Tuesday, September 20, 2016

Housing: Part 179 - Prosecuting the Banksters

Elizabeth Warren wants to know why the FBI "failed to hold the individuals and companies most responsible for the financial crisis and the Great Recession accountable."

She has posted letters to the FBI and to the DOJ Inspector General, citing potential illegal activities at 14 corporations from the FCIC report, which the DOJ has declined to prosecute.

In the 9 of the 11 referrals that refer to corporate activities, where dates are referenced they range from August 2006 to the end of 2007.  This is common in the complaints about wrong-doing.  The reason is, securities from 2005 and before performed pretty well.  There are few who would have standing to complain.

My question is, how can you place responsibility for the crisis on banks that were either trying to place mortgages in a declining market or trying to sell securities whose values were collapsing?  Clearly the collapse happened before these activities were happening.  The causation here is backwards.

I'm sure a common reaction to this is that malfeasance was happening before 2006, but that, in the words of Warren Buffett, you don't know who is swimming without trunks until the tide goes out.  That's all well and good as a presumption, but this is simply question begging.

I say that it was the collapse of credit that caused the crisis, not a boom in credit.  That may seem wrong, but referring to a bunch of desperation moves during the collapse does nothing to address this question.  The rise in prices is frequently taken as proof itself that credit expansion created an unsustainable market.  But, at this point, there is plenty of academic work showing that credit was a passive factor.  This requires more than a presumption.  It requires evidence.

The other 2 of Warren's 11 points refer to activities at the GSEs.  Citing the FCIC: "Fannie Mae may have overstated assets, earnings and capital through various accounting improprieties. . . [and] a failure to disclose accurate information about the state of risk management at Fannie Mae."
Fannie and Freddie were actually very conservative during the boom.  LTVs and FICO scores were becoming less aggressive and the GSEs lost a significant amount of market share, which they only began to regain as private lenders were reeling during the early part of the housing contraction.

But the greatest irony here is that the first round of pressure coming from housing boom angst was directed at the GSEs in 2004.  They were accused of managing earnings at the time.  Among their sins was overstating their loss reserves and underreporting their earnings so that they would have more room to take losses without it affecting future stated profits.  The CEOs were driven out during that round of pressure.  It took until 2007 and early 2008 for the CEOs to settle their cases.  Both of them agreed to make donations to funds meant to help suffering home owners.

Now, their successors are being blamed for understating loss reserves literally at the same time that they were paying fines for overstating previous loss reserves.  It's kind of like the joke, if your price is too high it's gouging, if it's too low, it's predatory pricing, and if it's the same, it's collusion.  I think we can safely say that there was no functional way to be the CEO of a GSE from 1998 to 2008 without being accused of criminality.

I think there is something here regarding the problem we continue to have with mortgage markets that continue to be inaccessible to middle class homebuyers.  There aren't any hard and fast rules directing banks to lock them out of credit.  But, there are a lot of vague liabilities attached to it.  There is so much profit to be made making mortgages to owner-occupiers in the bottom half of the housing market.  It is perplexing to me that we haven't seen more activity in the market, even if it would have to be outside the securitization market and outside commercial banking.  Yet, it doesn't seem to be developing.

But, the limits keeping marginally credit-worthy households from getting mortgages may not be quantifiable.  If you were an analyst at a bank, and you presented a report to the head of the mortgage division about how much money there is to be made in middle income mortgages, he's going to take it to the CEO, who will have it on his desk, next to a letter from a US Senator asking pointedly why he isn't in jail.  That's a market that's not about to clear.

I think this is another aspect of the issue that fits in the North, Wallis, and Weingast limited access order framework.  There is a lot of risk being imposed here through the discretion of powerful people.  And, it's got the economy tied up in knots, hurting the most vulnerable households the most, as limited access orders and discretion of power brokers usually does.

I suggest writing in "dart throwing monkey" in November.  It's not optimal, but it would be a huge step in the right direction.  It works for portfolio management.  Why wouldn't the same be true of governance, especially when discretion, grudge-bearing, and liquidationism are the order of the day.


  1. So one part of the feferal government---the Fed---tihhtens the screwsvand kills housing. Another part of the federal government proposes throwing into jail lenders on housing.

  2. So one part of the feferal government---the Fed---tihhtens the screwsvand kills housing. Another part of the federal government proposes throwing into jail lenders on housing.

  3. I think you are both right, Kevin. I think the boom was contrived, meaning that the securitization of the loans was fraudulent. So, AAA bonds were not AAA bonds. The David X Li Gaussian Copula, thought up while he worked for JP Morgan, and adopted by Basel 2, was totally bogus.

    But, as you have said, this subprime disaster was not a disaster everywhere. There were sound loans being made. They were not all bad, but moreso in a few states. So, the Fed did kill the subprime, forcing the bad loans back on the books of the banks, which also killed HELOCS, and that was the final straw according to Marcus Nunez.

    So, there is an element of truth to both positions and I believe they can exist side by side. Clearly the Fed mispriced risk based on Basel 2 con artistry. Clearly, the Fed took it all down, when it could have saved much of it and saved the GDP from crumbling.

    At the height of the bubble in Reno, NV, houses were selling as liquid assets turning over in a day. Housing is real estate, which is supposed to be illiquid.

    At my name, I have an article which attempts to show that the Fed was responsible for both the housing bubble and for the crash. I think it is correct.