Rethinking home loans without regulation means a repeat of crisis

Update:  Thursday, August 9. Today Fannie Mae announced a quarterly profit of $10 billion and projected profits for the foreseeable future. When this dividend is paid, Fannie will have repaid approximately $105 billion of $116 billion it received from taxpayer bailout.

The latest quarterly gain followed a record $58.7 billion net income in the first quarter, when Fannie capitalized on tax benefits it had saved from its losses on loans during the crisis. It paid a first-quarter dividend of $59.4 billion to the Treasury.

In a major policy speech yesterday President Obama announced plans to reshape federal rules for 30-year fixed mortgages. The idea is to preserve the policy goal of getting American workers and their families into affordable home loans, but in practice this has played out with troubling consequences.

Obama’s speech comes on the heels of news that Freddie Mac, the country’s largest home loan lending institution along with Fannie Mae, reported a $5 billion net profit in the second quarter, compared with $3 billion from the same period last year. The earnings will offset all losses from mortgage defaults, which continue to be a problem for the housing sector, banks, and consumers.

The federal bail out Freddie Mac and Fannie Mae during the financial crisis in 2008 amounted to $187 billion, but since a housing recovery started percolating last year both institutions have again become profitable. Roughly, they have paid back roughly $136 billion of government loans, which is helping to make the budget deficit this year the smallest since Obama took office.

In his speech yesterday the President proposed overhauling the home loan system, including the elimination of Freddie Mac and Fannie Mae from the mortgage guarantee business. Obama claimed taxpayers should not be in the position of “holding the bag” for the risky business strategies of such giant financial institutions. However, President Obama did not clarify the rationale of the goal to preserve the 30-year home loan, a financial instrument that does not appear in other industrialized countries.

One problem with the long-term strategy of home ownership is that the size and cost of owning property has increased while income has stagnated for those working individuals and families who need such long-term loans. Another problem is that banks and lending institutions still have no regulations that prohibit them from using mortgage guarantees in risky financial investments, including derivatives trading, which led to the sub-prime mortgage crisis and, by extension, the financial collapse of the economy. The preservation of this policy goal under the same economic circumstances therefore means a future catastrophe for lenders and borrowers alike. Why finance a 30-year home loan on a mortgage that consumers cannot afford, when it remains a risky investment strategy?

Economists worry financial lessons from last recession are ignored

There is an interesting article in today’s New York Times by Adam Davidson of NPR’s “Planet Money” that explores both sides of the economic spectrum about whether more or less regulation is an essential lesson we have failed to learn from the Great Recession. Below is an excerpt:

Five years ago this month, before Lehman Brothers imploded and the global economy lurched to a halt, Fannie Mae issued a report that encapsulated the financial system’s biggest problem. The mortgage-finance company, which was wobbling on account of rising defaults, tried to reassure investors that it had $47 billion in capital, which was considerably more than the $30 million required by law. At the time, the report’s authors seemed to fear that some investors might think Fannie was too cautious. In any event, a month later, that protection seemed like a joke. Fannie may have conformed to the rules, but the rules didn’t conform to reality. The lender and its brother company, Freddie Mac, were declared insolvent and handed over to the U.S. government.

Remarkably, five years after the crisis, the health of the financial industry is just as hard to determine. A major bank or financial institution could meet every single regulatory requirement yet still be at risk of collapse, and few of us would even know it. Despite endless calls for change, many of the economists I’ve spoken with have lamented that the reports that banks issue about their finances remain all but useless. The sprawling Dodd-Frank Act, which rewrote banking regulation in 2010, didn’t resolve things so much as inaugurate a process of endless rules-writing by regulators. Meanwhile, the European Union is in the early stages of figuring out how it will change the way it regulates banks; and the gargantuan issue of coordinating regulations across borders has only barely begun. All of these regulatory decisions are complicated, in part, by a vast army of financial-industry lobbyists that overwhelms the relatively few consumer advocates.

Economists have also been locked in their own long-running arguments about how to make the banking industry safer. These disagreements, which are generally split between the left and the right, can have the certainty and anger of religious wars: the right accuses the left of hobbling banks and undermining prosperity; the left counters that the relatively lax regulation advocated by the right will lead to a corrupt oligarchy. But there actually is consensus on one of the most important issues. Paul Schultz, director of the Center for the Study of Financial Regulation at the University of Notre Dame, led a project that brought together scholars of financial regulation from the left, the right and the center to figure out what caused the financial crisis and how to prevent a sequel. They couldn’t agree on anything, he told me. But a great majority favored higher equity requirements, which is bankerspeak for the notion that banks shouldn’t be allowed to borrow so much.

Read the entire article here.

Mergers return but is it real growth?

Despite weak economic growth and dim forecasts for more robust growth in the future, large corporations are taking advantage of weak sales and declining profits to make big on mergers and acquisitions. This week the boards of both American Airlines and U.S. Airways approved an $11 billion merger that has been in the works for almost two years while American has sought bankruptcy protection after losing over $12 billion over the last decade.

Analysts say mega-mergers like the one by the two airlines are back in vogue for some very specific reasons. First, the climate of fiscal austerity after the financial collapse led to firms downsizing and laying off thousands of workers. As a result Fortune 500 companies are now sitting on $1 trillion in cash reserves that are being used to make big plans for a period of future growth.

In addition, credit and finance appears to be on healthier footing than the last few years as banks and lending institutions begin to lend again. Also, private equity firms are once again bargain shopping after  consolidating their credit lines and divesting themselves of toxic holdings.

Finally, financial analysts and investors are cautiously looking to the future in which a period of growth will mean expansion and larger shares of profit. The 500 stock index of the S&P reached its highest levels since 2007 signaling to investors that the time for growth is coming and encouraging companies to go bargain shopping for other firms.

When combined together these different factors are behind the mega-mergers. For example, Dell Computers announced last week as well that it was planning a $24 billion buyout by owner Michael Dell in order to take the company private again. Also, Virgin Media announced a $16 billion acquisition deal by media mogul John Malone for Liberty Global.

The new wave of mega-mergers brings with it mixed results, however. Mergers and acquisitions always lead to downsizing and layoffs, which cripples effective demand further during recessions. Moreover, the promise of improved products and better deals for consumers almost never turn out to be accurate. Profits are the primary concern of such large commercial transactions, and as its been the case historically with other large airline mergers, lower airfares will not be forthcoming.

Justice Department, SEC give up investigation into Goldman Sachs

The Department of Justice announced it will not bring civil or criminal charges against investment bank Goldman Sachs, despite its probable violations of various banking and securities laws that precipitated the financial collapse of 2008. In a statement it released yesterday, investigators said they “ultimately concluded that the burden of proof to bring a criminal case could not be met based on the law and facts as they exist at this time.”

On the same day Goldman Sachs also revealed that the Securities and Exchange Commission was ending its investigation into a $1.3 billion subprime mortgage deal without bringing charges.

Given the close ties between Goldman Sachs and the government, the timing of these announcements raises red flags about the adequacy of banking and financial regulations and signals a lack of political will to hold large banks accountable for creating our present economic mess.

These announcements are surely disappointments to millions of mortgage holders, consumers, and taxpayers who are shouldering the costs of Goldman Sachs and other large banks’ complicated and ill-conceived banking practices. Although the Justice Department and SEC claim there is insufficient evidence to prosecute, these announcements in no way exonerate the large investment bank from its share of responsibility in creating and sustaining America’s largest financial disaster since the Great Depression.

Despite election year rhetoric pinning America’s economic problems on President Obama’s shoulder the real problem  appears to be lax Congressional oversight, impotent laws, and regulatory agencies with cozy ties to their friends in the banking industry. Without the political will in Congress to write stronger laws to regulate this industry, mortgage holders, consumers and taxpayers alike are unlikely to see any substantial relief from the financial and political corruption that is rife in this country.

Barclays scandal spreads to US banks, regulators, and politicians

As big banks face the fallout from a global investigation into interest rate manipulation, American and British lawmakers are scrutinizing regulators who failed to take action that might have prevented years of illegal activity

Political officials in London and Washington this week are questioning whether regulators allowed banks to report false interest rates that precipitated the 2008 financial collapse. On Monday, Congress requested information about the role of the Federal Reserve Bank of New York in failing to properly regulate bank interest rates. The Senate Banking Committee on Tuesday also announced it was looking into the issue.

The new focus on regulators, banks, and other financial institutions such as credit rating agencies has intensified in the last two weeks after the British bank Barclays agreed to pay $450 million to resolve a civil case after it was discovered it had been manipulating key interest rates. Regulators accused the bank of improperly influencing these rates to deflect concerns about its capital backing and financial viability.

The Barclays settlement is the first of its kind stemming from an ongoing investigation into the question whether banks set key benchmarks, including Libor, or the London interbank offered rate. Other countries are considering action against more than ten large banks, including JPMorgan and Citigroup. The banks also face civil litigation from cities, investors, and financial firms that contend they lost billions from the misreporting of these key interest rates. Such lawsuits could end up costing the banking industry tens of billions of dollars.

The House Financial Services Committee sent a letter to the New York Fed on Monday seeking transcripts from dozens of phone calls in 2007 and 2008 that took place between central bank officials and executives at Barclays. Among the officials that the Senate Banking Committee plans to question during hearings this month include Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner, who ran the New York Fed during the crisis. Geithner has long been criticized by opponents on both the left and right as an insider to the financial mess who has allowed key players off the hook.

The attempt by political officials to reign in financial manipulation by large firms and create more regulation has been hampered by political corruption during a presidential election year where multiple and conflicting constituencies must be satisfied. The Obama administration in particular has been lax to regulate the financial industry, in part, because Wall Street donors were one of President Obama’s largest contributors in the 2008 election.

Moody’s downgrades world’s banks

In 2011, a Congressional Report was released exposing those financial institutions responsible for the recession. The finger was pointed squarely at large investment banks as well as credit rating agencies for colluding to undermine the checks and balances that are supposed to keep the latter impartial, so that investor’s can be confident their evaluations of the former are accurate.

The report found that both Moody’s and Standard and Poor’s were both complicit in rigging scores for those banks, as well as the toxic financial products they were selling to investors. Both agencies knew that banks were off-loading toxic assets in investment bundles that were bogus, but gave those same products high scores in order to attract investors to them. As a result, hundreds of billions of dollars of other people’s money was lost, banks made out big by betting against these toxic assets in the derivatives market, and credit rating agencies made large bonuses from those banks for their part in perpetuating lies to the public

What a difference a year makes. Yesterday, Moody’s announced it was downgrading 15 of the world’s largest financial institutions, including several major U.S. banks such as Citigroup and Bank of America. Once cozy in their collusion with these agencies, banks reacted swiftly and disingenuously to the news. Citigroup accused Moody’s of doing poor research and advised its investors to search for other agencies with credit ratings more favorable to it (and therefore probably false). The bank released a statement to the effect that Moody’s “fails to recognize Citi’s transformation over the past several years…Citi strongly disagrees with Moody’s analysis of the banking industry and firmly believes its downgrade of Citi is arbitrary and completely unwarranted.”

Along with Citigroup and Bank of America, Moody’s evaluated 13 other banks:  Morgan Stanley, JPMorgan Chase, Goldman Sachs, Credit Suisse, Deutsche Bank, UBS, HSBC, Barclays, BNP Paribas, Crédit Agricole, Société Générale, Royal Bank of Canada, and Royal Bank of Scotland.

Analysis was based on firms’ capital ratios and whether they would be able to survive so-called “stress tests” modeling another severe recession. Many of the largest U.S. banks failed those tests, or were close to failing, prompting the downgrade in their credit ratings.

For consumers, homeowners, small business owners and retirees the downgrade is too little, too late. In election year politics relief for these stakeholders has also been slim to none. Democrats and Republicans alike play the blame game on one another, pandering for emotionally-charged votes, while members from both parties take significant amounts of cash from the financial industry, which has one of the largest armies of lobbyists in Washington to ensure very little is done to regulate it.

The move by Moody’s is good, and reflects a long-overdue divorce between two industries that should not be in bed together. Whether the long-term effects of this downgrade will mean more accurate information and better oversight remains doubtful without aggressive political action to curtail the greed Wall Street has substituted for the public agenda.

When it comes to smart investing, the lesson is bankers gamble big

The CEO of JPMorgan Chase continued his testimony before Congress today concerning the multi-billion trading loss that bank announced last month. Jamie Dimon testified before the House Committee on Financial Services yesterday, and in a humorous exchange with Rep. Gary Ackerman (D-NY) revealed just how deep self-deceit goes for those holding the cards of America’s financial future.

Ackerman: What is the difference between gambling and investing?

Dimon: I think when you gamble you usually lose to the house.

Ackerman: That’s been my general experience with investing.

Dimon: I’d be happy to get you a better financial advisor.

The idea that the house is fixed but investing is not is increasingly falsified by our experience with the financial collapse. The joke would be funny if Dimon could deliver better financial advise, but as it is JP Morgan does not have a great track record when it comes to making winning bets on acceptable risks.

Andrew Rosenthal of the NYT said this:  “There are many obvious differences between gambling and investing, but let’s just stick to the one that Mr. Dimon offered – there is no fix for the house (the bank) when you invest.”

Rosenthal reports that Chase regularly engages in questionable gambles with apparent fixes. According to an article from last year on JPMorgan and Sigma, a troubled pre-crash investment vehicle. “In the summer of 2007, as the first tremors of the coming financial crisis were being felt on Wall Street, top executives of JPMorgan Chase were raising red flags about … Sigma…But the bank chose not to move out $500 million in client assets that it had put into Sigma two months earlier.”

As a result Sigma collapsed and all of the bank’s clients lost nearly all their money, while JP Morgan collected nearly $1.9 billion. That’s one more example of gamblers losing to the house. I’ll take 10 to 1 odds that its clients wish they had a better financial advisor!

JP Morgan’s Dimon lies to Congress

Today marks the second day of testimony before Congress from JP Morgan’s CEO and chief financial officer Jamie Dimon regarding a multi-billion trading loss the bank recently disclosed to investors.

Despite an increasingly heated debate about financial regulation and banking reform Dimon and other CEOs from the nation’s largest banks have insisted all along that oversight is not necessary, that financial institutions are capable of policing themselves. His testimony before the Senate Banking Committee today included the same naïve assessment—or is it “bad faith”?—despite the fact that risky investments with massive social and economic consequences has become standard operating procedure in the unchecked derivatives markets.

Dimon claimed the loss was an “isolated incident” and spent much of his time defending a pipe-dream vision of the economy called the “free market.” When Sen. Jeff Merkeley (D-OR) asserted that the government had already bailed out Chase Bank in 2008 from similar risky ventures, Dimon (falsely) asserted, “You’re factually wrong.”

Maybe Dimon’s wealth has insulated him from reality and the truth because he is dead wrong, and someone should put his impromptu lying in its context.

  • Fact:  JP Morgan/Chase was on the verge of bankruptcy in 2008 after it colluded with other banks, insurers, and credit agencies in packaging toxic assets and selling them on the derivatives market, all the while betting against its own toxic assets as a form of insurance fraud.
  • Fact:  The U.S. taxpayer bailout of its risky and unethical behavior amounted to $25 billion.
  • Fact:  The recent disclosure of a trading loss on he same derivatives market is likely to reach $5 billion, proving beyond a reasonable doubt that JP Morgan continues its pattern of risky and unethical behavior.
  • Fact:  The U.S. needs serious financial regulation and banking reform. Without such efforts financial institutions like JP Morgan and their lying-for-a-living CEOs will continue to erode the economy, our trust in one another, and the social fabric as well.

SEC permits fraud by big banks, taxpayers call for real oversight

A recent New York Times investigation of Securities and Exchange Commission (SEC) cases involving fraud by some of the nation’s biggest banks discovered dozens of instances over the last decade in which banks were charged with violating anti-fraud laws but were never punished because they “promised” not to violate the law again.

For example, Citigroup agreed last month to pay $285 million to settle civil charges that it defrauded customers during the housing meltdown. They promised not to violate the law again, even though they had made this same promise in settling similar charges in July 2010 and several other instances going back to 2000.

An analysis of enforcement actions during the past 15 years found at least 51 cases in which the SEC concluded that Wall Street firms had broken anti-fraud laws they had agreed never to breach. The 51 cases spanned 19 different firms, including Citigroup, Bank of America, Goldman Sachs, JP Morgan, and Morgan Stanley.

Critics of the SEC and big banks are urging Congress to take action against the agency and force it to do the job it is intended to do as the nation’s watchdog and enforcement agency for financial and banking laws. Sen. Carl Levin (D-MI) is calling for an investigation into the agency’s enforcement practices. When asked why none of the banks had been charged with contempt of the law for repeatedly violating promises not to break anti-fraud laws, the SEC could only respond that it had not brought any contempt charges in the last decade despite repeated violations.

The cozy relationship between banks and politicians is primarily to blame for the failure of both markets and market oversight in this country. If the SEC is unwilling to enforce the law’s it is charged with enforcing, then Congress and the Obama Administration have the duty to force a turnover in that agency and appoint regulators who will do their job. When regulators don’t do their job, private actors are encouraged to make poor and risky economic decisions that adversely impact the rest of us. It’s time Congress put teeth into the regulation the financial and banking industries. Otherwise, it is not a question “if” there will be another financial collapse but “when.” ::KPS::

NYT analysis of repeat Wall Street offenders.