As one tragedy unfolds, a group of industry representatives gather in a White House conference room, called to task as their recklessness causes incalculable suffering. The president, flanked by his experts, pressures the representatives to agree to set aside money to make their victims whole. An opposition blinded by its reflexive resistance to the president sticks up for the industry, angering even its own members, some of whom must actually be elected by the industry's victims. Public and private lawyers line up to investigate criminal and civil charges against the industry, seeking to ensure that all damages are accounted for and all responsible for the tragedy are brought to justice.
Another tragedy has developed differently. When disaster struck, brought on by the recklessness of an industry, the economic viability of that industry was propped up by billions of dollars in direct government support and trillions in explicit government guarantees. Yes, industry representatives were invited to the White House, but some of them failed to even show. Those who were able to make it were pressed, politely no doubt, to do more to help the victims who continue to suffer at the hands of industry practices. And industry dollars have lined the coffers of supporters on Capitol Hill to preserve the industry's immunity from accountability. The gold-plated government lifeline to this industry was extended with few strings attached, and that industry has used its new-found solvency to fight the very reforms that would prevent the same tragedy from taking place again.
The disaster in the Gulf is, of course, the first of these two tragedies. The second is the ongoing catastrophe that is the financial crisis, which is marked by efforts of the financial industry to maintain its power and dominance while millions of its victims are left to fend for themselves. The tragedy in the Gulf will devastate whole communities, and its impact will touch every American. The financial crisis is no different. Yet we have taken two very different approaches in our response to these two disasters.
Some intrepid state attorneys general have used their powers to bring some subprime lenders to justice, at times even making them establish the kind of fund BP will create. In fact, Bank of America, to settle claims brought by a small group of states against its subprime lending subsidiary, Countrywide, created just such a fund, of more than $8 billion, which is slowly making its way to bank victims. This and other, similar funds are being used to support enforcement efforts and modify predatory loans, like a $10 million settlement of a lawsuit in Massachusetts against the now bankrupt Fremont Bank. But millions of Americans face the prospect of foreclosure without any form of relief, and, apart from modest efforts to date to get a handful of lenders to create such funds, little has been done to force banks to the table to modify mortgages.
Nearly one in seven homeowners with a mortgage is either in the foreclosure process or at least 30 days delinquent on that mortgage. What percentage of these homeowners are saddled with loans that have illegal terms? It's hard to say, but according to information unearthed by Congress, one internal investigation conducted by Washington Mutual before its collapse revealed that 83% of the loans from just one of its offices in California involved some fraud on the part of bank officials.
Getting borrowers out from under illegal loans would go a long way towards resolving the foreclosure crisis. The Obama administration's mortgage modification program, which is entirely voluntary for banks, has netted about 300,000 permanent modifications, out of the millions of borrowers currently behind on their mortgages. Since few of these agreements include the key to successful modifications -- a reduction in the mortgage principal to bring borrowers out from "under water" -- many of these borrowers will end up falling behind in their mortgages once again. What's worse, the negotiation process does not involve an assessment of whether the underlying loans have illegal features, so borrowers are left to plead with banks to modify their mortgages, even when such mortgages may have involved bank fraud or other types of illegality.
The Justice Department's Operation Stolen Dreams has led to the arrest of more than 500 mortgage brokers and other low-level bank officials in mortgage fraud stings. But such efforts are unlikely to create the type of pressure on banks needed to make them take more aggressive -- and meaningful -- steps to modify underwater mortgages. What such efforts might yield, however, is information on bank practices, as such low-level functionaries may just give up their superiors to save their own hides. A recent lawsuit filed by the city of Memphis is supported by affidavits of former bank officials who allege that Wells Fargo had a policy of targeting African-Americans for subprime loans, steering them to risky loans even when they qualified for prime loans on terms that were fair.
While lawsuits to bring delinquent borrowers out from unduly burdensome mortgages might prove unwieldy, and will come too late for millions who have already been foreclosed upon, there is nothing written in stone that says banks have to wait for such lawsuits to provide more meaningful help to delinquent borrowers. As with the 9/11 Victims Compensation Fund -- which is undoubtedly how the BP fund will work -- victims could apply directly to the fund for relief without having to file a lawsuit (in fact, victims applying to the 9/11 fund had to waive their right to pursue litigation). Such an approach would work quite well in the mortgage arena, where a system for assessing the fairness and potential illegality of subprime loans could be established, and borrowers could apply directly to the system for assistance negotiating with their banks to bring down the costs of their mortgages. In the case against Fremont discussed above, the office of the Massachusetts attorney general reviews every mortgage Fremont wants to foreclose on if such a mortgage has a range of questionable features, and the bank must get permission from a court to carry out any foreclosure if it turns out the loan cannot be renegotiated.
The federal government's support for the big banks has generated little pressure on them to reform their ways. Instead, it has actually consolidated their powers. Fewer large banks exist, but they now hold more assets and are dominating the mortgage market. Federal support for such banks is ongoing, as the big banks enjoy opportunities to borrow money from the Fed at a steep discount, at a rate that is much less than that which these banks are charging their own customers. They also purchase federal deposit insurance on the cheap. Imagine the outcry that would arise if, instead of going after BP for the discharge in the Gulf, the federal government was subsidizing other, similarly risky extraction practices elsewhere? What's worse, forcing borrowers to languish under the weight of illegal loans would be like forcing fishing boat captains in the Gulf to pay BP for the privilege of cleaning up spilled crude.
If the federal government is not going to take the aggressive measures against banks it is using against BP, which could be accomplished by doubling down on mortgage fraud investigations and picking a few high profile banks to pursue, at least it could cut off the federal lifeline to the big banks that is allowing them to make money hand over fist while they refuse to give an inch on mortgage modifications, and battle financial reform hammer and tong. The threat that their lifelines might end, or at least cost more, is likely enough to force banks to give delinquent borrowers some relief.
Continuing to ask banks to modify mortgages voluntarily is not yielding the results a more forceful approach would generate. High-level pressure, like that which has been applied to BP, is likely the only type of pressure that will influence bank conduct. There is no reason to treat a financial crisis any differently than an environmental one. If you create a mess, you've got to clean it up. What was General Powell's "Pottery Barn Rule": If you break it, you own it?