I have a good accounting professor friend at the University of San Diego. (We first met at a religious retreat while we were both graduate students at the University of Houston.) Unlike me, Tim has remained steadfast in his liberal Democratic point of view; my point of view started shifting that first semester when I took my first graduate economics course as a part-time MBA student. [If my business professors had a political point of view, they never wore it on their sleeve.] By 1984, my principal complaint with Reagan was the large deficit he was running up.
Tim and I managed to co-exist despite our diverging political opinions, but at one point I became so annoyed with director Michael Moore's series of propaganda films, I mentioned that Michael Moore might find me a more worthy adversary. Tim laughed and said that he would buy tickets to see that show. Of course, if you saw Moore and myself side by side, not knowing I have a nutrition blog, you might think that the real argument is over who gets the last doughnut...
So over the weekend I was flipping through cable channels when I did a double-take--did I just see media conservative Sean Hannity and Michael Moore talking to each other? I think of all the media conservatives, Sean Hannity comes across as less strident and more likable, but he often repeats the same talking points.
I was instantly wary about the interview, because Moore is a professional polemicist and has made a small fortune out of ridiculing his blindsided targets, including sophomoric setups and gotcha interviews. [You have to thoroughly know progressive talking points going into an interview like this. Hannity has covered Obama enough to realize that Obama repeatedly tries to make "greedy Wall Street" the scapegoat for the economic tsunami. You also have to realize that Obama as a US Senator filed S. 1222, which would have limited charging "mortgage professionals" for fraud, not predatory borrowers engaging in "fraud for housing" (e.g., obtaining a loan by misrepresenting level of income, not disclosing other debt, etc.) In fact, a study completed through a period of low unemployment (through 2006) found up to 70% of early payment defaults involved fraudulent misrepresentations on their original loan application, and those with fraudulent misrepresentations were 5 times more likely to go into payment default.]
So when Michael Moore tried to get Hannity to agree on whether the FBI is an authoritative source, I instantly smelled a trap. To his credit, Hannity seemed to realize it and tenuously agreed. The key exchange is as follows:
Part III, start: After Hannity agrees that the FBI are “good guys,” Moore cites the FBI: “80% of the mortgage fraud has been caused by the banks and the lending institutions.”Hannity: “Everybody got greedy.”
Greed or Victim?
It's difficult to blame these loans on bank "greed" or "recklessness". Banks are in the business of making loans, which is a competitive business; for example, mortgage brokers have gained from 60 to 70% of the marketplace with certain advantages of lower overhead and pricing flexibility, and Internet quotes are available. There is no doubt that some mortgage giants (e.g., Countrywide) were looking to maintain or increase market share and profits by adding riskier loans, loosening underwriting standards and granting exceptions. Why? Because the gross margin of servicing these loans was somewhat higher. Foreclosures occur even during a robust economy (a working spouse becomes seriously injured or ill, mounting bills, etc.)
While Michael Moore prefers to scapegoat "greedy lenders" targeting easily duped consumers, he ignores the fact that "financial institutions and the federal government are by far the biggest victims in terms of [monetary] loss". [In fact, one of the reasons that the SEC is going after former Countrywide CEO Mozilo is an allegation he had not fully disclosed to stakeholders concerns he mentioned in certain emails about fraud for housing and for some of its riskier (e.g., 80-20) products.] Other parties affected by mortgage fraud include accountants (e.g., more extended audit plans), bank regulators, community groups (abandoned homes adversely affecting nearby property values), the secondary market (mortgage-backed securities), taxpayers (losses on federally-insured loans), and future homeowners (higher costs).
What progressives, including Michael Moore, are doing is a game of blaming the victim. For example, it's the bank's fault for not detecting conspiracies of dishonest employees familiar with the ins and outs of internal mortgage approval mechanisms--what facts raise red flags, what gets checked, how it's verified, what checks might get waived under which circumstances, how checks might vary between loan products, etc. Once a criminal knows these facts, it's easy to create a strategy to game the system. For instance, a criminal could buy a property at market price, work with a dishonest appraiser to artificially inflate the value of the home, use a stolen identity's sterling credit history to secure a mortgage loan (in this case, perhaps the contact information for the stolen identity isn't cross-checked) for the phantom buyer, and pockets the difference. [Maybe some initial mortgage payments are made to deceive the bank while the criminals move on...] The bank then takes possession of the property, but it has to realize its loss (or make allowance for the loss) to reflect market value.
Dishonest activity occurs in all sorts of disciplines. I've written past posts describing some of my experiences as a university instructor or professor. In most cases, the people who cheated were among the most able students in class. Second, almost invariably they wanted to know how I caught them (their motive was rather transparent: they wanted to develop a workaround). Occasionally a student would express frustration that an unnamed classmate was cheating but declined to provide additional details or evidence; I had to follow due process procedures, including compelling evidence, in resolving academic dishonesty issues.
Many relevant professionals (e.g., mortgage brokers and accountants) have codes of conduct. Accountants should vouch and track an adequate sample of transactions, relative to perceived risk. Bank regulators have a number of relevant responsibilities, including an assessment of systemic risk. Credit rating services, security regulators, investors and business media had a right to demand that lenders were fully disclosing risks affecting ongoing viability. The secondary market has the right and obligation to scrutinize the creditworthiness of the mortgage notes it purchases; no doubt if a bank or broker was stuck with nonperforming loans, it certainly would have a natural incentive to clamp down on mortgage loan approvals. Certainly the Fed Reserve should have responded in a more proactive manner to what were clear signs of excess speculation in the housing market (condo flipping in Florida, housing prices vastly outpacing increases in household income, etc.) And obviously the federal government didn't do due diligence in the aftermath of the GSE accounting scandals earlier this decade.
Among other things, a whole lot of big mortgage money floating around and lax controls attracts organized crime and other criminal behavior much like garbage lures pests. Hannity and Moore are both wrong; it wasn't industry greed so much as collective stupidity and lack of due diligence in both the private and public sectors. Even if a sales guy is earning a commission on a mortgage deal, he does not have the authority to approve the loan; if the loan amount exceeds the market value of the property and/or if the company has to repossess in a down market, the loss can exceed any relevant generated income. Where were the credit rating agencies, the accountants, the bank regulators, the Federal Reserve, the Congress, and the President? The fact is that public policy and policymakers were part of the problem, not the solution.
The Nature of Mortgage Fraud
But hold on... Moore is deliberately (or incompetently) misstating what the FBI really said:
The FBI investigates mortgage fraud in two distinct areas: Fraud for Profit and Fraud for Housing. Fraud for Profit is sometimes referred to as "Industry Insider Fraud" and the motive is to revolve equity, falsely inflate the value of the property, or issue loans based on fictitious properties. Based on existing investigations and mortgage fraud reporting, 80 percent of all reported fraud losses involve collaboration or collusion by industry insiders.
Now, what exactly are these "industry insiders"?
Sometimes it is just the garden variety grifter who implements a fraud, but the FBI is seriously going after mortgage fraud that involves insiders: real estate agents, loan originators, appraisers, home builders, and closing attorneys.
The FBI's outlines a wide variety of mortgage fraud offenders including mortgage brokers, lenders, appraisers, underwriters, accountants, real estate agents, settlement attorneys, land developers, investors, builders, bank account representatives, trust account representatives, investment banks, and credit rating agencies with a criminal activity which is relatively low-risk with high-yield returns.
What is a motive for collusion among these professionals?
In conjunction with the ‘White Collar Crime’ department, the FBI investigates mortgage fraud, which often involves many professionals working in collusion... All of these profit through various commissions, fictitious sales and fees – often on loans that aren’t genuine.
And what kinds of fraud are we talking about?
The report indicates that the schemes most directly associated with the escalating mortgage fraud problem continue to be those defined as fraud for profit. Popular schemes include builder bail-out, short sale, foreclosure rescue, credit enhancement, loan modification, illegal property flipping, seller assistance, bust-out, debt elimination, mortgage backed securities, real estate investment, multiple loan, assignment fee, air loan, asset rental, backwards application, reverse mortgage fraud, and equity skimming. Many of these tactics use various strategies like the use of a straw buyer, identity theft, silent seconds, quit claims, land trusts, shell companies, fraudulent loan documents (to include forged applications, settlement statements, and verification of employment, rental, occupancy, income, and deposit), double sold loans to secondary investors, leasebacks, and inflated appraisals.
The net result? According to the IMF, about $2.7 trillion in expected US mortgage writedowns and more than $4 trillion globally. Those writedowns affect bank stakeholders, many left with pennies on each dollar of investment if, in fact, the bank doesn't fail, and obviously the government, where the bank has federally-insured accounts and which backs implicitly or explicitly a large percentage mortgages or mortgage-backed securities.
Does Michael Moore consistently condemn well-documented failures of the "generous" federal bureaucrats to prevent fraud, e.g., Medicare/Medicaid, tax, welfare, defense industry, etc.? I don't think so.
Does Michael Moore consistently condemn well-documented failures of the "generous" federal bureaucrats to prevent fraud, e.g., Medicare/Medicaid, tax, welfare, defense industry, etc.? I don't think so.
Credit Default Swaps
Let me briefly address the latter point; this is not an economics/finance blog. There's no doubt that AIG's incompetent writing of certain derivatives (credit default swaps) threatened its viability as a going concern; there was systemic risk from the nature and extent of its dealings in multiple markets, across the world; they wrote contracts worth around 44% of assets (vs. Berkshire Hathaway's recent transactions under 2%). Merton Miller of the Chicago School wrote an interesting paper a few years ago, entitled "Do We Really Need More Regulation of Financial Derivatives?"; among other things, he points out: progressives often describe derivatives in misleading and irrelevant terms; bank regulators already have access to relevant transactions; the issue isn't intrinsically with derivatives but their incompetent use by management; there are vested interests/hidden agendas behind calls to regulate (e.g., lawsuits for parties whom lose money in transactions); regulating the derivatives business is like squeezing a balloon; and additional regulations and reporting beg the difficult questions of competent regulation and regulators and of what exactly to report. As Rancière and Tornell note, "[Excess] financial repression and government intervention ...would drastically reduce risk-taking and growth. Our research shows that over the last five decades countries that have liberalized financially are the ones that have grown faster, even though they have experienced rare crises."
Which is greater hubris: corporate managers speculating they know more than Wall Street specialists on the direction and extent of future general economic metrics, or the Obama Administration thinking heavy-handed regulation and stifling financial innovation will eliminate economic crises (instead of unilaterally handicapping future American business and job growth)? If there is something which could bring more order in the recent chaos, it's greater transparency, the kind that arises through an exchange. Lenzner points out that the new Intercontinental Exchange is serving as a national clearinghouse for CDS contracts, including the related books of almost all relevant major banks and dealers, made available to regulators (and, one would hope one day, the general financial marketplace).
Public Policy Played a Big Role in the Housing Bubble
The fact is, both parties got political benefit from a robust housing market and a historically high relative percentage of American homeowners. The private sector, quasi-public sector (GSE's) and the government (e.g., the FHA) have approved bad loans.
We had fundamental supply/demand issues; there was too much money in the market chasing a limited number of houses. Accommodative monetary policy by the Fed Reserve; high demand by foreign investors for mortgage-backed securities implicitly backed by the government, and Democratic politician pressure to open the market for lower-income/high-risk applicants without conventional down payments or other creditworthiness factors (including stable income and other assets, limited coexisting debts, credit history, etc.) played roles. A number of mortgage-backed securities were not properly diversified by geographic risk, being disproportionately weighted toward clearly frothy markets in California, Nevada, Florida and elsewhere.
Government-Run Mortgage Lending: A Role Model of Lending Prudence?
Hannity did, of course, raise up the topic of Fannie Mae and Freddie Mac (which has become a bumper sticker issue, given the high-ranking contributions of the GSE's to Obama's campaigns); Michael Moore sidestepped that in favor of discussing the progressive economic theory it was the fault of unregulated "new" financial products, like credit default swaps, run amuck.
Let me briefly address the latter point; this is not an economics/finance blog. There's no doubt that AIG's incompetent writing of certain derivatives (credit default swaps) threatened its viability as a going concern; there was systemic risk from the nature and extent of its dealings in multiple markets, across the world; they wrote contracts worth around 44% of assets (vs. Berkshire Hathaway's recent transactions under 2%). Merton Miller of the Chicago School wrote an interesting paper a few years ago, entitled "Do We Really Need More Regulation of Financial Derivatives?"; among other things, he points out: progressives often describe derivatives in misleading and irrelevant terms; bank regulators already have access to relevant transactions; the issue isn't intrinsically with derivatives but their incompetent use by management; there are vested interests/hidden agendas behind calls to regulate (e.g., lawsuits for parties whom lose money in transactions); regulating the derivatives business is like squeezing a balloon; and additional regulations and reporting beg the difficult questions of competent regulation and regulators and of what exactly to report. As Rancière and Tornell note, "[Excess] financial repression and government intervention ...would drastically reduce risk-taking and growth. Our research shows that over the last five decades countries that have liberalized financially are the ones that have grown faster, even though they have experienced rare crises."
Which is greater hubris: corporate managers speculating they know more than Wall Street specialists on the direction and extent of future general economic metrics, or the Obama Administration thinking heavy-handed regulation and stifling financial innovation will eliminate economic crises (instead of unilaterally handicapping future American business and job growth)? If there is something which could bring more order in the recent chaos, it's greater transparency, the kind that arises through an exchange. Lenzner points out that the new Intercontinental Exchange is serving as a national clearinghouse for CDS contracts, including the related books of almost all relevant major banks and dealers, made available to regulators (and, one would hope one day, the general financial marketplace).
Public Policy Played a Big Role in the Housing Bubble
The fact is, both parties got political benefit from a robust housing market and a historically high relative percentage of American homeowners. The private sector, quasi-public sector (GSE's) and the government (e.g., the FHA) have approved bad loans.
We had fundamental supply/demand issues; there was too much money in the market chasing a limited number of houses. Accommodative monetary policy by the Fed Reserve; high demand by foreign investors for mortgage-backed securities implicitly backed by the government, and Democratic politician pressure to open the market for lower-income/high-risk applicants without conventional down payments or other creditworthiness factors (including stable income and other assets, limited coexisting debts, credit history, etc.) played roles. A number of mortgage-backed securities were not properly diversified by geographic risk, being disproportionately weighted toward clearly frothy markets in California, Nevada, Florida and elsewhere.
Government-Run Mortgage Lending: A Role Model of Lending Prudence?
Michael Moore, no doubt, wants us to aspire to the generous government-run example of the FHA versus the greedy private-sector. Consider this excerpt I've reorganized from The New York Times:
Skittish lenders are asking for 20 percent down, which few prospective borrowers have to spare. As a result, private lending has dwindled. The government has stepped into the breach, facilitating loans with down payments as low as 3.5 percent and offering other incentives to stabilize the market. The F.H.A. is insuring about 6,000 loans a day, four times the amount in 2006...As the number of loans has soared, random quality control checks have decreased sharply, F.H.A. staff members say. Mr. Donohue, the inspector general, cited numerous examples of organized fraud in testimony to Congress earlier this year.
The number of F.H.A. mortgage holders in default is 410,916, up 76 percent from a year ago, when 232,864 were in default, according to agency data...7.77 percent of the portfolio is in default, up from 5.6 percent a year ago...The troubled loans are nevertheless weighing on the agency’s capital reserve fund, which has fallen to below its Congressionally mandated minimum of 2 percent.
“It appears destined for a taxpayer bailout in the next 24 to 36 months,” Edward Pinto, a former Fannie Mae executive, said in testimony, [predicting] that F.H.A. losses would more than wipe out the agency’s $30 billion of cash reserves.Don't you just love the way the FHA is stepping up to build up market share (just like GSE's Fannie Mae and Freddie Mac once did) at the expense of the private sector, while a properly chastened private sector is clamping down on credit risk? Where is Michael Moore's indignation at the FHA furiously writing new mortgages in the middle of a severe recession with already inadequate reserves to service ill-performing loans?
The Times provides 2 cases of FHA-mortgage homeowners for our consideration:
[Take] Bernadine Shimon. She lost a house to foreclosure, declared bankruptcy, got divorced and is now a single mother, teaching high school [in Denver]. She wanted a house but no lender would touch her. The Federal Housing Administration was more obliging. With the F.H.A. insuring her mortgage, Ms. Shimon was able to buy a $134,000 fixer-upper in August.
Chaz Fullenkamp, an automotive technician in Columbus, Ohio, got an F.H.A. loan even though he was living on the financial edge. “If I got unemployed, I’d be wiped out in a month or two,” he says. Mr. Fullenkamp used F.H.A. insurance to buy a house this spring for $179,000. The eager seller paid the closing costs and also gave Mr. Fullenkamp $2,500 in cash. He immediately applied for the $8,000 tax rebate. Even taking his down payment into account, he came out ahead. “I knew in my heart I could not really afford the house, but they gave it to me anyway,” said Mr. Fullenkamp, 22. “I thought, ‘Wow, I’m surprised I pulled that off.’ ”People might wonder how well-paying and secure a high school teaching job is (given government budget constraints in a deep recession), not to mention household expenses for a single-parent home and out-of-pocket expenses to renovate the home. Yes, Mr. Fullenkamp, we American taxpayers can't believe you pulled that off, too. You have to admire his inventive double-dipping, using the Obama tax rebate to cover the FHA-required down payment (money is fungible). Two months away from not covering his mortgage payment? He's not sure he can afford to own a home, but Barack Obama is there to say, "Yes, you can!"
In Maryland, there is a local car dealer group (Antwerpen) with a distinctive tagline for a prospect's offer for a car: "Jack says, "Yes!"" I'm waiting for the White House
