Wednesday, November 19, 2008

Why Have Homeowners Been Forgotten?

As part of the latest directional shift in the allocation of the bailout funds being managed by Hank Paulson, it seems homeowners have once again been overlooked. The bailout funds which were originally intended to boost the lending markets have now been earmarked to boost bank balance sheets. Paulson and Bernanke seem much more concerned with propping up failing banks than homeowners at this point. Anthony Freed from Your Mortgage or Your Life even goes so far as to call them liars. You can read more about this in his blog post below.

Two months ago, in late September, I penned a piece titled Liars, and the Lying Lies They Are Telling You, which examined just one single publicly available FDIC document from 2002 which shows beyond any doubt that the Feds were not only aware of the problems in the finance industry that have led to near economic collapse today, they were already convinced that there would soon be dire repercussions.

Yet, today we have Treasury Secretary Hank Paulson and his mini-me Neel Kashkari, as well as a host of other top Federal officials, testifying under oath that the threats to our economic security were not immediately apparent until just months ago - hence the gun-to-the-head threats that produced the biggest bailout of private industry in history, while prescribing less governance on the application of those funds than is required to redeem a typical twenty-cent manufacturers coupon for kitty-litter.

Now we will see Barney Frank and others on the Hill posture and shuffle, as they feign attempts to look like they are in control of anything whatsoever, and they will act surprised that they had handed Paulson and his boy a blank check, and they is spending it as they sees fit.

Well, there should be no surprise there if they actually took the time to read the legislation they passed.

Paulson, who is overseeing the bailout program for the Bush administration, changed course and announced last week that the government would not use any of the money to buy rotten mortgages and other bad assets from banks. That had been the centerpiece of the plan when Paulson and Bernanke originally pitched it to lawmakers.

“Our assessment … is that this is not the most effective way” to use the bailout money, Paulson said at that time.

Instead, Paulson said the department would focus on rolling out a capital injection program to pour $250 billion into banks in return for partial ownership stakes in them.

The idea behind the capital injection program is for banks to use the money to rebuild reserves and lend more freely to customers. However, banks do have the leeway to use the money for other things, such as buying other banks or paying dividends to investors. That has touched a nerve with some lawmakers. Locked-up lending is a prime reason why the U.S. is suffering through the worst financial crisis since the 1930s. All the fallout from the housing, credit and financial crises have badly hurt the economy, which is almost certainly in recession, analysts say.

FDIC chief Sheila Bair continues to be the loan voice - I mean lone voice - advocating that some of the crumbs of the Bailout Cake be scattered in the direction of distressed borrowers who are, or will soon be, facing foreclosure.

In a break with the administration stance, Sheila Bair, chairman of the Federal Deposit Insurance Corp., who also will testify Tuesday, recently proposed using $24 billion of the bailout money to help some American households avoid foreclosure. So far, the Treasury Department has pledged $250 billion for banks and has agreed to devote $40 billion to troubled insurer American International Group(AIG Quote - Cramer on AIG - Stock Picks) — its first slice of funds going to a company other than a bank. That leaves just $60 billion available from Congress’ first bailout installment of $350 billion.

As much as I appreciate that there is at least one person in the Federal Government’s ivory tower who has some sense of the pain and heartache that the American Homeowner is facing, even if her advocacy basically ends with the gavel and the conclusion of the hearings.

The hearings may address a lot of things today, but the most important thing they will not address is who is responsible for letting us get into this terrible position in the first place? Are we and the now completely vegetative national press, really expected to believe that no one saw this entire catastrophe heading our way, when a simple Google search will produce hundreds of documents that show that version of the truth is ridiculously false?

In the article Liars, and the Lying Lies They Are Telling You, I featured testimony by Karen Shaw Petrou and others who were sounding the alarm repeatedly, exposing the vulnerabilities to the system posed by the nearly industry-wide use of risk-abatement models that only work in a market that never contracts.

That was a fatal strategy on the part of the financial industry. The notion that Federal Regulatory agencies were not aware of the risks is patently false. From 2002:

“The next panelist, Karen Shaw Petrou, Managing Partner of Federal Financial Analytics, had a considerably different take on the appropriateness of the Basel initiative. Ms. Petrou said that she has significant concern with Basel II, not because the individual pieces of it are necessarily wrong but because “nobody understands how it all works together.”

Ms. Petroustressed that reliance on models on which the Basel rules are based must be evaluated with tremendous caution and a careful look at the bottom line. She also highlighted problems with the operational risk rule. Reputation risk is not included in the Basel definition of operational risk for purposes of determining a capital requirement. As another weakness of the Basel II proposal, Ms. Petrou stressed the difficulty with relying on models.

She suggested that the Basel Committee move forward only with the provisions of the rule on which there is widespread agreement and considerable evidence of immediate need.”

In the article, I half-jokingly asked if any readers happened to know where Karen Shaw Petrou was today, and wheter or not she was available to take either Paulson’s or Bernake’s jobs. Well, a friend from - Tom Cordle - was curious enough to follow through, and what he found is gold: More proof that the Federal Regulatory Agencies charged with protecting the economy, the nation, and the American taxpayer from the reckless profiteering that is the nature of capitalism were at best asleep on the job - at worst they were completely complicit in the manufacturing of this crisis.


Trillions of dollars of our tax money to bailout foreign investors, and nothing for distressed homeowners but failed programs and broken promises. The bailout money is now being directed to the Credit Card companies and foreign investors, and the icing is that they want us to believe that they never imagined this could happen.

That is a bald-faced lie. The following is subsequent Congressional testimony from Karen Shaw Petrou, this time the pudding is from 2006:

Testimony Of Karen Shaw Petrou

Managing Partner

Federal Financial Analytics, Inc.

Before the Subcommittee on Financial Institutions and Consumer Credit

Committee on Financial Services

U.S. House of Representatives

September 14, 2006

This panel has led the way in recognizing the critical importance of the Basel risk-based capital rules, starting the policy debate in early 2002 with the first Congressional hearings on the rules long before many in the industry realized their critical importance. I was honored to testify then to offer views on the rules at that early stage and am grateful again now to outline ways to modernize the regulatory-capital requirements governing U.S. financial-services firms.

Sad to say, much of what I will say today is what I said in 2002 and at several later hearings on the proposal in the House and Senate. For example, in 2002, I urged the regulators carefully to consider the competitive implications of their rules. The House Financial Services Committee has pressed hard on this point and the agencies are now paying heed to it, but I fear that many aspects of the most recent proposal still do not address ongoing problems raised by the unique nature of the U.S. industry. It is different in many key respects from other national financial-services regimes, and U.S. rules must thus be carefully tailored to reflect U.S. reality.

There is, though, one key difference between 2002 and now: the Basel risk-based capital rules - for better or worse - are final everywhere else but here. Thus, we no longer have the luxury of pushing for a better international Accord. That is now final, and banks around the world will start to operate under it in January of 2007. This means not only that internationally-active U.S. banks will operate under anachronistic capital rules that place them at a disadvantage and that put the banking system at risk - that would be bad enough. However, it also means that foreign firms may have an undue capital advantage with which to enter the U.S. and acquire banks and other financial-services firms. As I said before this panel in May of 2005, M&A by global firms here is fine if it’s a fair fight. It isn’t fine, though, if our domestic institutions are gobbled up by foreign competitors able to engage in “regulatory arbitrage” solely because we can’t make up our minds on our capital standards.

What are the key U.S. financial-system realities that must be kept carefully in mind as new capital rules are finalized? Put very simply, they are:

  • We are facing emerging financial risks, most notably in housing and mortgage markets. We can debate all day long if the housing “bubble” will burst or fizzle, but we know for sure that U.S. consumers are highly leveraged and are making use in unparalleled fashion of high-risk mortgage products. The current Basel I rules applicable to all U.S. institutions woefully under-capitalize high-risk assets, creating a regulatory incentive for banks to hold them. Getting the risk right in risk-based capital is not just an issue for model builders. It’s a critical challenge to protect the FDIC and the economy more generally.
  • In the U.S. bank regulatory capital rules cover only insured depositories and a subset of parent holding companies. We have a wide range of charter options, the consolidated supervised entity (CSE) importantly among them, that permit astute companies to pick and choose among the charters. Outside the U.S., almost all firms fall under the Basel rules, eliminating much of the competitiveness concerns critical in the U.S. The Basel rules as now finalized may be good, bad or indifferent, but they will apply with few distinctions outside the U.S., ensuring the proverbial “level playing field.” We will have a most uneven one - with dangerous systemic-risk ramifications - if the final U.S. bank capital rules do not reflect our charter and supervisory diversity. The proposed operational risk capital standard is particularly problematic in our competitive and legal reality.
  • We have a unique capital requirement, the “leverage” standard proposed now to continue under the Basel IA and II regimes. Advocates of leverage argue that it will counteract possibly risky drops in regulatory capital. However, the leverage standard, while providing false comfort, exacerbates the charter disparities noted above because it applies only to some financial-services players, not to all of them. It is, further, no panacea for the problems in Basel. This panel will well remember the thousands of banks and S&Ls that failed in the 1980s and early 1990s even as the leverage standard applied to each and every one of them.
  • We have thousands of banks, savings associations and credit unions - not just the four or five big players that dominate most other markets. Initial plans simply to ignore all but the biggest U.S. banks in the Basel rules have rightly been shelved, but the current proposal still has unnecessary restraints on what size institution may choose which capital regime. Each insured depository and, when applicable, holding company should choose the rules it thinks are right for it, not have that choice defined by its regulators. Supervisors have full powers - actually expanded under the Basel proposals - to intervene and add more capital if they think an institution’s choice is risky.

With these thoughts in mind, I offer and urge the following recommendations related to the Basel rules in the U.S.:

  • First, we need to get our rules in place as fast as possible. If we can’t make up our minds on the more complex issues, leave them aside and finalize at least the simpler, “standardized” sections of the rules (revised for U.S. mortgage and other issues as necessary) and the Basel IA requirements. As noted, the current Basel I rules encourage risk-taking because there is no regulatory capital penalty for it. A simple rewrite that better equates risk-based capital to risk is urgently needed, and debate over the fine points of these highly-complex rules should not deter action on their key points on which there is, in fact, broad general agreement.
  • Second, we should not cling to the leverage standard in hopes that it will protect us from “undue” capital drops. I very much doubt that risk-based capital under Basel II would drop here in anywhere near the amounts suggested by the fourth quantitative impact study, which was based on top-of-the-cycle numbers and back-of-the-envelope estimates. Putting banks and their holding companies through all of the hoops and all the added expense of the Basel rules and then slapping the leverage standard atop them undermines the entire point and purpose of the Basel standards and - importantly - is far from the guarantee of safety and soundness hoped by those now pushing for retaining the leverage standard. It should be discarded - especially for holding companies - and regulators should rely on their own powers and market discipline to press banks that might consider unwise capital reductions to think again.
  • Third, the U.S. rules should not include an operational risk-based capital (ORBC) standard. The Basel IA proposal rightly does not include this and it should similarly be omitted from the Basel II rules. While this will put the U.S. Basel II rules at still more variance with the international Accord, it is necessary because of the lack of any agreed-upon methodology or measurement systems for operational risk. Worse still, a focus on ORBC will distract both banks and supervisors from urgently-needed disaster preparedness and contingency planning - capital is no substitute for back-up systems and advance planning as was made all too clear after September 11 and Hurricane Katrina.
  • Finally, we must make up our mind and move forward. All of the benchmarks, caveats, limits and questions in the Basel II rules create wholesale uncertainty about what capital rules will apply when to whom. As noted, U.S. banks operate in the real world of aggressive competitors at home and abroad. We have proposed imposing not only new risk-based capital standards, but also new powers for regulators to buttress these - Pillar 2 - and new disclosure standards - Pillar 3 - to enhance market discipline. Far too little attention has been paid in the current debate to these critical elements of the overall Basel framework - indeed, they are almost unmentioned in the current notice of proposed rulemaking. Rightly structured, however, these two additional pillars will give U.S. regulators all the tools they need to ensure that capital is right for each bank under their purview without forcing institutions into the one-size-fits-all leverage standard, benchmarks, and other constraints on Basel now under consideration.

In conclusion, Basel critics might wish none of this had started and the U.S. could just get back to Basel I as is. This is understandable given all the flaws in the initial proposal and all the problems to which regulators turned a deaf ear for so long. However, it is critical to remember that Basel I as is rewards risk-taking and the leverage standard as is will do nothing to constrain this. It is also vital to remember that major competitors at home and abroad are now or will soon come under a more risk-sensitive capital regime with no leverage standard. Each and every one of these firms is a major force to be reckoned with in the U.S. whether or not it chooses to become a bank under the Federal Reserve’s domain or headquarter itself here.

Thus, Basel II is here like it or not. Charters will be selected and deals done based on it, like it or not. The longer U.S. banks are kept under Basel wraps, the fewer of them there will be under our traditional regulatory framework. The longer Basel I is in place, the riskier our banking system will be - leverage standards now have no meaningful impact on risk other than to encourage taking it. Unless Congress is prepared to rewrite our rules and force all banks - big and small - and all competitors under the same capital regime - a major challenge that would keep Congresses busy for years to come - U.S. banks cannot be the last ones allowed to come under modern, risk-sensitive regulatory capital standards.

This article has been reposted from Your Mortgage or Your Life. The full post can also be viewed on


Anonymous said...

Nothing will be perfect, we can't save everyone - but we can at least make the banks and the borrowers both negotiate in good faith a resolution that keeps the losses from being passed on to the taxpayer - this will solve a chunk of the problem.

It is sure better than what we are doing now, which is using our tax dollars to incentivize the banks to let the foreclosures happen - they get reimbursed for their losses, end up owning 1/3 of all the homes in America, and never lose a dime of their 100's of billions of ill-gotten pay, bonuses and sweetheart stock option deals - putting the economy in the toilet while they walk away with our money.

This is better than anything I have heard, as it addresses most of the issues surrounding the crisis for the working-folk: foreclosure and eviction.

Screw the banks, let them pick up the repair costs out of the billions in fees they charged to make these bad loans - then there will be work for unemployed construction workers.

Anonymous said...

help homeowners with a tax paid only buy people that don't rent. that way it will be fair.

put a line in the federal tax code that says "if you own a house, add $2,000"

simple enough. people that rent to avoid paying inflated home prices shouldn't pay a dime of the homeowners bailout.

Anonymous said...

Sorry to be a wet blanket, but people who rent their abodes do so from people who own them.

Renters are already paying a mortgage, all housing upkeep, taxes, interest, insurance - and they would end up paying the $2K you want to lump on top of that.

How about no bailouts, force the lenders and borrowers to fix their own problems - if a borrower can Refi at a current 30y Fixed, than do it - I don't care if the borrower is under water in a 50 year amortization, i don't care if the bank and their investors take it in the shorts because they have to forgive principle - it's their deal, make them work it out.

There will be some who can't pay the 30y fixed payment, they will get foreclosed upon but not evicted, and they will be forced to pay rent and mitigate the banks losses.

I f they can not pay rent - they have bigger problems which are not mortgage related.

there will be pain, but make it equal for the lenders and borrowers, and stop paying the banks to foreclose on people who could be made to pay.