(AP Photo/Paul Sakuma, file)
In this May 28, 2009 file photo, a foreclosed home is shown in Mountain View, Calif. More than 13 percent of American homeowners with a mortgage are either behind on their payments or in foreclosure as the recession throws more people out of work, the Mortgage Bankers Association said Thursday, Aug. 20, 2009.
Other People's Houses: How Decades of Bailouts, Captive Regulators, and Toxic Bankers Made Home Mortgages a Thrilling Business
By Jennifer Taub
416 pp. Yale University Press $30
In the early 2000s, the media regularly turned to David Lereah, chief economist for the National Association of Realtors. He provided consistently optimistic predictions about rising housing prices and labeled those who disagreed a "Chicken Little." In 2006, at the peak of the housing bubble, he published a book entitled Why the Real Estate Boom Will Not Bust-And How You Can Profit from It.
Within a year, the housing bubble popped. Between 2006 and 2012, housing prices nationwide fell by a third. Americans lost about $7 trillion in household wealth as a result of the real estate crash. Six million families lost their homes to foreclosure and short sales. As late as mid-2014, almost 10 million American households (about one in five of all mortgaged homes) were still "underwater"-their homes worth less than their mortgages. Millions of middle-class families watched their major source of wealth stripped away, their neighborhoods decimated, and their future economic security destroyed. Foreclosed homes in a neighborhood bring down the value of other houses in the area, magnifying the impact. The slowness of this recovery has much to do with the housing collapse.
In Other People's Houses: How Decades of Bailouts, Captive Regulators, and Toxic Bankers Made Home Mortgages a Thrilling Business, Jennifer Taub explains how they got away with it and how this house of cards came crashing down. She names names-of greedy bankers, sleazy mortgage lenders, compliant politicians, indifferent government regulators, and occasional heroes who fought for stronger government oversight of banks and tougher consumer protections.
Taub reminds us that the nation's economic troubles were entirely preventable. She pinpoints the key decisions-primarily by presidents, cabinet secretaries, key members of Congress, and government bank regulators-that allowed banks to engage in an orgy of speculation that caused the mortgage meltdown and the subsequent economic crisis. They weren't following some predetermined script. They were making conscious choices about which interests to serve. They knew what they were doing and what the consequences might be. But, blinded by greed, they simply didn't care.
Taub traces the 2008 financial crisis to the deregulation that began in the Carter years in the 1970s, accelerated during the Reagan-Bush period in the 1980s, and continued during the Bill Clinton and George W. Bush eras. The 2008 disaster, she writes, was a replay of the savings-and-loan debacle of the 1980s, when hundreds of S&Ls and banks went under and the federal government was left to bail out the depositors whose money the speculators had looted to the tune of about $125 billion. At the end of each catastrophe, the industry consolidated, with fewer banks owning more assets. The nation's ten largest banks increased their control of the industry's assets from 21 percent in 1960 to 60 percent by 2005.
The financial and real-estate lobbies used their political muscle to promote deregulation, which opened the floodgates to risky and predatory practices. Banks and private mortgage lenders began pushing subprime mortgages, many with "adjustable" rates that jumped sharply after a few years. These loans comprised 8.6 percent of all mortgages in 2001, soaring to 20.1 percent by 2006. That year, ten lenders accounted for 56 percent of all subprime loans, totaling $362 billion.
Instead of cautiously making loans to people who could repay them, banks and brokers made money by lending to people who were unable to repay. They bent the rules, lowered normal banking standards, and engaged in a variety of fraudulent practices-hidden fees, confusing loan documents, failure to verify borrowers' income-that increased the odds that consumers would eventually lose their homes to foreclosure, after which lenders and brokers would make money by "servicing" the loan and reselling the home to the next unsuspecting buyer.
Predatory lenders touted 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 would soon have higher rates. Mortgage brokers, the street hustlers of the lending world, made a commission for every borrower they handed to a lender. They used mail solicitations and ads that shouted, "Bad Credit? No Problem!" and "Zero Percent Down Payment!" to find people who were closed out of homeownership, or homeowners who could be talked into refinancing.
Taub, a professor at Vermont Law School (and former associate general counsel at Fidelity Investments), is a great storyteller. She peppers her history of the financial crisis with profiles of people who played key roles and bit parts in the unfolding disaster.
The bit players include Harriet and Leonard Nobelman. In 1984, the couple borrowed $68,250 from a mortgage broker to purchase a modest condo in Dallas. The broker then sold the loan to American Savings and Loan Association in Stockton, California, the nation's largest S&L. Its executives' greed and mismanagement led to several reorganizations, but whenever it fell on hard times, the federal government bailed it out. Eventually, it was purchased by Washington Mutual, which later collapsed under a mountain of bad mortgages brought on by its own predatory practices, including the creation of a devious idea called the Option ARM (adjustable rate mortgage), which allowed the borrower to defer a portion of the interest due. These mortgages were a trap almost guaranteed to result in massive foreclosures.
While American Savings' various incarnations kept feeding at the federal trough, the Nobelmans had no such luck. By 1990, they had lost their jobs and faced health problems. They filed for bankruptcy to avoid losing their home. They wanted a bankruptcy judge to modify their mortgage, based on their condo's depressed value ($23,500-a result of Dallas's worsening real estate market). But the bankruptcy judge rejected their plan. When they appealed the case, the federal court for the Northern District of Texas turned them down, too. They took their case to the Federal Circuit Court of Appeals for the Fifth Circuit, but they had no better luck there. So they appealed to the U.S. Supreme Court.
In 1993, in Nobelman v. American Savings Bank, the U.S. Supreme Court prohibited judges from requiring banks to modify mortgages by reducing principal to help homeowners facing bankruptcy and foreclosure. With the Nobelman ruling, lenders quickly recognized that consumers who fell behind on mortgage payments couldn't rely on the same bankruptcy protections routinely used by businesses. This, Taub explains, gave lenders "added incentive to place people in homes they could not afford," often using deceptive mortgage products. As Taub observes, our government determined that while the Nobelmans were "too small to save," American Savings, "with $30 billion in assets, was too big to fail."
One fascinating figure in Taub's story is Kerry Killinger, who became CEO of Washington Mutual in 1990 at age 40. Throughout its history, WaMu had engaged in what Taub calls "simple, safe banking" that was cautious and consumer-friendly. Killinger changed WaMu's corporate culture. Between 1990 and 1998, WaMu grew from $7 billion to $150 billion in assets and from 50 to 2,000 branches, in part by buying other banks. In 2001, American Banker named Killinger its Banker of the Year. As WaMu got bigger, so did Killinger's appetite. He stopped flying coach and began traveling on corporate jets. As a young CEO, he earned a modest salary. By 2007, he was earning $14.3 million in compensation; the next year, $25.1 million.
WaMu pumped up its profits by pushing riskier loans that were more profitable than fixed-rate mortgages. By 2006, 75 percent of WaMu's home loans were subprime, adjustable mortgages. WaMu intentionally failed to verify, and sometimes falsified, the income or credit history of borrowers, and even forged borrowers' signatures on loan documents. It hired appraisers who inflated the value of homes to increase loans and put borrowers in precarious over-leveraged positions. It relied on 34,000 independent brokers to bring in business but had only 14 of its own employees to oversee their work. Not surprisingly, fraud was rampant and unchecked. Salespeople who delivered the most borrowers received invitations to WaMu's annual President Club event, an opulent party held in various vacation spots like Cancun, the Bahamas, Maui, and Kauai. Salespeople who refused to sell the Option ARMs as a matter of conscience were fired.
"If you were alive, they would give you a loan," said one appraiser who worked closely with WaMu. "Actually, I think if you were dead, they would still give you a loan."
In September 2008, WaMu's board fired Killinger. A few weeks later, after WaMu reported that it faced $19 billion in losses from troubled mortgages, the Office of Thrift Supervision seized WaMu's banking divisions and put the FDIC in place as the receiver. It was, at the time, the largest bank failure in the nation's history. The FDIC arranged for JPMorgan Chase to purchase WaMu's assets. Nevertheless, Killinger received $15.3 million in severance payments.
The conclusion Taub draws from the malpractices of WaMu and kindred lenders, rating agencies, investment banks, and others is stark: "Any hope for a large business to self-regulate at the expense of profit is likely not tenable on a playing field with competitors waiting to take one's place. And especially not when a CEO and other top executives are compensated for driving up short-term profits and thus the stock price, even when losses are certain to follow." She concludes that Killinger "led this company off the cliff, but he did so because lawmakers and regulators took down the guardrails and eliminated the speed limits."
Although Taub uses Killinger and WaMu as exemplars, she reminds us that this was a systemic disease that infected the entire financial industry. Many bankers, brokers, and rating agencies broke the law, but much of what they did was perfectly legal, the consequence of decades of deregulation.
Taub reveals that, with a few exceptions, the heads of the crazy quilt of state and federal bank regulatory agencies viewed the lenders as clients. They did little to ensure banks' safety and soundness or to protect investors, depositors, borrowers-and the wider economy.
The worst culprit was Fed Chair Alan Greenspan, a disciple of Ayn Rand, whose libertarian views colored his tenure as the nation's top bank regulator. Greenspan believed that the banks could and should police themselves, with investors and rating agencies serving as back-up cops. He didn't think that any bank would jeopardize its long-term solvency to make short-term profits. Only after the bubble burst and the economy crashed did Greenspan admit he was wrong, telling Congress in 2008 that he was in a state of "shocked disbelief."
But Greenspan and other regulators had plenty of information warning them that many huge banks were engaging in fraudulent, reckless, and risky activities that would eventually explode. They choose not to act, blinded by ideology, self-interest (including potential jobs in the banking industry), and timidity.
"Had Greenspan acted," Taub writes, "the entire mortgage crisis could have been averted."
Taub does not spare the Obama administration for its unwillingness to hold the worst culprits accountable for their misdeeds or to address the suffering of homeowners victimized by reckless lenders. Obama's key economic advisers, particularly Larry Summers and Tim Geithner, did not believe that directly addressing the foreclosure problem by providing financial relief to distressed homeowners was necessary or politically feasible.
Obama eventually supported the effort that led to the Dodd–Frank legislation. The new law focused primarily on protecting consumers from abusive practices, but it did little to challenge the concentration of ownership or key aspects of the industry's business practices, including the "originate to distribute" loan model and regulation of derivatives.
Particularly frustrating was Attorney General Eric Holder's reluctance to prosecute the banks and their top executives. Eventually, the Justice Department put enough pressure on several major banks to agree to negotiate multibillion-dollar settlements. The funds were targeted to some of the victims of the banks' fraudulent practices, and to help homeowners. But the top executives admitted no wrongdoing. The settlement fees came out of the banks' revenues, not the pockets of the bigwigs. And the real culprits avoided spending time behind prison bars, which in the end is the only way to really stop them from misbehaving and crashing the economy again.
In 2011, for example, the FDIC sued Killinger and two other WaMu executives for mismanagement. They reached a settlement agreement for $64.7 million, most of it covered by the bank's insurance policy. That year, too, the Justice Department investigated WaMu but failed to file any charges.
Indeed, many Wall Street honchos survived the financial crisis not only with their jobs intact but with substantial raises. JPMorgan Chase CEO Jamie Dimon received a hefty bonus after negotiating a settlement with the feds over his bank's involvement in the mortgage crisis. On January 24, 2014, it was announced that Dimon would receive a 74 percent raise-to $20 million-despite what was reported as the bank's worst year under Dimon's reign.
The Institute for Policy Studies, in a March 2014 report, found that the $26.7 billion in bonuses handed to 165,200 executives by Wall Street banks in 2013 was enough to more than double the pay for all 1,085,000 Americans who work full-time at the current federal minimum wage of $7.25 per hour.
No bank CEO has faced prosecution or gone to jail for the widespread mortgage fraud that fueled the bubble and the collapse that followed. "The message to every Wall Street banker is loud and clear," said Senator Elizabeth Warren at a Senate Banking Committee hearing last year. "If you break the law, you are not going to jail, but you might end up with a bigger paycheck."
Taub's tale of malfeasance, corruption, and indifference is occasionally interrupted with stories of dissenters who challenged the bankers and regulators. Her heroes include Warren and Senator Richard Durbin, who pushed for legislation to give bankruptcy court judges the power to modify mortgages through "principal reduction"-to reduce the balance owed on the mortgage to the home's current market value-which would save "underwater" homeowners from spiraling debt and foreclosure, but who ran into a buzz saw of industry lobbyists who killed the bill in the Senate. Another dissenter was Brooksley Born, chair of the Commodity Futures Trading Commission from 1996 to 1999, who wanted her agency to regulate derivatives and other exotic financial investments (including credit default swaps) that she accurately predicted were too risky and would lead to disaster. Treasury Secretary Robert Rubin, Summers, and Greenspan stopped her from exercising the kind of regulatory authority that would have prevented the calamity. Edward M. Gramlich, a Federal Reserve Board member, repeatedly warned about subprime mortgages and predatory lending. He tried to get Greenspan to crack down on irrational subprime lending, but his warnings fell on deaf ears, including those in Congress. Taub also praises Sheila Bair, the FDIC chair who resisted banks' reckless practices, but was usually outmaneuvered by White House officials and regulators closer to centers of power. Taub credits two economists, Dean Baker and Susan Wachter, who warned that the upsurge of subprime loans and the upward spiraling of housing prices was unsustainable, but who were marginalized by their more mainstream colleagues and the industry's hired experts.
Missing from Taub's account are the many community organizing and advocacy groups, like National People's Action and ACORN, who, since the 1970s, were on the front lines of the battle against bank redlining and who issued early warnings about predatory lending. She also ignores the role of Americans for Financial Reform, the Washington, D.C.–based liberal coalition that played a key part in pushing for tough reform measures that resulted in the Dodd–Frank legislation. Nor does she discuss Occupy Wall Street, which helped inject outrage about the banking industry's abuse of power into the national conversation. For the story of those grassroots activists, readers will have to rely on Larry Kirsch and Robert Mayer's Financial Justice: The People's Campaign to Stop Lender Abuse and Chester Hartman and Gregory Squires's From Foreclosure to Fair Lending: Advocacy, Organizing, Occupy, and the Pursuit of Equitable Credit.
Taub's book is a jeremiad, a warning that we need to understand what led to the 1980s S&L crisis and the more recent financial meltdown, or else it could happen again. She would certainly be upset, but not surprised, by a story that appeared on the front page of The New York Times on January 14, soon after the Republicans took control of both the House and Senate. The article began, "In the span of a month, the nation's biggest banks and investment firms have twice won passage of measures to weaken regulations [adopted as part of the Dodd-Frank law] intended to help lessen the risk of another financial crisis, setting their sights on narrow, arcane provisions and greasing their efforts with a surge of lobbying and campaign contributions." She may have to add a chapter to the book before it appears in paperback, recounting the sorry tale of lessons unlearned.
