Amid the Bush Administration's so-far faltering response to the current financial meltdown, the cause of this catastrophe has been all but forgotten.
In case you've lost it in the clouds of smoke and the avalanche of opaque financial jargon emanating from President Bush's Treasury Department, the root cause was mortgages. Home loans marketed by deception by unregulated cowboy lenders. Loans to people who were encouraged not to understand what they were getting into. Bait-and-switch loans with low introductory interest rates set to balloon into the ionosphere a couple of years later. Loans many should never have had received and predictably were unable to repay.
But not to worry. Didn't we all know that the credit cup would always runneth over and that the housing market could never go down, only up? Well, that's the way we behaved and that underlying assumption finally resulted in what we now call the housing bubble.
The busted one!
Most of these toxic mortgage loans were not made by banks. They came from mortgage lenders and mortgage brokers. These entities were not regulated by any government oversight body. They were operating in the wild wild West of the housing industry. Many didn't even require proof of the borrower's income; in some cases, the sales pitch included lending you the down payment.
Once these guys sold a bunch of mortgages, they sold them to investors, including the big commercial and investment banks all over the world, which bundled them up and sold them again. It was the unabated greed of these big financial institutions and their advisors that ultimately made them victims as well as perpetrators of the disaster. When their investments turned out to be worthless -- or of unknown value -- they started worrying about the accuracy of their balance sheets, stopped lending money to anyone, and turned to the government for help.
The government obliged with the most massive bailouts in U.S. history. You still with me? The bankers were a big part of the gang that caused the housing bubble in the first place, yet were the first ones to be rescued with our tax dollars. Seven-hundred-billion of them.
All but forgotten in the Treasury Department's frenzy to save Wall Street were those millions of homeowners who couldn't make their mortgage payments and whose homes were being seized in foreclosure at a pace not seen since the Great Depression of 1929.
The Treasury's rationale for pouring its billions into the nation's largest banks was to end the acute constipation in the credit markets. That bit of government largesse cost $350 billion. It came with no strings attached -- and no results either, unless you count using our tax dollars to acquire other banks and pay out dividends to shareholders. In the meantime, these banks are still not lending -- even to one another. Many are said to be "hoarding" money while waiting for another shoe to drop, and there is no indication that the flow of credit is likely to restart any time soon.
But there is at least one person who didn't forget where this mess started. And, for her trouble, she is being quietly dissed by the Bush Administration.
She is Sheila Bair and her job is Chair of the Federal Deposit Insurance Corporation. The FDIC, started by Franklin Roosevelt as one of his recovery weapons after massive bank failures in the Great Depression, is the agency that provides Federal guarantees to depositors of banks that fail. When Washington woke up facing a protracted recession or worse, Bair's outfit quickly increased that insurance from $100,000 to $250,000 for each bank account. That's one of the very few positive and successful moves yet made.
Ironically, Sheila Bair was appointed by George W. Bush. The term of this self-described moderate Republican runs through 2011, meaning that W. can't fire her -- though it appears he would if he could. She is currently far more popular with Democrats than she is with her own party's leaders. Or with Treasury Secretary Henry Paulson.
The reason: Bair has focused like a laser not on propping up banks, but on rescuing homeowners. Her objective is to help stem the tsunami of foreclosures now putting people out of their homes and decimating entire neighborhoods as house values continue to drop like stones.
Bair has put forward a proposal to use $24 billion of the government bailout funds to help 1.5 million borrowers avoid foreclosure by guaranteeing modified home loans through the end of next year. This move is being opposed by Paulson and the Bush administration. So now Bair finds herself locked in a so far mild-mannered but potentially ugly duel.
There are two key elements to the Bair proposal.
First, delinquent borrowers who are two months or more late can arrange to have their monthly payments reduced to 31 per cent of their gross monthly income. To achieve that result, mortgage rates could be set as low as 3 per cent for five years. The rate would increase annually by one percentage point until it reached the prevailing market rate. Loan terms could be extended for as long as 40 years.
Second, as an incentive to servicers and investors to get with the program, the government would share up to 50 per cent of losses in the case of a default by a borrower who had been helped by the program. The FDIC would also pay servicers -- the people who process mortgages -- $1,000 for each loan they re-worked.
Bair says her plan would initially help some 2.2 million borrowers to get new loans. The FDIC estimates that, after making allowances for re-defaults, 1.5 million borrowers would ultimately be able to keep their homes.
The plan would cost an estimated $24.4 billion, which Bair has proposed to fund with part of the $700 billion bailout fund approved by Congress.
Observers say there is already evidence that the Bair plan works. At IndyMac, a large California federal savings bank that failed last July, a total of 65,000 borrowers, or 10% of IndyMac's loan portfolio, were delinquent when the government took over. The FDIC has already modified 5,000 of these troubled mortgages, and incomes are currently being verified for another 20,000 delinquent borrowers.
Payments on the modified IndyMac loans have been lowered an average of $380 a month, Bair told Congress. In 70 per cent of these cases, affordable payments were achieved through interest rate modifications.
Bair says she is "hopeful that the current or future administration, or perhaps some combination of both" will be able to adopt her plan in hopes of preventing additional foreclosure distress.
President-elect Obama said on Meet the Press last weekend that he would address the foreclosure issue promptly if the Bush Administration failed to act by the date of his inauguration, January 20.
The FDIC has briefed the Obama transition team, but Bair says "We continue to have discussions" with the Treasury Department on the issue. However, her frustration has been barely hidden during various recent public appearances.
Bair's is not the only plan to address foreclosures. Another is Senate Banking Committee Chairman Christopher Dodd's "Hope for Homeowners" plan, part of the Housing and Economic Recovery Act of 2008. Under that plan, troubled borrowers would be able to refinance into an FHA-insured, fixed-rate loan at 90 per cent of newly appraised home values, or what the borrower can comfortably afford. The government would be compensated with three per cent of the new loan amount for taking on the added risk and borrowers would pay annual insurance premiums of up to one per cent of the loan. Lenders would have to waive all prepayment penalties and late fees.
The Dodd plan, similar to one introduced in the House of Representatives by Rep. Barney Frank of Massachusetts, has generally been rated favorably by consumer protection groups and by lawmakers on both left and right. The Dodd-Frank approach could operate effectively alongside the Bair plan.
Then there's the "Hope Now" program -- an attempt to streamline and consolidate workout and mitigation procedures used by individual servicers. This initiative was launched last October by a private sector alliance of mortgage servicers, counselors, and investors. The alliance claims that its mortgage industry members prevented 225,000 foreclosures during last October alone, 13,000 more than the record the group says it set in September.
Hope Now claims it assisted approximately 1.7 million homeowners during the first ten months of this year and anticipates that the total by the end of the year will be 2.2 million, 45 per cent more than it says it helped during 2007.
However, considerable doubt has been expressed about the accuracy of these numbers and the overall effectiveness of the program. In a speech in San Francisco last week, the chairman of the Federal Reserve System, Ben Bernanke, characterized private sector initiatives such as Hope Now as "not very successful."
According to the Mortgage Bankers Association, some 1.2 million homes were in foreclosure during the second quarter of 2008, and that number is expected to increase, with another two million families possibly losing their homes to foreclosure in the next two years. These foreclosures hurt not only the families who lose their homes, but the national economy as well by depressing home values and consumer spending.
Sen. Dodd insists that both the government and the mortgage servicers need to do more to help distressed homeowners. "All of these measures frankly have not produced anywhere near the results we hoped they would," says Dodd, adding it's "terribly regrettable" that the Paulson is not behind the Bair plan.
Consumer advocates as well as most of the nation's largest banks have also endorsed the Bair plan. Her proposal "is just an absolute no-brainer," said Martin Eakes, head of the Center for Responsible Lending. "There's just no reason why we shouldn't get it done...."
But without Hank Paulson's blessing, it's likely that it will be an Obama Administration that does the doing.