Two recent bank bailouts and another on the way in 2013
The US Government and the federal reserve spent billions bailing out the banking system in 2008 from a financial crisis created by foolish lending. Commercial banks and Wall street securitizers pumped trillions of dollars into dodgy mortgages, much of which was refinance money given to Ponzis, so it wasn’t just late purchasers who were in trouble. When the toxicity of the lending products became apparent, a credit crunch ensued, and residential real estate prices plummeted by 30% or more nationwide. With limited collateral backing their bad loans and millions of delinquent borrowers, lenders couldn’t foreclose on all the properties to recover their capital. The problem was so large that the banks couldn’t absorb the losses without bankrupting the system. Given the political influence of the financial sector, politicians decided to bail out the banks with your tax dollars. So millions of Americans who did not participate in these private, greed-induced financial transactions ended up covering the losses.
But it gets worse. The banks weren’t content with just an initial round of bailouts. They continue to use their political influence to seek ongoing bailouts, not the direct cash infusions of the financial crisis, but stealth bailouts where the interests of taxpayers are ceded in favor of bank profits. There were two recent stealth bailouts, and one more is on the way.
Bailout Outrage #1:
By GRETCHEN MORGENSON — Published: February 16, 2013
MANY people became rightfully upset about bailouts given to big banks during the mortgage crisis. But it turns out that they are still going on, if more quietly, through the back door.
The existence of one such secret deal, struck in July between the Federal Reserve Bank of New York and Bank of America, came to light just last week in court filings.
That the New York Fed would shower favors on a big financial institution may not surprise. It has long shielded large banks from assertive regulation and increased capital requirements.
Still, last week’s details of the undisclosed settlement between the New York Fed and Bank of America are remarkable. Not only do the filings show the New York Fed helping to thwart another institution’s fraud case against the bank, they also reveal that the New York Fed agreed to give away what may be billions of dollars in potential legal claims.
Here’s the skinny: Late last Wednesday, the New York Fed said in a court filing that in July it had released Bank of America from all legal claims arising from losses in some mortgage-backed securities the Fed received when the government bailed out the American International Group in 2008. One surprise in the filing, which was part of a case brought by A.I.G., was that the New York Fed let Bank of America off the hook even as A.I.G. was seeking to recover $7 billion in losses on those very mortgage securities.
It gets better.
What did the New York Fed get from Bank of America in this settlement? Some $43 million, it seems, from a small dispute the New York Fed had with the bank on two of the mortgage securities. At the same time, and for no compensation, it released Bank of America from all other legal claims.
This is an outrage. Bank of America should be liable to the US taxpayer for repayment of funds that were used to cover losses from their toxic securities. To release them from this liability is no different than giving them a direct cash gift.
But Walker F. Todd, a former official at the Federal Reserve Bank of Cleveland, warned: “As a public entity, the Federal Reserve needs to take its custody of public funds seriously enough to ask for more than merely nominal compensation when it is giving up things of value to a bank holding company. If the central bank starts releasing binding legal claims for nominal compensation, it looks like just one more element of the secret or back-door bailout of the banking system.”
It looks like a back-door bailout because it is. The federal reserve hopes this bailout is too complex for people to understand and that very few people will find out. The federal reserve wants to maintain its independence, but if they continue to provide taxpayer-funded bailouts to their cronies, they need to come under stronger federal government oversight and control. This kind of activity should require the approval of congress, after all, they gave away billions of taxpayer dollars.
Bailout Outrage #2:
A lesser-known but equally grave problem is that banks have been given a backdoor mechanism to continue foreclosures at the same pace as before.
The problem involves second mortgages, which millions of homeowners took out during the housing bubble. It’s estimated that as much as a quarter of all mortgage debt in the United States is in the form of second mortgages. Some of these loans were taken out to finance home improvements; others were part of a subprime product known as an “80/20 mortgage,” in which 80 percent of the purchase price was covered by a first, adjustable-rate mortgage, and the remainder by a second mortgage, often with a much higher interest rate.
And many were taken out by HELOC abusing Ponzis who spent it like drunken sailors.
The second mortgages have given the banks a loophole: each dollar a bank forgives goes toward fulfilling its obligation under last year’s settlement. But many lenders have made it a point to almost exclusively modify secondary loans while all but ignoring the troubled, larger primary mortgages.
It’s a real problem: when it comes to keeping your home, it’s the first mortgage that counts.
… When a lender forecloses on a first mortgage, the house in question is typically sold at auction. If the house is worth less than the loan amount, the bank gets only part of its money back. But after the sale, of course, there’s no asset left to pay off any of the second loan. The holder of that second loan — which has lower priority than the holder of the first — gets nothing.So a lender can forgive a second mortgage — which in the event of foreclosure would be worthless anyway — and under the settlement claim credits for “modifying” the mortgage, while at the same time it or another bank forecloses on the first loan.
Banks carry billions of dollars of worthless second mortgages on their balance sheets. The fact that they get credit toward their settlement obligations for recognizing a loss they should have recognized years ago is another outrage. If the banks hadn’t convinced regulators to suspend mark-to-market accounting, they would have been forced to recognize the losses on hundreds of billions of dollars in worthless second mortgages years ago. Now, they are selectively recognizing these losses and getting kudos for doing so. Unbelievable.
The upshot, of course, is that the people the settlement was designed to protect keep losing their homes.
Many of the political left suffer from this delusion. The settlement was never designed to prevent people from losing their homes. If that occurs for a few, its a bonus, but the real purpose was to give the banks a shield against future litigation and provide politicians for political cover for providing this shield. The cost of the settlement, the supposed punishment, is being covered by recognizing losses they would have incurred anyway. It’s a sham.
Bailout Outrage #3:
WASHINGTON – For the second consecutive State of the Union speech, President Obama called for legislation that would allow struggling homeowners to refinance their mortgages and take advantage of lower interest rates.
In a speech almost entirely devoted to other issues, Obama said the housing markets were “healing,” noting that “home prices are rising at the fastest pace in six years.”
But he said Congress must do more, and urged lawmakers to pass a pending bill that would make it easier for homeowners to refinance their homes.
“Even with mortgage rates near a 50-year low, too many families with solid credit who want to buy a home are being rejected,” Obama said. “Too many families who have never missed a payment and want to refinance are being told no. That’s holding our entire economy back, and we need to fix it.” …
Democratic Sens. Robert Menendez of New Jersey and Barbara Boxer of California reintroduced a bill last week that would help borrowers with Fannie Mae and Freddie Mac mortgages to refinance.
I wrote about the upcoming bailout in the post, Menendez, Boxer plan bill to transfer bank losses to US taxpayer. If passed into law, the legislation would encourage private-label mortgage backed securities to be repackaged into lower interest loans backed by the GSEs even if these loans are severely underwater. Since underwater loans are the most likely to go into default, and since underwater loans create the largest default losses, this bill transfers billions of dollars in future losses and trillions of dollars in liabilities away from the private sector and on to the back of the US taxpayer.
And what does the taxpayer get out of it? Nothing.
It may benefit a few loanowners who will get to refinance at a lower rate — an inappropriate use of public funds to benefit private parties — but the cost to taxpayers will be enormous. The real beneficiaries of this law are the banks and investors holding these toxic assets on their balance sheets. Right now, they have to reserve significant accounting reserves for future losses. Once these loans get refinanced, the loss reserves can be eliminated boosting their capital ratios and improving their bottom line.
The other bailout
We shouldn’t forget that the biggest bailout of the banks isn’t recognized as such: low interest rates. The federal reserve is doing its part to reflate the housing bubble and put collateral value behind their bad loans. This is the biggest bailout of all, and everyone will pay for it through higher house prices and future inflation. And they’re not done bailing out the banks yet. I expect more of the same going forward.