators to stand down come directly from the White House?

That's a question above my pay grade. It's the kind of question only historians are able to answer decade later, sifting through memoranda in presidential libraries (which is why this White House kneecapped the Presidential Records Act [9] that puts such memos in the public domain; lawyers call this "mens rea" [10]). What we do know now is that that the positive policies the Bush White House has actually put forward to realize greater homeownership bear no relationship whatsoever to the importance, politically and policy-wise, the White House claims to place on the problem. For all intents and purposes, it's been but a single program - the American Dream Down-payment Fund, funded at a paltry $200 million. Let's do a little math. There are, by last count, 73.4 million [11]homeowners. Rough-and-ready, without adjusting for population increase, a homeownership rate [8] of 67.4 percent in 2000 and 68.9 percent in 2005 - and stat-heads, correct me if I'm wrong - we're talking about approximately 1.1 million new homeowners. That's a one-hundred-eight-one buck subsidy for new homeowner. I have to imagine, if Karl Rove was relying on more homeowners to help mint more Republicans, he'd be making some greater effort above and beyond this?

Was Karl Rove relying on all those NINJA loans instead? Was the White House, sub rosa, encouraging them? It's not hard to imagine. If so, how well and truly rogered the Republicans finds themselves. One more Bushian house of cards has collapsed. If only the damage could be contained within the political fortunes of the Republican Party.

*******

It's not like the problems weren't there for all to see. New Century Financial, much in the news as the second biggest sub prime lender, and now in ruins, was founded in 1995. They are clever, clever boys. In 1994, the last year before the Apotheosis of Newt Gingrich made such enlightened, public-spirited legislation impossible, Congress passed a Home Ownership and Equity Protection Act which gave the Federal Reserve broad authority to prohibit unfair and dodgy lending practices. By 2002, in a last gasp of sanity, the Federal Reserve expanded the number loans and sorts of dodgy practices covered by "HOEPA." So companies like New Century, whose volume had doubled to $27.4 billion by 2002, rewrote their underwriting criteria so their loans would fall under HOEPA. The rest of the mortgage broker business raced with them toward the bottom. The kind of NINJA mortgages described in Part 2 [12], set up, if not to fail, at least not to succeed, became the norm.

Fears of the coming meltdown began bubbling up [13] at the beginning of Bush's second term - just when the propagandists of the American Enterprise Institute in their special issue (see Part 1 [12] of this series got to yapping about the "Ownership Society" as some combination of Valhalla, Shangra-La, and Reaganite New Jerusalem. Reports Steven Pearlstein: "Several members of Congress of Congress called for a clampdown. Mortgage insurers and numerous independent analysts warned of a gathering crisis. But it wasn't until December 2005 that four bank regulatory agencies were able to hash out their differences and offer for public comment some 'guidance' for what they politely called 'nontraditional mortgages.'"

"Months ensued as the mortgage bankers fought the proposed rules with all the usual bogus arguments, accusing the agencies of 'regulatory overreach,' 'stifling innovation,' and substituting the judgment of bureaucrats for the collective wisdom of thousands of experienced lenders and millions of sophisticated investors..." Federal and state guidelines did eventually come forth - last September.

By then, of course, it was - is -too late.

Wall Street was still in denial. Pearlstein says they sounded "almost exactly like the accounting firms and investment banks back when Enron and WorldCom were crashing around them." Sub prime mortgages, and the next level down, Alt- A (not a computer command) account for 40 percent [4] of the mortgages written in the last two years. Sub prime foreclosures are now growing a rate about half a percentage point more per quarter, It's about 2.5 percent - about one of forty - compared to one out of 400 for credit-worthy mortgages. This is a profound market failure. The rates, in an efficient market system, should be similar - because people with poorer prospects for paying back loans, in a sensible credit market, would have a harder time getting credit.

And Wall Street is not in denial any more. The piper has to be paid. "A huge cloud hanging over Wall Street investment houses," Steve Pearlstein writes [14], "which packaged and sold these mortgages to investors around the world." Smart, responsible people fear for the future of the financial markets themselves. Investment guru Jim Stack created an index [15] of housing related stocks. It begins a steep assent in 2001 and starts tanking at the 1400% point roundabout '05. Some smartass mapped [16] it against pronouncements of David Lereah, chief economists of National Association of Realtors. At top: "All the doom and gloom forecasts of a housing debacle are not only irresponsible, but also downright wrong." Right before a particularly precipitous dip a few months later: "The leel of homes sales...is likely to pick up a bit in the months ahead." What does he say now? "We're going to have negative home prices in 2007." Though some regulators are still fighting regulation

nonetheless. As Fed governor Radall Krozner [17] put it at hearings in June, regulation meant to fix the crisis might "curtail responsible sub prime lending or beneficial financing options for consumers."

What does that mean, say, in Cleveland? Wells Fargo Bank - one of the most aggressive and anti-social sub prime culprits has become one of the biggest homeowners in town. (Read about them here [18] and here [19]. According to Cleveland blogger Bill Callahan [20], "Wells Fargo and Deutsche Bank now own over eight hundred of Cleveland's one-family and two-family houses - about 1 percent of the city's total - and they're foreclosing on hundreds more each month." It's rough for the aspiring professionals in Shaker Heights: "It's sucking the life out of the neighborhood," says the suburb's probation officer [3]. "These are big empty houses near the Cleveland border, and people start worrying about letting their kids out to play." For precarious working class neighborhoods, where sub prime lenders "push-marketed" [3] their products to undereducated consumers most aggressively. it's well nigh the end of the world. "Many of the houses are filled with smelly trash and mattresses used by vagrants. They have been stripped of aluminum siding, appliances, pipes, and anything else that scavengers can sell to scrap dealers."

********

Back in February of 2004, Jim Gilleran, head of the Office of Thrift Supervision, spoke at the first meeting of a new Financial Literacy and Education Commission. He delivered himself of the following piece of homespun wisdom, courtesy of his sainted mother: "If you make a buck and you spend 99 cents of it, you're in heaven. If you make a buck and you spend a dollar and 1 cent, you're in hell."

Gilleran left the administration the next year, in April, after "supervising" the thrifts by neglecting to discipline a single one for irresponsible lending practices. He didn't retire, though. He's now the CEO of Federal Home Loan Bank of Seattle. Where, NINJA-style, glad-handing salesman no doubt once told a young professional who'd made a buck to sign papers promising him a house if he'd only commit $1.50, but not to fear, because his exploding home equity would cover it anyway, and that he could only pay interest for ten years, no money down, and that the interest rate would be tiny anyway for two years, after which it would become gigantic, but no matter, because rainbows and puppy dogs and sweets and flowers strewn would greet the liberators of Baghdad because George Bush says so.

But, oh yeah, by the that time you might be out in the street, your former house filled with smelly trash and mattresses used by vagrants, stripped of aluminum siding, appliances, pipes, and anything else that scavengers can sell to scrap dealers. But Gilleran's Federal Home Loan Bank of Seattle will have already made their vig, devil take the hindmost.

There's your Ownership Society, George Bush. Sounds like hell. Hope Wall Street survives.

[Next time: A historical conclusion [21] - back when there were progressive politics of homeownership, and the middle class knew prosperity, opportunity, and stability unlike any in the history of humanity.]