Learning Center
Plans & pricing Sign in
Sign Out

BoA's proposed bailouts


									New Y ork TImes

February 23, 2008

A ‘Moral Hazard’ for a Housing
Bailout: Sorting the Victims From
Those Who Volunteered

WASHINGTON — Over the last two decades, few industries have
lobbied more ferociously or effectively than banks to get the government
out of its business and to obtain freer rein for “financial innovation.”

But as losses from bad mortgages and mortgage-backed securities climb
past $200 billion, talk among banking executives for an epic
government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of
Congress this month provides a stunning glimpse of how quickly the
industry has reversed its laissez-faire disdain for second-guessing by the
government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at
“moderate to high risk” of defaulting over the next five years and that
millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal
Homeowner Preservation Corporation that would buy up billions of
dollars in troubled mortgages at a deep discount, forgive debt above the
current market value of the homes and use federal loan guarantees to
refinance the borrowers at lower rates.

“We believe that any intervention by the federal government will be
acceptable only if it is not perceived as a bailout of the bond market,” the
financial institution noted.
In practice, taxpayers would almost certainly view such a move as a
bailout. If lawmakers and the Bush administration agreed to this step, it
could be on a scale similar to the government’s $200 billion bailout of
the savings and loan industry in the 1990s. The arguments against a
bailout are powerful. It would mostly benefit banks and Wall Street
firms that earned huge fees by packaging trillions of dollars in risky
mortgages, often without documenting the incomes of borrowers and
often turning a blind eye to clear fraud by borrowers or mortgage

A rescue would also create a “moral hazard,” many experts contend, by
encouraging banks and home buyers to take outsize risks in the future,
in the expectation of another government bailout if things go wrong

If the government pays too much for the mortgages or the market
declines even more than it has already, Washington — read, taxpayers —
could be stuck with hundreds of billions of dollars in defaulted loans.

But a growing number of policy makers and community advocacy
activists argue that a government rescue may nonetheless be the most
sensible way to avoid a broader disruption of the entire economy.

The House Financial Services Committee is working on various options,
including a government buyout. The Bush administration may be
softening its hostility to a rescue as well. Top officials at the Treasury
Department are hoping to meet with industry executives next week to
discuss options, according to two executives.

“There are a lot of ideas out there,” said Scott Stanzel, a spokesman for
President Bush, when asked at a White House press briefing on Friday
about a possible buyout program. “There are many different ways in
which we can address this problem and we continue to look at ways in
which we can do that.”

Supporters contend that a government rescue could be the fastest and
cleanest way to force banks and investors to book their losses from bad
mortgages — a painful but essential first step toward stabilizing the
housing market.

The government would buy the mortgages at their true current value,
perhaps through an auction, at what would probably be a big discount
from the original loan amount. The mortgage lenders, or the investors
who bought mortgage-backed securities, would be free of the bad loans
but would still have to book their losses.

If the government took control of the bad mortgages, supporters of a
rescue contend, it could restructure the loans on terms that borrowers
could meet, keep most of them from losing their homes and avoid an
even more catastrophic plunge in housing prices.

“Every citizen has a dog in this hunt,” said John Taylor, president of the
National Community Reinvestment Coalition, a community advocacy
group that has developed its own mortgage buyout plan. “The cost of
spending our way out of a recession is something that everybody would
have to bear for a very long time.”

Mr. Taylor estimated the government might end up buying $80 billion
to $100 billion in mortgages. But he said the government could recoup
its money if it was able to buy the mortgages at a proper discount,
repackage them and sell them on the open market.

Surprisingly, the normally free-market Bush administration has
expressed interest. Treasury officials confirmed that several senior
officials invited Mr. Taylor to present his ideas to them on Feb. 15. Mr.
Taylor said he had also received calls from officials at the Office of Thrift
Supervision and the Office of the Comptroller of the Currency, which is
part of the Treasury Department.

But even supporters acknowledge that a government rescue poses risks
to taxpayers, who could be left holding a very expensive bag.

Ellen Seidman, a former director of the Office of Thrift Supervision and
now a senior fellow at the moderate-to-liberal New America Foundation,
said the government’s first challenge is to buy mortgages at their true
current value. If the government overpaid or became caught by an even
further decline in the market value of its mortgages, taxpayers would
indeed be bailing out both the industry and imprudent home buyers.

“It’s not easy, but it’s not impossible,” Ms. Seidman said. “There are
various auction mechanisms, both inside and outside government.”

A second challenge would be to start a program quickly enough to
prevent the housing and credit markets from spiraling further
downward. Industry executives and policy analysts said it would take
too long to create an entirely new agency, as Bank of America suggested.
But they expressed hope that the government could begin a program
from inside an existing agency.

But even if the government did buy up millions of mortgages and force
mortgage holders to take losses, the biggest problem could still lie
ahead: deciding which struggling homeowners should receive breaks on
their mortgages.

Administration officials have long insisted that they do not want to
rescue speculators who took out no-money-down loans to buy and flip
condominiums in Miami or Phoenix. And even Democrats like
Representative Barney Frank of Massachusetts, chairman of the House
Financial Services Committee, have said the government should not
help those who borrowed more than they could ever hope to repay.

But identifying innocent victims has already proved complicated. The
Bush administration’s Hope Now program offers to freeze interest rates
for certain borrowers whose subprime mortgages were about to jump to
much higher rates. But the eligibility rules are so narrow that some
analysts estimate only 3 percent of subprime borrowers will benefit.

Bank executives, meanwhile, warn that the mortgage mess is much
broader than people with subprime loans. Problems are mounting
almost as rapidly in so-called Alt-A mortgages, made to people with
good credit scores who did not document their incomes and borrowed
far more than normal underwriting standards would allow.

Borrowers who overstated their incomes are not likely to get much
sympathy. But industry executives and consumer advocates warn that
foreclosed homes push down prices in surrounding neighborhoods, and
a wave of foreclosures could lead to another, deeper plunge in home

Right or wrong, the arguments for rescuing homeowners are likely to be
blurred with arguments for rescuing home prices. At that point, industry
executives are likely to argue that what is good for Bank of America is
good for the rest of America.
OC register

Wall Street refugee examines mortgage bust

February 23rd, 2008 · 3 Comments · posted by Matt

Don’t hate Louis Pizante. He worked for a Wall Street firm that made mortgage-
backed securities, but he personally never to uched subprime.

Still, now seems like a good time to pick his brain on what the heck is going on in
Wall Street’s world and where we go from here.

Pizante, 37, previously was an associate in the investment banking arm of
Greenwich Capital Markets, a bond specialist based in Greenwich and owned by
the Royal Bank of Scotland. Before that he worked for New York-based Nomura
Asset Capital, Goldman Sachs, and Deloitte & Touche.

These days Pizante, who has a law degree from New York University School of
Law, is chief of Irvine-based Mavent Inc., a company that automatically checks if
home loans comply with more than 300 federal, state and local consumer
protection laws. His clients range from Fannie Mae, the largest U.S. funder of
home loans, to Wall Street firms such as Citigroup and Morgan Stanley.

Pizante gives Mortgage Insider his scorecard on Wall Street winners and losers
as well as what regulators should or shouldn’t do next.

Q. What do you think of the brouhaha over rating agencies giving
investment grade blessings to subprime-related debt that now doesn’t look
so investment grade?

A. Clearly a great many of those ratings were — to be kind — wide of the mark.
Critics point to several problems, including: (1) inherent conflicts of interest
because issuers pay the agencies; (2) bad advice because ratings are based on
data taken at face value and supplied by issuers; and, (3) oligopolistic
inefficiencies because financial regulations require ratings.

These are difficult issues to resolve. The agencies have introduced some
meaningful, albeit limited, changes to their businesses. But the most practical
solution would be an independent standards board with policing authority, similar
to the accounting industry. And investors have to do more due diligence
themselves. Of course, it may all be moot depending on when the market comes
back and what it looks like then.

Q. So how do you rate the performance of your former Wall Street
investment banking colleagues during the credit boom and bust?
A. The writedowns provide a pretty unambiguous scorecard on the Street’s
performance. Clearly some institutions — such as Goldman and JP Morgan —
get high marks. But others got high on their own supply, holding onto the less
marketable classes of mortgage-laced securities. Unquestionably, greed got
ahead of good judgment.

But lost in all this is that for a while the subprime and securitization markets did
provide meaningful liquidity to an underserved borrower segment, increasing
homeownership rates nationally. The problem is that the market as a whole, and
its regulators, did not exercise responsible checks and oversight. In this light, is
levying a wholesale indictment of Wall Street akin to throwing the baby out with
the bathwater?

Q. What’s your fix for the Wall Street side of this mess?

A. Of the many things that can be said about Wall Street, few can disagree that
the subprime correction started before the regulators and media became
involved. The current rush of investigations and enforcement actions may be
warranted. But none of this will prevent what has already happened and its future
impact is questionable. The fact is that Wall Street’s present deal flow is slower
than a wounded snail towing a tank. We know Wall Street will come back, but it
will look and smell a whole lot different. In the meantime, lawmakers need to be
careful not to hastily introduce new rules crafted for a market that no longer

Q. On the consumer side, what do you think of the government f ixes so far
(raising conforming loan limit, getting lenders to extend introductory teaser
rates on loans etc.)? Will any of them work?

A. These government fixes are well-intentioned. But they don’t look like a very
good bargain from the point of view of ta xpayers and responsible consumers.
They’re also not very fair to responsible lenders. Raising the conforming loan
limit will affect a very small number of neighborhoods. Even then, most borrowers
in those neighborhoods still will not qualify for a new loan. Freezing interest or
payment rates and retroactively changing bankruptcy rules will ultimately result in
higher cost loans. Lawmakers and regulators should focus on enforcing existing
consumer protection laws. Several existing laws afford victimized borrowers
adequate remedies and protections. Enforcement provides relief to those truly
aggrieved borrowers, while forcing those lenders and investors that broke the law
to bear the costs.

Q. Here are three key fixes suggested by columnist Jonathan Lansner: Let
everyone make home loans including Wal-Mart, make brokers and lenders
have as much fiduciary responsibility to consumers as stock brokers, and
make the income reported by a borrower under a “stated income” loan go
automatically to the IRS. What do you think?
A. These suggestions are worth consideration. Not surprisingly, the mortgage
industry considers “fiduciary duty” the f-word. Brokers who claim to get their
clients the best rate are arguably holding themselves out as agents and should
have fiduciary obligations accordingly. Imposing fiduciary duties on lenders is a
tougher sell. Is it sensible to force one party to a contract to protect the interests
of the other party? In any event, fiduciary standards are subjective and fact -
sensitive. This makes them difficult to enforce and harder to fulfill. Regarding “low
doc” loans, borrowers should be legally required to verify income or assets. If this
means that a few truly well off terrorists and drug dealers are unable to obtain
financing, so be it.

Q. Speaking of the consumer side, consumer activists say California
regulators have been too lax in their oversight of lenders and brokers.
What do you think?

A. Enforcement is a problem for consumers and for mortgage lenders. Lax
enforcement creates an uneven playing field that benefits unscrupulous lenders
and puts responsible lenders out of business. But to solve the problem it is first
important to understand who it is that regulates mortgage institutions.

Most mortgage institutions that were engaged in subprime lending are licensed
by the state. In California, the Department of Corporations (DOC) had 25
examiners at the peak of the boom to oversee more than 4,800 state-licensed
lenders. But some of the largest financial institutions are federally regulated.
Wells Fargo, for instance, is a national bank regulated by the Office of the
Comptroller of the Currency (OCC). The OCC has 34 examiners assigned to
Wells. However, the OCC is primarily concerned with “safety and soundness” not
consumer protection. In fact, the OCC has been very aggressive in preempting
state consumer protection laws and blocking state attorneys’ general from
investigating allegedly systemic fair and predatory lending claims. So, in some
cases the enforcement problem is created by resource shortfalls and in others
policy decisions.

Q. Your statement that the OCC has been very aggressive in preempting
state consumer protection laws echoes a recent commentary in the
Washington Post by Elliot Spitzer, current governor of New York and
former AG there – he basically said the same thing. The Comptroller of the
Currency John Dugan responded by saying: “Almost everyone who has
paid attention to the subprime lending crisis has concluded that OCC-
regulated national banks were not the problem. Instead, the worst abuses
came from loans originated by state-licensed mortgage brokers and
lenders that are exclusively the responsibility of state regulators.” Dugan
said state regulators should have done a better job. So who is right?

A. I think that is an interesting story. They are both a little bit right. The national
banks were not as aggressive in subprime as state licensed lenders like
Ameriquest and New Century. But there were operating subsidiaries of national
banks that did engage in some of this lending and national banks did fund the
state licensed lenders either by providing warehouse lines or purchasing their
loans for securitization. So I do think it’s a little bit of both.

Q. Let’s talk more about the federal level. Critics say the Federal Reserve
under Alan Greenspan was too ideological. Under his free market ideology,
the Fed did not enforce consumer protection power granted to it by the
Home Ownership and Equity Protection Act (HOEPA) of 1994, critics say.
Your take?

A. The criticism that federal regulators did little to restrain lenders and protect
consumers when the boom was under way has some merit. But it only goes so
far in explaining what went wro ng. The most expansive reading of HOEPA grants
the Fed limited authority. It does not address deceptive broker representations or
a borrower’s ability to repay. This notwithstanding, there are other federal
consumer protection laws aside from HOEPA, such as the broader Truth-In-
Lending (of which HOEPA is part), UDAP, RESPA and CRA. The current crisis
makes clear that the federal agencies need to do a better job of balancing
institutions’ “safety and soundness” with the enforcement of these laws and
consumer protection more generally.

  Stumble it!

This entry was posted on Saturday, February 23rd, 2008 at 3:00 am and is filed under Q&A. You
can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or
trackback from your own site.

3 Responses to “Wall Street refugee examines mortgage bust”

   1. mo Says:
       February 23rd, 2008 at 6:13 am

       FYI - Stock brokers are NOT held to a fiduciary standard - only Registered
       Investment Advisers are held to such standards. Google “Merrill Lynch
       Rule” to find out more.l

   2. Neal Says:
       February 23rd, 2008 at 11:13 am

       “Don’t hate Louis Pizante. He worked for a Wall Street firm that made
       mortgage-backed securities, but he personally never touched subprime.”
   I’ll try not to. I would suggest, however, that the damage from this
   “situation” exceeds that of 9/11 in both cost and lives. Oh sure, no one has
   died - but how many lives have been ruined? This is a shameful episode
   in American history and all involved should be too embarrassed to be

3. Rational expectations Says:
   February 23rd, 2008 at 12:25 pm

   My ears always prick up when I hear the “baby with the bath water”
   metaphor. Who put the baby IN the bath water? Where are they now? Any
   unnecessary damage that is being done now to mortgage bankers is a
   direct consequence of their stupidity and greed. The sad fact is that there
   are also externalities. Firms and individuals (our whole society, really) will
   suffer from this, even though many were not involved. Misguided attempts
   to help “homeowners keep their homes” are really helping the same
   entities that caused this disaster. We must do eve rything possible to help
   people walk away from their homes. This leaves the banks holding the
   bag (entirely appropriate). It clears the market more quickly, and since
   most people are not inclined to leave if they have equity or even out of
   inclination, there is not a huge need to police this. The banks will squeal
   like stuffed pigs, but as they have been stuffed for years with our money, a
   little bacon is due. Higher borrowing costs? Do you really think that this
   isn’t going to happen anyway? It may even draw in some new actors.
   Small to medium sized banks are looking to re-enter mortgage lending.
   The closer connection to the community is a good thing. Warren Buffet is
   opening a bond insurer. He is charging more, but I have yet to see anyone
   claim that this is bad for business. Making it more expensive to borrow
   may even encourage borrowers to be a bit more careful, next time. For
   now, if mortgage bankers suffer, good.

To top