Rightwing origins of the sub-prime mortgage fiasco

The Conservative Origins of the Sub-Prime Mortgage Crisis

Everything you ever wanted to know about the mortgage meltdown but

were afraid to ask.

by John Atlas and Peter Dreier

Hardly a day goes by without a news story about the accelerating

number of foreclosures, an economic tsunami that is causing chaos in

the housing and stock markets, the banking industry, and the global

money markets, not to mention upending families and neighborhoods.

Business leaders, activist groups, and Democratic presidential

candidates are calling for our government to do something before the

situation declines even further. The problem is worsening in every

part of the country, but two early primary states -- Florida and Nevada

-- are among the hardest hit.

The crescendo of criticism recently pushed President George W. Bush to

announce a plan to freeze interest rates for up to five years for some

homeowners who purchased homes with high-risk adjustable rate

mortgages (ARMs) that are scheduled to be "reset" at higher rates, in

many cases, by hundreds of dollars a month.

The Republican candidates for president generally supported the Bush

plan but were reluctant to call for further regulations to protect

borrowers. Some pundits, including former Texas Rep. Dick Armey, a

right-wing Republican who now runs a conservative think tank,

FreedomWorks, suggested that the Bush plan violated the president's

oft-spoken zeal for allowing the "free market" to work. The media fell

for Bush's media spin, describing it as a interest rate "freeze" and

an "agreement" hammered out with lenders and investors. But in fact

the Bush plan involves no mandates or legislation, just a voluntary

agreement by lenders that lacks the force of law. There's absolutely

no requirement that would force banks or investors to share the pain

or be part of the solution. It isn't even clear if investors in

mortgage-backed securities will allow the lenders to reset the rates.

They may even file suit to halt the freeze.

Consumer activists, and the Democratic candidates, pointed out that

the plan excludes most sub-prime borrowers, including those who are in

the deepest trouble and are delinquent on their mortgage payments and

facing foreclosure. Of the perhaps 2 million adjustable-rate mortgages

that are expected to reset through the end of 2009, only 240,000 of

them -- 12 percent -- would be covered by Bush's proposal, according to

Barclays Capital, as reported in The New York Times. The Center for

Responsible Lending, a nonprofit group, estimates that only 145,000

households will qualify for the rate freeze. Most borrowers will be on

their own to negotiate with their lenders on a case-by-case basis.

Many families who persuade banks to temporarily freeze their rates

still won't be able to afford to make the payments, and will face

foreclosure.

"It's very disappointing," said Michael Shea, executive director of

ACORN Housing, a national group that provides homeownership counseling

for low-income consumers. "Wall Street has made billions and now

they're hardly paying anything at all" for their role in the sub-prime

crisis.

Make no mistake -- it is a crisis. Since 1998, more than 7 million

borrowers bought homes with sub-prime loans. One million of those

homeowners have already defaulted on their loans The crisis is likely

to get worse. Financial analysts predict that at least a quarter of

these people -- over 2 million families -- will default and face the

financial pain and psychological grief of losing their homes over the

next few years.

Bush, who once touted his administration's goal as creating an

"ownership society," may now go down in history as the president on

whose watch ownership declined. The nation's homeownership rate has

fallen during the last two years and will plummet further next year.

Moreover, Bush's unwillingness to take bold steps to regulate lenders,

brokers, and investors will guarantee that the next president will

inherit a much bigger mortgage mess.

To many Americans, the crisis seems too complex to comprehend. To

understand it, we need to know: What is the problem? Who benefited?

Who got hurt? Who is to blame? Who should we help? What should be

done? Although the immediate cause is the widespread use of sub-prime

mortgages, the root cause is a decades old failure of government to

adequately regulate the banking industry.

What Is Sub-Prime Lending?

Sub-prime lending is a fancy financial term for high-interest loans to

people who would otherwise be considered too risky for a conventional

loan. These include middle-class families who have accumulated too

much debt and low-income working families who want to buy a home in

the inflated housing market. To cover their risk, lenders charge such

borrowers higher-than-conventional interest rates. Or they make

"adjustable rate" loans, which offer low initial interest rates that

jump sharply after a few years. Only a decade ago, sub-prime loans

were rare. But starting in the mid-1990s, sub-prime lending began

surging; these loans comprised 8.6 percent of all mortgages in 2001,

soaring to 20.1 percent by 2006. Since 2004, more than 90 percent of

the sub-prime mortgages came with exploding adjustable rates.

With interest rates low, housing prices on a steady rise, and

practically no government regulation, mortgage finance companies

devised high-interest, high-fee schemes to entice families to take out

loans that traditional savings banks would not make. Many of the

lenders were legitimate operations providing a market for credit-risky

people. But there also were huge corporations, such as Household

Finance, that sought extraordinary profits through unsavory means,

called predatory loans. Not subject to government regulation, they

bent the rules, lowering normal banking standards.

Mortgage brokers, the street hustlers of the lending world, often used

mail solicitations and ads that shouted, "Bad Credit? No Problem!"

"Zero Percent Down Payment!" to find people who were closed out of

homeownership, or homeowners who could be talked into refinancing.

They seduced millions of people into signing on the dotted line.

Although sub-prime lending has been concentrated in minority and low-

income urban areas, it has spread to the middle-class suburbs.

The sub-prime lenders didn't hold on to these loans. Instead, they

sold them -- and the risk -- to investment banks and investors who

considered these high interest rate, sub-prime loans a goldmine. By

2007, the sub-prime business had become a $1.5 trillion global market

for investors seeking high returns.

The whole scheme worked as long as borrowers made their monthly

mortgage payments. When borrowers couldn't or wouldn't keep up the

payments on these high-interest loans, what looked like a bonanza for

everyone turned into a national foreclosure crisis and an

international credit crisis. For millions of families, the American

Dream of homeownership has become a nightmare.

The mortgage meltdown has serious ripple effects. Foreclosed houses

become vacant, deteriorate into eyesores, and detract from the

neatness and feeling of well-being in neighborhoods. Vacant houses

also attract crime and make it more difficult for neighbors to

purchase homeowners' insurance.

In neighborhoods with several foreclosed homes, property values, and

thus local property-tax revenues, plummet, making it harder for cities

to provide good schools, police protection, and other services.

According to a new report by the U.S. Conference of Mayors, the weak

housing market and the large inventory of unsold homes will likely

reduce home values by $1.2 trillion next year. About half of that

amount is due to the sharp increase in foreclosures.

Who Benefited and Who Got Hurt?

Mortgage brokers, who occupy an unregulated niche of the lending

world, made a commission for every borrower they handed over to a

mortgage lender. These brokers are like the drug dealers on the street

corner. They are the smallest link in a lending chain that includes

some of the largest and most respectable Wall Street firms.

Large mortgage finance companies and banks made big bucks on sub-prime

loans. Last year, 10 lenders -- Countywide, New Century, Option One,

Fremont, Washington Mutual, First Franklin, RFC, Lehman Brothers, WMC

Mortgage, and Ameriquest -- accounted for 59 percent of all sub-prime

loans, totaling $284 billion.

Wall Street investment firms set up special investment units, bought

the sub-prime mortgages from the lenders, bundled them into "mortgage-

backed securities," and for a fat fee sold them to wealthy investors

around the world. According to The New York Times, China's second-

largest bank, Bank of China Ltd, held almost $9.7 billion of

securities backed by U.S. sub-prime loans. These investors, who bought

the collateralized securities, were happy as long as they got paid

their higher interest on the bonds or other investments.

With the bottom falling out of the sub-prime market, more than 80

mortgage companies went under in the past six months. Major Wall

Street firms took billion-dollar losses as the crisis ripped into

foreign money markets, from London to Shanghai. Lehman Brothers

underwrote $51.8 billion in securities backed by sub-prime loans in

2006 alone; as of September, 20 percent of those loans were in

default, the Times reported. Similarly, about one-fifth of the sub-

prime loans packaged by Morgan Stanley, Barclays, Merrill Lynch, Bear

Stearns, Goldman Sachs, Deutsche Bank, Credit Suisse, RBS,

Countrywide, JP Morgan, and Citigroup are 60 or more days delinquent,

in foreclosure, or involve homes that have already been repossessed.

The executives and officers of some mortgage finance companies cashed

out before the market crashed. The poster boy is Angelo Mozilo, the

CEO of Countrywide Financial, the largest sub-prime lender. He made

more than $270 million in profits selling stocks and options from 2004

to the beginning of 2007. And the three founders of New Century

Financial, the second largest sub-prime lender, together realized $40

million in stock-sale profits between 2004 and 2006. Paul Krugman

reported in The New York Times that last year the chief executives of

Merrill-Lynch and Citigroup were paid $48 million and $25.6 million,

respectively.

The hardest hit are the innocent borrowers of sub-prime loans. Many of

them are working- and middle-class families who fell victim to the

country's economic squeeze, a hardship not of their own doing but a

symptom of the Bush years. They faced layoffs, stagnant wages, and

rising costs of home heating, gasoline, utilities, food, and child

care. For those without health insurance, one serious medical problem

wiped out their savings. At a time when soaring housing prices were

out of whack with the rest of the economy, sub-prime loans were the

only way they could purchase a home. But when they could no longer

keep up their mortgage payments, they had no safety net. They began

skipping their monthly mortgage payments, especially after the

adjustable-rate mortgages kicked in with higher interest rates, as

high as a 30 percent spike for some borrowers.

Lenders sent letters threatening to take their homes in foreclosure if

they didn't pay up. But for millions of families, the harsh warnings

didn't matter. They couldn't refinance out of high-interest adjustable-

rate mortgages because the value of their home had dropped below the

outstanding mortgage or because they just didn't have the money. And

they couldn't tap into a government aid program for at-risk homeowners

facing foreclosure because none existed.

Those who deserve our greatest sympathy are the victims of predatory

lending, a segment of the sub-prime market that involves deceptive

practices by lenders, as well as unconscionable high fees and interest

rates, sometimes running well over 22 percent. Predatory lenders range

from sleazy operators in the financial netherworld to mainstream

financial institutions like Household Finance. These lenders typically

have salespeople who hound vulnerable families for months, soliciting

and encouraging them to take out a loan to buy a house or refinance.

Borrowers are charged hidden high fees, labeled with confusing terms

like "discount points," suggesting that the fees will lower the

interest rates, which they don't.

Predatory loans sometimes involve a conspiracy between loan agents and

unscrupulous home-improvement contractors, as well as appraisers who

inflate the value of a house so that families will borrow more than

the houses are really worth. Predatory mortgages often include last-

minute, hidden second mortgages. Using bait-and-switch tactics,

predatory lenders tout low interest rates in ads targeting the elderly

and residents of low-income, working-class, and minority

neighborhoods, without explaining the actual interest rates or that

adjustable-rate mortgages mean that the rates will increase.

Borrowers are enticed with deals that require them to pay little or

nothing down. The unscrupulous lenders approve borrowers for loans

even if they've recently been bankrupt or don't have sufficient income

to keep up the payments. These lenders don't document an applicant's

ability to pay back a loan. They often just accept the borrower's word

about his income and expenses. "You could be dead and get a loan," a

mortgage broker told Holden Lewis of Bankrate.com, a leading Web

source for financial rate information.

Predatory lenders turn lending logic on its head. Instead of

cautiously making loans to people who can repay them, they get their

money by lending to people who are unable to repay. The loans are

structured to guarantee failure. Predatory lenders get borrowers to

agree to an adjustable-rate mortgage without explaining how it works,

including the big bump in rates with a few years after taking out the

loan. Borrowers suckered by predatory lenders often wind up having a

monthly mortgage payment that is more than half their income. A

predatory loan is often for more than the value of the house. The

victims of predatory loans frequently don't realize they've been

snookered until they're about to lose their homes.

Not all sub-prime borrowers are innocent victims. Some were

speculators themselves, seeking to profit from the real estate housing

bubble, and had their eyes wide open. They expected to rent their

houses or quickly "flip" them to another buyer in a rising housing

market. Others were simply living dangerously above their means,

taking on too much debt and occupying houses that, by any reasonable

standard, they couldn't really afford. These borrowers should live

with the consequences of their behavior, not be rewarded with any

help.

Where Do We Go from Here?

What should government do to address this crisis? Public officials

need to distinguish legitimate sub-prime lenders from the scam artists

who engage in predatory lending. Likewise, the people facing

foreclosure need to be treated differently depending on whether they

failed to exercise personal responsibility or were victims of

predatory practices. Banks and other lenders and investors who

speculated in mortgage-backed debt must shoulder some of the blame for

this debacle.

Government needs to help the victims of predatory lenders who are at

risk of losing their homes, but it must also adopt preventative

measures to stop the crisis from getting worse and prevent it from

happening again. Congress should enact legislation to protect victims

of predatory loans from foreclosure. The victims should have a right

to a nonprofit loan counselor or lawyer who can help them renegotiate

the loan or sue banks, including big Wall Street firms, for violations

of state and federal consumer protection laws. Indeed, Congress should

require lenders to restructure predatory loans and provide more

funding to nonprofit groups that help homeowners renegotiate loans.

One of these groups, ACORN, a national network of community

organizations, has been pressuring Citigroup to restructure loans

rather than foreclose on low-income consumers. ACORN wants lenders to

agree to 30-year, fixed-rate, affordable modifications to existing

loans so borrowers can avoid interest rate increases that come with

adjustable-rate mortgages. ACORN has also urged lenders to impose a

moratorium on foreclosures, which some Democratic candidates have

supported.

Another group, the National Community Reinvestment Coalition, has a

foreclosure prevention program that has saved thousands of homeowners

from losing their homes by pressuring lenders to change adjustable-

rate mortgages into fixed-rate loans. "This is not a homeowner

bailout," said John Taylor, group's president. "This is a bailout for

failed regulatory oversight. Infectious greed and malfeasance by

lending institutions is the overwhelming culprit, not consumer

misbehavior."

And UNITE HERE, the garment and hotel workers' union, has launched a

campaign against Countrywide Financial, the nation's largest sub-prime

lender, calling on consumers to boycott the bank until it guarantees

it won't foreclose on borrowers who have fallen behind on adjustable-

rate loans.

These activist groups have made some headway, but without a federal

mandate they have to rely on protest and other threats to get banks to

cooperate. They support a bill sponsored by Rep. Brad Miller, a North

Carolina Democrat, and Rep. Loretta Sanchez, a California Democrat,

that would allow bankruptcy judges to amend the terms of home

mortgages. Under current law, the terms of a mortgage on a yacht or a

vacation home can be adjusted during bankruptcy, but not primary

residences. "This makes no sense," said Eric Stein of the Center for

Responsible Lending, testifying before the House Judiciary

Subcommittee on Commercial and Administrative Law. Advocates say that

the Miller-Sanchez bill could help as many as 600,000 homeowners avoid

foreclosure, but the Mortgage Bankers Association is fighting the

legislation.

Looking forward, we need the federal government to be a lending-

industry watchdog, not a lapdog. Step one is to stop predatory

lending. The Mortgage Reform and Anti-Predatory Lending Act of 2007,

passed by the U.S. House of Representatives in November, contains some

useful provisions. It requires lenders to verify all applicants'

income and document that borrowers have a reasonable ability to pay --

not just at the initial interest rate, but any future hike in the

rate. It puts private mortgage companies and mortgage brokers under

the umbrella of federal lending regulations, requiring them to be

registered and licensed, just like stockbrokers and insurance brokers.

It would also allow a borrower to modify an illegal loan, before being

forced into foreclosure. And it allows states to pursue cases against

fraud, misrepresentation, false advertising, and civil-rights abuses.

Under the bill, wronged borrowers could seek some redress from the

original lender, even if they're not in danger of losing their homes.

But, under pressure from the banking lobby, Congress gutted some of

the better parts of the bill. The Mortgage Bankers Association and the

American Banking Association lobbyists persuaded the House to allow

lenders to continue the insidious practice of paying an increased fee

to brokers for steering borrowers into higher cost sub-prime

mortgages. It also bars borrowers whose predatory loans have been sold

on Wall Street from suing investors for relief until the homeowners

are facing foreclosure. In effect, it forces borrowers into

foreclosure as a condition for asserting their rights.

Under the bill, in other words, victims of predatory loans have almost

no ability to pursue claims against investment banks and other

investors. Wall Street and the big players in the mortgage market

won't be held accountable for buying abusive loans. Borrowers who were

ripped off should be encouraged, not discouraged to sue Wall Street

firms in state court for relief from mortgages that they never had a

realistic chance of repaying.

A sweeping bill introduced last week by Sen. Chris Dodd, chairman of

the Senate Banking Committee, closes many of the loopholes in the

House bill by adding more consumer protections and industry penalties.

The Homeownership Preservation and Protection Act of 2007 makes Wall

Street and other investors liable for illegal practices of mortgage

brokers and lenders. Unlike current law, which puts the burden on the

borrower to identify the broker or lender who made the original deal,

Dodd's bill allows the borrower to sue the current mortgage holder.

The Dodd bill would prohibit lenders from steering borrowers towards

more expensive loans than they would otherwise qualify for, and from

influencing an appraisal's value of a house. It requires that lenders

confirm that a borrower can afford to pay an adjustable rate mortgage

after the rate jumps, and that loans provide a "net tangible benefit"

to the borrower. It also prohibits prepayment penalties on sub-prime

loans.

But to prevent the current crisis from getting worse -- and to avoid

future crises -- Congress needs to take much bolder action to rein in

abusive mortgage lending. Congress should simply outlaw adjustable-

rate mortgages, which basically ask borrowers to treat their home

mortgages like stocks, just like Bush wants to turn Social Security

into individual accounts that people can invest, and risk losing their

retirement savings.

Congress should also ban private lenders and brokers from issuing sub-

prime loans of any kind. Instead, the focus should be on strengthening

nonprofit lending institutions to serve the credit needs of high-risk

borrowers. Like the old savings-and-loan (S&L) companies, these

nonprofit lenders are highly regulated and devoted entirely to helping

people purchase homes with transparent, stable loans.

Nonprofit lenders actually do better than their for-profit

counterparts. One such lender, Neighborhood Housing Services of

America (NHS), a federally charted nonprofit group with chapters in

every American urban area, makes 90 percent of its loans to low and

moderate income home buyers -- the so-called "risky borrowers" who only

qualify for sub-prime loans in the private market. About 54 percent of

NHS' borrowers are minority households. As of June 30, 2007, it has

made some 3,000 loans totaling $205 million to these borrowers who

otherwise would have been forced into the private sub-prime market.

These NHS borrowers don't have the same mortgage problems as sub-prime

borrowers in private sector. In fact, NHS' delinquency rate is only

3.34 percent -- well below the national rate of 14.5 percent for sub-

prime loans in the private sector. The same is true for foreclosures.

Only one half of one percent of NHS loans went into foreclosure during

the second quarter of 2007, one fifth the foreclosure rate (2.45

percent) among private lenders.

NHS succeeds for two reasons. It has an effective mortgage education

program carried out by its own loan counselors. It requires every

borrower to participate in its counseling program before and after a

loan is made. Moreover, and importantly, NHS makes no adjustable

interest rates loans.

And It All Started with Deregulation

There was a time, not too long ago, when Washington did regulate

banks. The Depression triggered the creation of government bank

regulations and agencies, such as the Federal Deposit Insurance

Corporation, the Federal Home Loan Bank System, Homeowners Loan

Corporation, Fannie Mae, and the Federal Housing Administration, to

protect consumers and expand homeownership. After World War II, until

the late 1970s, the system work. The savings-and-loan industry was

highly regulated by the federal government, with a mission to take

people's deposits and then provide loans for the sole purpose of

helping people buy homes to live in. Washington insured those loans

through the FDIC, provided mortgage discounts through FHA and the

Veterans Administration, created a secondary mortgage market to

guarantee a steady flow of capital, and required S&Ls to make

predictable 30-year fixed loans. The result was a steady increase in

homeownership and few foreclosures.

In the 1970s, when community groups discovered that lenders and the

FHA were engaged in systematic racial discrimination against minority

consumers and neighborhoods -- a practice called "redlining" -- they

mobilized and got Congress, led by Wisconsin Senator William Proxmire,

to adopt the Community Reinvestment Act and the Home Mortgage

Disclosure Act, which together have significantly reduced racial

disparities in lending.

But by the early 1980s, the lending industry used its political clout

to push back against government regulation. In 1980, Congress adopted

the Depository Institutions Deregulatory and Monetary Control Act,

which eliminated interest-rate caps and made sub-prime lending more

feasible for lenders. The S&Ls balked at constraints on their ability

to compete with conventional banks engaged in commercial lending. They

got Congress -- Democrats and Republicans alike -- to change the rules,

allowing S&Ls to begin a decade-long orgy of real estate speculation,

mismanagement, and fraud. The poster child for this era was Charles

Keating, who used his political connections and donations to turn a

small Arizona S&L into a major real estate speculator, snaring five

Senators (the so-called "Keating Five," including John McCain) into

his web of corruption.

The deregulation of banking led to merger mania, with banks and S&Ls

gobbling each other up and making loans to finance shopping malls,

golf courses, office buildings, and condo projects that had no

financial logic other than a quick-buck profit. When the dust settled

in the late 1980s, hundreds of S&Ls and banks had gone under, billions

of dollars of commercial loans were useless, and the federal

government was left to bail out the depositors whose money the

speculators had put at risk.

The stable neighborhood S&L soon became a thing of the past. Banks,

insurance companies, credit card firms and other money-lenders were

now part of a giant "financial services" industry, while Washington

walked away from its responsibility to protect consumers with rules,

regulations, and enforcement. Meanwhile, starting with Reagan, the

federal government slashed funding for low-income housing, and allowed

the FHA, once a key player helping working-class families purchase a

home, to drift into irrelevancy.

Into this vacuum stepped banks, mortgage lenders, and scam artists,

looking for ways to make big profits from consumers desperate for the

American Dream of homeownership. They invented new "loan products"

that put borrowers at risk. Thus was born the sub-prime market.

At the heart of the crisis are the conservative free market

ideologists whose views increasingly influenced American politics

since the 1980s, and who still dominate the Bush administration. They

believe that government is always the problem, never the solution, and

that regulation of private business is always bad. Lenders and brokers

who fell outside of federal regulations made most of the sub-prime and

predatory loans.

In 2000, Edward M. Gramlich, a Federal Reserve Board member,

repeatedly warned about sub-prime mortgages and predatory lending,

which he said "jeopardize the twin American dreams of owning a home

and building wealth." He tried to get chairman Alan Greenspan to crack

down on irrational sub-prime lending by increasing oversight, but his

warnings fell on deaf ears, including those in Congress.

As Rep. Barney Frank wrote recently in The Boston Globe, the surge of

sub-prime lending was a sort of "natural experiment" testing the

theories of those who favor radical deregulation of financial markets.

And the lessons, Frank said, are clear: "To the extent that the system

did work, it is because of prudential regulation and oversight. Where

it was absent, the result was tragedy."

Some political observers believe that the American mood is shifting,

finally recognizing that the frenzy of deregulation that began in the

1980s has triggered economic chaos and declining living standards. If

they needed proof, the foreclosure crisis is exhibit number one.

Those who profited handsomely from the sub-prime market and predatory

lending, the mortgage bankers and brokers, are working overtime to

protect their profits by lobbying in state capitals and in Washington,

DC to keep government off their backs. The banking industry, of

course, has repeatedly warned that any restrictions on their behavior

will close needy people out of the home-buying market. Its lobbyists

insisted that the Bush plan be completely voluntary.

This isn't surprising, considering who was at the negotiating table

when the Bush administration, led by Treasury Secretary Henry Paulson,

forged the plan. The key players were the mortgage service companies

(who collect the homeowner's monthly payments, or foreclose when they

fall behind) and groups representing investors holding the mortgages,

dominated by Wall Street banks. The Bush plan reflected both groups'

calculation that -- for some loans -- they would do better temporarily

freezing interest rates than foreclosing. Groups who represent

consumers -- ACORN, the National Community Reinvestment Coalition, the

Greenlining Institute, Neighborhood Housing Services, and the Center

for Responsible Lending -- were not invited to the negotiation.

The best hope for real reform rests with a Democratic Party victory in

November. And after an electoral win, it will require that Democrats

make sure that these consumer groups are key participants in shaping

legislation.

And wouldn't it be nice to hear the next president tell the American

people that, "the era of unregulated so-called free-market banking

greed and sleaze is over"?

http://www.commondreams.org/archive/2007/12/19/5901/

Pretty long post, too bad it's all crap. you must have a lot of time

on your hands. You still in prison?