In “Murder on the Orient Express,” one of Agatha Christie’s most famous mysteries, the answer to “who dunnit” turned out to be “everyone.” All of the potential suspects stabbed the despicable victim so that no single murderer could be blamed.
In much the same way, the Financial Crisis Inquiry Commission, charged with finding the causes of the financial meltdown, spreads the blame widely, citing “dramatic failings of corporate governance and risk management” at many strategically important financial institutions and shortsighted, inexcusably lax oversight by federal regulators who should have recognized the early warning signs, among the major causes of a crisis that the commission concluded could and should have been avoided.
“The crisis was the result of human action and inaction, nor of Mother Nature or computer models gone haywire,” the 585-page report contends. “The captains of finance and the public stewards of our financial system ignored warnings and failed to question, understand and manage evolving risks within a system essential to the well-being of the American public. Theirs was a big miss,” the report argues, “not a stumble….The greatest tragedy,” the report cautions, “ would be to accept the refrain that no one could have seen this coming and thus nothing could have been done [to prevent it]. If we accept this notion, it will happen again.”
Although the report spares no one in assigning blame, it singles out Goldman Sachs for feeding the subprime bubble by securitizing and selling billions of dollars in toxic loans, Merrill Lynch executives, for failing to disclose to investors the extent of the company’s problems, and (among the regulators), the Securities and Exchange Commission, for failing to set adequate capital and liquidity standards and the Federal Reserve for “a pivotal failure to stem the flow of toxic mortgages” by halting high-risk and abusive lending practices. “The Federal Reserve was the one entity empowered to do so and it did not,” the report asserts.
The report provides little new information about the details of the financial crisis, but it does recall the fear that gripped financial institutions, investors, regulators and elected officials as the markets seemed to be spiraling out of control. At the peak of the crisis, Fed Chairman Ben Bernanke told the commission, 12 of the nation’s 13 largest financial institutions “were at risk of failure.”
Partisan differences divided the commission, delaying publication of the report and raising questions about its impact. All six Democrats supported the conclusions but all four Republican members refused to do so. The issue that divided the commission most sharply was the role Fannie Mae and Freddie Mac played in the subprime mortgage debacle. Democrats faulted the two Government Services Enterprises (GSEs) for following the financial herd over the subprime lending cliff, but concluded that it was competitive concerns – a fear of losing market share – and not government pressure to boost homeownership rates for minorities, that drove their ill-fated lending decisions.
Fannie and Freddie “followed rather than led Wall Street and other lenders,” pursuing high-risk practices that, the report says, were undertaken “to meet Wall Street expectations for growth, to regain market share, and to ensure generous compensation for…employees.”
In one of two Republican dissents, Peter Wallison, a fellow at the American Enterprise Institute, disagrees, insisting that the push for homeownership “[fostered] the growth of a bubble of unprecedented size and an equally unprecedented number of weak and high-risk residential mortgages.” “If the U.S. government had not chosen this policy,” Wallision contends, “the great financial crisis of 2008 would never have occurred.”
In a separate dissent, the other three Republican members faulted the majority for painting their analysis with a brush too wide to draw a clear picture of what caused the crisis, providing “more an account of bad events than a focused explanation of what happened and why. When everything is important,” the dissenters complain, “nothing is.”
The Republicans criticized the majority report in particular for overstating the role of lax regulation and understating the global nature of the crisis. “By failing to distinguish sufficiently between causes and effects,” the minority report says, “the majority’s report is unbalanced and leads to incorrect conclusions about what caused the crisis.”
Struggling with Reform
Financial regulators haven’t yet proposed the new mortgage lending standards mandated by the Dodd-Frank financial reform legislation, but industry executives and consumer groups are already speculating variously that the regulations will go too far or not far enough, and issuing contrary warnings about the dangers posed by either outcome.
The new lending regulations will focus on the legislative requirement that issuers of mortgage-backed securities must retain 5 percent of the risk. Regulators are charged with establishing standards for “qualified residential mortgages” that will be exempt from the ‘skin-in-the-game’ requirement. Industry analysts are predicting that regulators will set that bar high, requiring a minimum down payment of 20 percent for qualified loans -- a benchmark that consumer advocates and lenders alike agree could deny credit to first-time buyers and further damage an already weakened housing market. A letter to regulators signed by an unusual coalition of typically antagonistic consumer and lending groups notes “the negative ramifications of setting further limits on the availability of credit” by establishing overly restrictive standards.
The potential harm would not be limited to the housing market and first-time buyers, according to Paul Merski, chief economist at the Independent Community Bankers of America. Tighter-than-needed mortgage standards would affect lending of all kinds, creating a particular disadvantage for smaller financial institutions, which would have to hold proportionally more loans in their portfolio. “The more you have to hold on bank balance sheets, the less [funding] that would be available for small business lending,” Merski told MarketWatch.com.
Further complicating the effort to develop ‘skin-in-the-game’ regulations are reported differences over what issues the regulations should address. Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC) is insisting that the regulations include new mortgage servicing standards, a challenge the other regulators and industry executives think should be addressed separately, either through a study that precedes any regulatory proposals or through legislation.
In a letter to Federal regulators, the Mortgage bankers Association (MBA) argued that too many important questions must be resolved before servicing standards are formulated, among them, “how such standards might interact with accounting and regulatory capital requirements, the legal and beneficial rights of different parties, and potential effects on consumers, lenders and investors. We urge policy makers to work with the MBA and other stakeholders to ensure that these different policy dimensions are understood before rushing forward with rulemaking.”
Consumer advocacy groups and some Democratic lawmakers agree with the FDIC’s Bair that correcting mortgage servicing flaws is an essential component of the risk-retention rules and, contrary to the arguments of industry executives, is within the scope of the authority granted regulators by the Dodd-Frank legislation. In a legal memo published in December, the FDIC said the law directed regulators “to help ensure strong underwriting and a safe and stable securitization market, and the FDIC strongly believes that servicing standards are a critical part of this effort.”
In a recent speech, Bair outlined the areas she thinks servicing standards should target, citing in particular:
- The need to designate a single point of contact for distressed borrowers;
- The need for servicers to disclose to investors any interest they have in the loans they service;
- The need for a “claims commission” funded by servicers, to compensate borrowers harmed by substandard lending and foreclosure practices; and
- The need to revamp the existing mortgage servicing compensation structure.
“There is no question that the fee structure currently in place for most servicers provides insufficient resources for effective loss mitigation and has led servicers to cut corners in their legal and administrative processes,” Bair said in a speech delivered at an MBA servicing summit in January.
The Federal Housing Finance Agency is also targeting servicing standards in response to widely publicized flaws in the foreclosure procedures followed by many financial institutions and shortcomings in loan modification initiatives designed to help struggling homeowners avoid foreclosure. In a statement issued jointly with the Treasury Department and the Department of Housing and Urban Development, Edward DeMarco, the acting director of the FHFA, said he has directed Fannie Mae and Freddie Mac to work jointly with the other two agencies to develop new mortgage servicing structures and standards for single-family mortgages.
“As the recent problems with managing mortgage delinquencies suggest, the current servicing compensation model was not designed for current market conditions,” DeMarco said. “The goal of this joint initiative is to explore alternative models for single-family mortgge servicing compensation that better address the needs of borrowers, servicers, originators, investors and guarantors.”
DeMarco noted that it will be the middle of next year, at the earliest, before the agency develops and implements a new mortgage servicing model.
Foreclosure Changes
While federal regulators are exploring new mortgage servicing models, several state legislatures are amending existing laws or enacting new ones to target perceived abuses in the foreclosure process. In Massachusetts, legislation requiring judicial review of all foreclosures is one of several bills lawmakers will be considering this year. Others would require lenders to attempt a negotiated agreement with borrowers before proceeding with a foreclosure action and would require foreclosing lenders to produce a valid title for the property before evicting a resident.
Elsewhere, the Virginia Legislature is considering a measure requiring lenders to provide written notification to owners at least 45 days before a foreclosure sale occurs; lawmakers in Vermont and New Jersey are considering similar measures that would require foreclosing entities to document their right to foreclose and verify the accuracy of their foreclosure documents. California lawmakers are reportedly considering amendments to that state’s real estate laws that would require foreclosing lenders to produce documentation for all transfers and all assignments of the loan.
These legislative initiatives respond to evidence of sloppy, poorly documented foreclosure procedures that have led some courts to reject or overturn foreclosure actions. In a decision that has attracted national attention, the Massachusetts Supreme Judicial Court (SJC) ruled recently (in U.S. Bank v. Ibanez) that lenders must produce documentation establishing their ownership of the mortgages on which they are foreclosing.
Industry executives in Massachusetts and elsewhere are urging lawmakers to proceed cautiously with any changes in existing foreclosure laws.
“We need to calm down a little bit and take a more judicious approach and figure out what the problems are and not use this as a pretext to completely change our foreclosure process,” Ward Graham, a member of the legislation and title standards committees for the Massachusetts Real Estate Bar Association, told the Boston Globe. “Basically, the foreclosure process has worked pretty well going on 200 years,” he noted.
Rent vs. Buy: A New Calculus
A soaring foreclosure rate has funneled many former homeowners into the rental market, pushing home prices down and rental rates up. As a result, in many of the nation’s largest cities, it now costs more to rent a home than to buy one. A rent vs. buy index created by Trulia, the on-line search and marketing firm, finds that in 36 of 50 major metropolitan areas, the equation now tips toward ownership.
“Since the start of the ‘Great Recession,’ many former homeowners have flooded the rental market,” Pete Flint, CEO and co-founder of Trulia, said in a statement. “Following the principles of supply and demand,” he said, “renting has become relatively more expensive than buying in most markets.”
The rental markets are being swelled not only by former homeowners’ who have lost their homes to foreclosure, but also by prospective buyers, unable to qualify for a mortgage under the tighter underwriting standards lenders have adopted.
“Though necessary for achieving true economic recovery, stricter bank lending practices have also further aggravated the struggling housing market in the short term,” Flint noted. “Even highly qualified homebuyers face intense scrutiny on their income, savings, existing debt and credit history before they can get a mortgage loan.”
Still, the perception that homeownership is desirable remains strong. A recent survey by the National Association of Realtors found that “a substantial majority” of renters and homeowners agreed that owning a home is still a wise financial choice over the long term. In the on-line survey of 3,793 adults, 95 percent of owners and 72 percent of renters agreed with that conclusion.
A majority of renters (63 percent) said it was at least “somewhat likely) that they would purchase a home in the future, with younger adults (18-29) expressing the strongest desire for ownership. Only 8 percent of respondents in this age group said it was “not at all likely” that they would ever purchase a home.
Recessionary Divisions
An old joke – more perceptive than funny – suggests that the difference between a recession and a depression is defined more by individual experience than economic statistics: A recession exists, this joke suggests, when other people lose their jobs; a depression, when you lose yours.
A recent study by the Pew Research Center reflects that division, finding that while the recession affected all Americans, it did not affect them in the same way, with more than half (55 percent) suffering “a mix of hardships,” and the other 45 percent more inconvenience than harmed by the downturn.
Age, location, and (to some extent) political identification were among the variables determining the recession’s impact, the study found. More than 7 in 10 retirees held their own, while a large majority of “20-somethings” lost financial ground. People living on the East coast fared better than residents of the South, West and Midwest, suburban and rural residents did better than city dwellers, and Republicans had a somewhat easier time, as a group, than Democrats.
Those hard-hit by the recession described severe economic hardships – 55 percent said they are “just getting by” or not making ends meet and more than 4 in 10 said the recession forced them to make “major changes in the way they live.” Those who “held their own,” by contrast, said they are “living comfortably.” And while some said they have cut back on discretionary spending, none said the recession has forced them to make major lifestyle changes.
Not too surprisingly, those in the “lost ground” group are more likely to think the economy remains mired in recession (60 percent vs. 45 percent of those holding their own). Nearly half of the ‘holding their own’ group thinks the economy is starting to recover, a view shared by only 35 percent of those who see themselves as “losing ground.” But hardly anyone in either group (3 percent in “lost ground” and 4 percent in ‘holding their own’) thinks the recession is definitely over.
