Loanowner bailouts were designed to benefit banks, an insider’s view

The bubble collapse was rife with denial caused by false rumors of homeowner bailouts. Many homeowners held out hope that if they could just keep current on their mortgage long enough, the government would come to their rescue in the form of a mandated bailout program.  Many such programs were attempted, but if their stated goal was to keep loanowners in the properties they occupied, these programs were a dismal failure — thankfully. If they had succeeded, the moral hazard would have served to inflate an even more massive housing bubble in the future. Moral hazard is central issue in housing bust.

Part of the bailout fantasy was not just that people could keep their homes, but that they could keep living their lifestyle as they did during the bubble. What few seemed to realize was any government bailout program would be designed to benefit the lenders by keeping borrowers in a perpetual state of indentured servitude. With all their money going toward debt service payments, little was going to be left over to live a life. Bailouts were designed to benefit the banks, if loanowners got something out of the deal, that was a bonus.

Unfortunately, most people simply don’t get it. Many believe the bailouts were actually designed to help them. This was a public relations boost for the government, but it served to rightfully increase the public’s anger against the banks.

America’s bank bailouts

They did not have to be so unfair

Oct 31st 2012, 12:38 by M.C.K. | WASHINGTON

… The common theme of both Neil Barofsky’s Bailout and Sheila Bair’s Bull by the Horns is that the U.S. government cared a lot more about saving the incumbent banks and bankers than it did about helping regular Americans blindsided by the collapse of the housing market and the ensuing contraction. As a result, many Americans now believe that the rules are rigged against them for the benefit of a few politically-connected financial speculators: privatized gains and socialized losses. It is difficult to disagree.

It is difficult to disagree because that is exactly what happened. Bailouts were only intended to keep incompetent bankers in power. The very men who made reckless and foolish bets — and lost — were given a massive bailout to cushion them from enduring any consequences for their actions.

On one side of the ledger, we see that the big banks are bigger than ever, more than 90% of the gains in GDP in the past four years have accrued to those in the top 1% of the income distribution, and total Wall Street pay is still near record highs despite a sharp drop in employment.

Those statistics are shocking and disturbing. A crony system that rewards incompetence with largess is doomed, but not before the perpetrators loot our economy and the government coffers for their own personal gain.

On the other, we find that median net worth fell by 40% since 2007, real median income is still 8% lower than in 2007, there are still more than 7 million fewer full-time jobs than in 2007, and there have been at least 4 million foreclosures, many of which could have been prevented through investor-friendly government policies.

The average American paid a heavy price for the greed of Wall Street bankers. Of course, the ones who fared the worst are those who played the game themselves. The rich and powerful bankers had better connections in Washington, so they got the bailouts rigged in their favor.

A few excerpts from the review:

Mr Barofsky reports that no one in the Treasury Department and almost nobody at the Federal Reserve seemed concerned that some might try to exploit the government’s largesse. Whenever Mr Barofsky tried to ensure that banks were using TARP funds to make loans—the stated purpose of the programme—he was told that it would be impossible because “all money is green”. Yet the bankers themselves had no problem telling journalists how they planned to use the cheap capital to buy competitors or hoard cash for a rainy day.

Why would banks have lent money in 2008? There were few qualified borrowers, and a significant portion of the national population had embraced Ponzi personal financing. Loaning money to Ponzis is akin to setting it on fire, so that would have served no one. If hoarding cash and buying competitors was the best use of the funds, that’s what these banks should have done. Would it be preferable for them to make more loans to Ponzis and go back for a larger bailout later?

Ms Bair recounts how the methodology used to calculate the “stress tests” was cleverly altered so that Citi would keep its tax breaks.

That one makes me sick. Anyone with half a brain knew the stress tests were a whitewash and a public relations theater to shore up confidence in the banking system. I didn’t know Citi obtained special dispensation.

This resourcefulness was not applied to help keep people in their homes … When asked how the government’s efforts were supposed to help homeowners, Timothy Geithner, the treasury secretary, responded by explaining that they would aid the banks by slowing down the pace of foreclosures.

Timothy Geithner specifically endorsed amend-extend-pretend and the creation of shadow inventory. Bankers must have been thrilled when Obama picked him.

… This subprime loan came in two parts. For the first two or three years borrowers paid a “teaser” interest rate of around 7% or 8%, after which they would then have to pay a much higher rate for the remainder of the thirty-year mortgage—often between 11%-15%. These products were literally designed to be unaffordable. The theory was that borrowers would be forced to perpetually refinance into new hybrid ARMs after the teaser periods expired, which would generate a fortune in fee income. Steep prepayment penalties discouraged refinancing from occurring until after the higher interest rate had already kicked in.

Serial refinancing was one of the sicknesses of the housing bubble. Ponzis came to rely on it, and lenders developed products to exploit the Ponzis. Despicable.

According to Ms Bair’s account, the lenders who originated hybrid ARMs deliberately misled borrowers—precisely the sorts of financially unsophisticated households who could least afford the risks and obscured fees presented by them. This might not have been illegal but it was definitely distasteful.

By late mid-2007, the incipient financial crisis had made it nearly impossible for borrowers to refinance these loans before getting crushed by the higher interest rates. While some might have been driven into default irrespective of the interest rate because they had been betting on future home price appreciation that did not materialize, many others, according to Ms Bair, could have afforded to keep paying their mortgage at the level of the teaser rate. …

Notice that the author of this article downplays the importance of the Ponzis while emphasizing the problems of those who didn’t understand what they were getting into. This is exactly backward. There were very few that got caught up in teaser rate loans without understanding that payments would go up, but these were the exceptions not the rule. Most were Ponzis who wanted the advantage of lower payments and cash out to live the good life. They knew the payments would go up later requiring them to refinance into another Ponzi loan.

The mistake these people made was believing the opportunity to refinance into another Ponzi loan would always be available. Most who got caught up on serial refinancing believed the cycle of serial refinancing would never end. Their mistake was foolishness, not gullibility. That’s an important distinction because the foolish are responsible for their choices whereas the gullible are not. The borrowers caught up with serial refinancing are responsible for the mistakes they made.

Fannie Mae and Freddie Mac, the government-sponsored mortgage insurance companies, had bought about one-third of all the toxic securities issued during the height of the bubble.

The foolish purchase decisions of the managers of the GSEs necessitated the bailouts. Contrary to the popular myth spun by the political Right, the GSEs had little to do with inflating the housing bubble. The bubble was inflated by private mortgage-backed security pools financing Option ARMs and interest-only loans that allowed balances much larger than incomes could support. These pools were not commissioned by the GSEs, nor did they carry GSE insurance guarantees. The GSEs did load up their balance sheets with this toxic crap at the height of the housing bubble because they were losing market share. Well, they got market share, and now we are paying the bills for their mistakes in judgement — not that they didn’t take bonuses and golden parachutes on the way out the door.

As a result, the government should have been able to exert leverage over other investors to come to a deal. Few seriously expected to earn anything above the teaser rate on these products, since they were designed mainly for creating churn fees. Yet Ms Bair reports that Fannie and Freddie were particularly resistant to any modification of the loans in their securities portfolio. …

In October, 2007, Ms Bair gave a presentation to a group that had been involved in bundling together subprime loans into toxic securities. She asked them why they were refusing to do something that was fundamentally in their interests. Subprime borrowers were deadbeats, they said. Give them a gift like this and they’ll blow it on a new flat-screen television.

Yes, they would have. However, I would add that this behavior isn’t limited to subprime. Ponzi borrowing crosses all socioeconomic bounds.

In that case, Ms Bair wanted to know, why had these Armani-clad dealmakers lent out the money in the first place? “Bad regulation,” she was told.

Bullshit. That is part of the right-wing narrative, but it simply isn’t true. The money was lent to these people because the lenders didn’t think they had any risk. First, nobody seriously thought house prices would go down, so even if they defaulted in large numbers — which they did — the resulting default losses would be small. Further, most investors who funded these securities purchased credit default swaps from AIG or other parties who dangerously underpriced the risk involved. To make matters worse, the ratings agencies gave these toxic securities AAA ratings giving a false sense of safety to the investors. Based on the erroneous and foolish assumptions the investors accepted at face value, these were not poor investments. None of this, I repeat, none of this had anything to do with bad regulation — other than perhaps the Greenspan federal reserve should have regulated the credit default swaps more vigorously.

… Both books also provide delightful accounts of Tim Geithner, the Treasury Secretary. … Ms Bair prefers to focus on Mr Geithner’s obsession with saving Citi and his relationship with Robert Rubin:

Tim Geithner’s mentor and hero, Bob Rubin, had served as the chairman of the organization and, as the Financial Crisis Inquiry Commission would later document, had had a big impact in steering it toward the high-risk lending and investment strategies that had led to its downfall. I frequently wonder whether, if Citi had not been in trouble, we would have had those massive bailout programs. So many decisions were made through the prism of that one institution’s needs.

Billions of dollars of taxpayer money was squandered because Timothy Geithner wanted to bail out Bob Rubin. That is the definition of crony capitalism.

Ms Bair makes the interesting observation that Citi’s large losses in the beginning of 2007 should have caused regulators to step in and prevent it from paying bonuses that year. Had it been normally-sized, this is surely what would have occurred, as well as management changes. Instead, Citi paid out the third-largest volume of dividends of all American firms in 2007. Who was Citi’s top regulator during that time? Timothy Geithner. …

Not just did he bail out the company, he arranged it so they could continue to pay out unwarranted bonuses. Nice job. He will probably be offered a job at Citi after he leaves government. He’s earned it.

Looking back four years after the bailouts began, it is worth taking stock, as these authors did, of the paths not taken. The proponents of the status quo like to present a false narrative that there were only two choices: do exactly what was done, or unleash Armageddon. As Mr Barofsky and Ms Bair show, there were alternatives.

I see many comments from readers who fall into this false dichotomy. We did have other choices. For one, we could have nationalized the banks, thrown out the incompetent management, recapitalized them, and sold them for a profit when conditions improved. This would have greatly accelerated the processing of bad loans and recycling of troubled assets. Perhaps the recession might have been deeper, but it also would have been shorter. The problems we still face today are a direct result of not taking more aggressive action back in 2008 when it was warranted.