In the previous two parts of this series I have recounted the multiple frauds perpetrated by MERS: it defrauded counties out of billions of dollars of reporting fees, it defrauded homeowners by destroying documents that provide a clear chain of title -- facilitating its foreclosure frauds, and it defrauded securities investors by failing to adhere to PSAs (pooling and servicing agreements) -- making their securities invalid. Now, in order to cover the trail of deceit MERS and the banks are stealing homes as fast as they can in the hope that no one will notice the fraud. Meanwhile, they are destroying real estate values and adding to the headwinds that are pushing our economy into the first great depression of the 21st century.
In this piece, let us step back and examine the big picture to answer the question: Why did Wall Street create this crisis? For the answer, we have got to go back several decades. I do not want to give a long-winded history lesson, but it is necessary to understand the transformation that has taken place since the 1960s. Back then, the financial system was small, simple, regulated and relatively unimportant. Banks made commercial loans; thrifts made home loans; and Wall Street handled investment finance. Households had jobs and rising wages so they didn't need to go into debt to finance rising consumption. With robust economic growth, each generation could expect to have roughly twice the living standard of the previous generation.
Things began to change in the 1970s, and especially in the 1980s as growth slowed, as median real wages stopped rising, and as financial institutions were unleashed to expand activities into new areas. At first households coped with stagnant incomes by putting more family members to work (especially women), but gradually they began to rely on debt. Banks created new kinds of credit and gradually expanded their views as to who is creditworthy. I can still remember one conference I attended at which someone from the financial sector proudly announced that the banks had discovered an untapped market for credit cards -- the "mentally retarded". The argument was that this group would be just as safe as college students, since parents would bail them out in order to avoid having their kids' credit ratings suffer. This was not a joke -- it was a business model.
With slower economic growth, it had become harder for American firms to make profits. They shifted their focus from actually producing goods and services to making money on financial products. GM and GE became primarily financial institutions that happened to make cars and light bulbs as a sideline business. Yes, you could buy a car made by GM, but the company made most of its profits on the auto loan. (It then branched out to -- you betcha -- mortgage backed securities and all other manner of risky assets. I hope readers understand that that is what the "auto" bail-out was all about.) As everyone got into the act of indiscriminate lending, banks found their own business dwindling -- so they had to continually innovate with new products and to find new activities to finance.
The economy became "financialized", as financial institutions inserted their activities into virtually every aspect of American life. Health care morphed into financialized health "insurance", given a huge boost by "Obamacare" legislation that for the first time in US history mandates that Americans turn their incomes over to private financial firms. Even death became financialized with "peasant insurance" (employers take out contracts on employees) and "death settlements" (life insurance policies on those with fatal illnesses are securitized and sold to gamblers betting on early death). Retailers increased the financialization of consumer goods -- they couldn't get enough profit on the sales or even on the consumer credit, so they offered "extended protection" on everything from TVs to toasters and then tried to scare customers with an unusual marketing pitch: the products they carry are so shoddily produced that insurance is necessary to protect the purchase.
Every kind of debt or insurance product became a financial commodity, packaged into a security and sliced and diced and bought and sold. At the same time, "insurance" (often in the form of credit default swaps) replaced underwriting (credit assessment) to make these loans more marketable. And then the credit default swap insurance, itself, became a way to bet on the death of securities, companies, and even nations. It is not a stretch to say that Wall Street's capitalists returned to their roots as "undertakers" (the old term for entrepreneurs), with death becoming their main line of business.
Debt grew. In 2007 just before the crisis hit, total US debt reached five times national income -- the previous record was just three times income, a level reached in the propitious year of 1929. In other words, each dollar of income had to service five dollars of debt. In the decade previous to the crisis, American households spent more than their incomes in almost every year. For every debtor created there is a creditor. Not surprisingly, creditors are richer than debtors. Over time, the proportion of Americans who were debtors grew, and the proportion of creditors fell. The rich got richer and every one else either got poorer or at best just managed to break even. In other words, the debt train fueled a massive redistribution of income and wealth to the very top. It is no coincidence that inequality in the US has returned to its previous peak -- reached, not coincidentally also in 1929. That is what President Bush actually meant when he talked about the ownership society -- a society in which a small elite would own everything.
Banks became giant one-stop casinos that facilitated every kind of crazy bet. They would make a loan to you, but then simultaneously securitize it to sell-on to an investor plus place a bet that you would default on your loan so that the security would go bad. For a fee, they'd let a hedge fund manager choose the riskiest loans to bundle into a sure-to-fail financial product that they would then sell to their own customers. And then they'd join the hedge fund in betting against their customers. The more loans they made, the more fees they collected; the more bad loans they made, the more bets they would win. The more debt they piled on households, the greater their profits; riskier debt meant even higher fees and more defaults and thus greater wins from gambling. Prospective death was a booming good business for our undertakers.
America became "Bubbleonia" -- with a "bubblicious" economy that moved from one bubble and crash to another: A commercial real estate bubble and crash in the 1980s that killed the thrifts; a series of developing country debt bubbles and crashes in the 1980s and 1990s fueled in part by American banks; a US stock market bubble and crash in 1987; the dot-com bubble and crash at the end of the 1990s; and then the US real estate and global commodities markets bubbles and crashes this decade.
Increasingly, the bubbles were managed cooperatively by Wall Street and Washington. Chairman Greenspan and President Clinton made a pact with Robert Rubin's Wall Street to pump up "new economy" internet stocks through "irrational exuberance". When that failed, Greenspan extolled the benefits of adjustable rate mortgages, while President Bush hawked the "ownership society". Wall Street turned America's residential real estate sector into the world's biggest casino -- $20 trillion worth of property that could serve as the basis for many tens of trillions of dollars of bets. Bernanke promoted the bubble by assuring markets that America was enjoying the "great moderation" -- a new era in which stability dominates -- and that in any case, the Fed would protect markets in the case of any hiccups.
The home finance food chain was fundamentally changed to facilitate the rapid pace of gambling that would be necessary to feed Wall Street's appetite. Real estate appraisers were paid more to over-value homes; mortgage brokers were rewarded with higher fees to induce borrowers to accept unfavorable terms; mortgage lenders got better fees for riskier loans; securitizers wanted more junky loans to increase the projected returns spit out by their own internal models that presume more risk is always rewarded with higher profits; credit raters got paid to rate trash as AAA -- as safe as treasuries; and investors shunned "plain vanilla" securities in favor of risky structured products that were so complex no one could understand them -- so that they could have any value desired. No worries, AIG sold "insurance" on all this garbage!
That homeowners would default on the unaffordable mortgages was a foregone conclusion. Indeed, it was the desired result of the business model. The preferred marketed loans tell it all: Subprimes! NINJAs! Liar's loans! Washington helpfully changed bankruptcy law to make it more difficult for a homeowner to get out of mortgage debt in preparation for the wave of defaults that everyone knew would result. Wall Street would get the homes, and homeowners would still have to pay on the debts. Then the foreclosed property would be resold, with more fees for everyone in the finance food chain, and the whole process through to default would begin again -- a nice virtuous cycle.
It might seem strange that banks would actually want default. But that is the beauty of a casino -- the house always wins, and homebuyers were gambling against the casino. On the way up, fees are collected, and on the way down fees are still collected on the foreclosures and as houses are resold. And if anything should go wrong, Washington backstops the casinos.
But it was necessary to streamline foreclosure to make it as fast and cheap as possible. Enter MERS -- another link in the food chain -- created by the banks in 1997 in preparation for the boom and bust. MERS was set up to be a foreclosure mill. It would break the centuries-old custom that protected property rights by requiring every sale of property to be publicly recorded, and requiring that any creditor claiming a right to foreclose to demonstrate clear title, with an endorsed note in the creditor's name and a record at the county office showing transfer of the property.
The banksters did not want to go through all that paperwork, and needed to subvert the transparency that would shine light on their crimes. Hence, they set up a fraudulent shell corporation that claimed to be the mortgagee; while the original sale would be recorded at the county office, subsequent sales and purchases of the mortgage would be recorded only by an "electronic handshake" between two "members" of MERS. Even that record was considered by the banksters to be purely voluntary -- MERS did not require members to actually record transactions. If they found it more convenient to conceal the transfers, that was permitted.
MERS even farmed out its name -- for 25 bucks anyone could buy the MERS trademark and use it. And in a touching display of fraternity, everyone got to be a certified vice president of MERS. (Sort of like those 1950s marketing campaigns advertised on cereal boxes -- for 25 cents, you too can be a Super Fraudster with a nifty membership ring and all the benefits of membership in an international criminal conspiracy!)
MERS deliberately undermined the legality of the loans and the records. Homeowners could no longer search the public records to find out who actually held their mortgage -- the record would show MERS as owner, but MERS was a shell corporation with no real employees. It was not a servicer, so the homeowner could not make mortgage payments to the purported owner. As a result, checks were sent to the wrong servicers; servicers credited the wrong accounts; servicers claimed delinquencies on homeowners who never missed a payment, and piled late fees and delinquencies on the wrong borrowers; sheriffs were sent to break down the doors of the wrong houses, and threw belongings out on the street in front of homes on which there was no mortgage at all. MERS purposely created the mess, at the behest of banksters who do not want mere legal technicalities to get in the way of stealing homes. The undermining of the public records was not a mistake -- it was MERS's business model, created by the member banks.
And MERS helped banksters to defraud securities holders. Banks not only separated the mortgages from the notes, but they even destroyed the notes as they entered the mortgages into MERS's electronic data base. MERS told servicers that it is "customary" practice to retain notes, not to endorse them over to REMIC trustees as required both by federal tax law and by the PSAs that govern the trusts. This made the securities a "nullity" -- as the Supreme Court ruled over a hundred years ago -- because a mortgage without a note is unenforceable in foreclosure. At best, the securities are unsecured debt, with no real property behind them.
In any case, the mortgages put into the trusts did not meet the representations made to investors -- so even if the notes had been properly endorsed over to the trusts, the securities could be turned back to the banks. By creating a completely fraudulent electronic registry system -- in which data would be entered only if banks found it convenient to do so, and in which data could be modified at any time by any member of MERS -- MERS made it easy to conceal the securities frauds. Destruction or forgery of the paperwork was absolutely necessary to cover the trail of fraud from origination of the mortgage to securitization and finally to the inevitable foreclosure. Again, destruction of documents was not a mistake. It was the business model.
MERS also made it easy to run the foreclosure frauds -- banksters could doctor the electronic entries whenever they wanted, and could claim that all paperwork including the notes had been lost. The servicers then hired Burger King robo-signers to manufacture new documents, and handed out notary stamps so they could certify the validity of whatever false information might enable swift passage through "rocket docket" courts. Banksters could take any home they desired -- and responded to the opportunity by stealing millions of homes, throwing owners out onto the streets, aided and abetted by a US justice system that was both overwhelmed by the caseload but also underwhelmed by the plight of dispossessed homeowners.
In defense of courts, nothing like this had ever happened before. In the old days, when a bank claimed a homeowner was in default, this was usually true and the bank could provide the paperwork to prove it. Today, however, most and perhaps all of the paperwork handled by members of MERS is destroyed or falsified. The record keeping is so sloppy that banks have no idea who owns what and who owes whom what. There is no public record to help sort things out -- the design feature of MERS that banksters found irresistible. The record is whatever the servicer says it is. Judges are only very slowly realizing that what the servicers claim is pure bunk, and that every single layer of the residential real estate onion is thoroughly compromised by fraud. And that the fraud did not result from mistakes but rather was by system design.
As an aside: foreclosure was not in the plans of the homeowners. When the crisis first hit, it seemed plausible to argue that borrower fraud played a big role -- home flippers, real estate speculators, and just plain deadbeats had knowingly bought homes they could not afford. Further, those soft-hearted Democrats had pushed banks to make loans to poor folks who never should have become homeowners. Clever people, often with browner skin, had duped the poor defenseless Wall Street banks that mostly employed nice but gullible white people from good homes and who had no idea that borrowers might lie.
This right-wing-nut-job fantasy just ain't true. First it was President Bush who pushed the ownership society, on behalf of what he called his Wall Street "constituency". It was Greenspan who pushed the dangerous adjustable rate loans -- indeed, he extolled the virtues of the "hybrids" with a low teaser rate and a kicker that would ensure default when rates were raised two or three years later. The loans were originated, mostly, by mortgage brokers and institutions not subject to the Community Reinvestment Act (which purportedly pushed banks to make subprimes -- and in any case, the big banks now in trouble had already met CRA provisions before the subprime lending bubble began, so they had no reason to increase mortgage lending to low income borrowers).
A large portion of the worst mortgages were actually made to refinance homes -- refinancing from an affordable loan to one that was unaffordable, at the instigation of mortgage brokers who were rewarded for delivering the worst terms possible to borrowers. (Knowing no bounds to its irony, Wall Street called these loans "affordability products"--an inside joke since they were actually neutron loans guaranteed to blow up the borrowers, but leave the homes standing.) In other words, those "bad" borrowers already owned their homes--so clearly the loans had nothing to do with CRA or bleeding heart liberals.
And banks created -- and heavily promoted -- products they called "NINJAs" and "liar's loans". As a result, all serious investigations conclude that while there was some borrower fraud, it was overwhelmingly lender fraud that created the loans doomed to go into default. Not a mistake, but a design feature.
And that, dear readers, is the short version of how we got into this mess.
The problem is that the banksters were too clever by half. They never foresaw the possibility that they'd get stuck with houses they could not sell. Recall, they planned on default and foreclosure. They wanted to repossess the houses, in order to resell them to renew the virtuous real estate cycle of fees piled on fees. They also did not foresee the full-on liquidity crisis that occurred in 2008 -- when the banks could not find finance for their positions in assets. Nor did they foresee a brave new world in which the demand for securitized loans would simply disappear. They never expected securities holders to fight back -- like PIMCO and the NY Fed are now doing. And they did not expect homeowners to fight back -- by squatting their own homes, by hiring lawyers, and by coalescing into support groups. They really, truly believed they would get away with the whole scam -- the biggest scandal in human history.
They might not.
I want to close this series with three comments.
Some might think I have used the "F" word excessively and cavalierly throughout these three pieces. To be sure, fraud is something that must be proven in court and since it involves intent that is not easy. I am using the term in the common everyday sense of the term and I think it accurately describes the behaviors I have outlined--and I am not alone. Christopher Peterson, Associate Dean and Professor of Law at the University of Utah calls MERS "a deceptive and anti-democratic institution", a "shell company" with a structure that could "arguably be considered fraudulent". In two HuffPost pieces I co-authored with my colleague, Bill Black, we called Bank of America a "control fraud". Bill is also a lawyer, who handled cases against the worst control frauds in the thrift crisis. He ought to know fraud when he sees it. I do not see how we can describe the entire housing finance system as anything other than a massive fraud designed to cheat borrowers out of their income and wealth, and then out of their home.
Second, and more important, I have been impressed by the comments and emails I have received -- almost all supportive and even congratulatory. I have become aware of really fantastic work done by many individuals, and of the wealth of information provided on numerous websites devoted to exposing the frauds. There are also many individuals and websites working to support desperate homeowners facing thieving bankers and indifferent judges. The most moving are the messages from those homeowners -- people who obviously did not set out to defraud banks but rather face foreclosure because of frauds perpetrated by the banks. In many cases, the homeowners were doing OK -- even in spite of onerous loan conditions -- but then the recession caused by Wall Street forced them to take a pay cut.
Third -- and I promise that this is the end of this too-long series -- in the days of Jimmy Stewart's thrifts, mortgages could be modified, and payments could be delayed. Success of the thrift required success of the borrower -- it was in no one's interest to throw homeowners out in a recession. But, by design, Wall Street created a home finance system that is both unable to accommodate borrower distress and that is strongly incentivized to foreclose as soon as possible. And the problem is not what we long believed -- it is not simply because the securitizations are complex, making it too difficult to get all the parties to agree to a modification. Rather, it is because the loans and the securitizations were fraudulent from the get-go that foreclosure is needed. Foreclosure is seen as the only protection the fraudsters have. Success of the fraudster requires destruction of the borrower.
And that means that rescue of the borrowers requires destruction of the fraudsters. That is the ultimate of the inconvenient truths that Washington refuses to recognize.
Most of the claims about MERS made here can be verified in written testimony presented by Christopher L. Peterson, Associate Dean for Academic Affairs and Professor of Law, Univeristy of Utah, S.J. Quinney College of Law, Salt Lake City, Utah, Dec 2, 2010 before the US House of Representatives Committee on the Judiciary, Hearing on "Foreclosed Justice: Causes and Effects of the Foreclosure Crisis".
For a much more detailed treatment of the transition of the financial system in the postwar period, please consult: Wray, L. Randall. "Financial Markets Meltdown: what can we learn from Minsky?" Levy Public Policy Brief No 94, April 2008a, and "The Commodities Market Bubble: Money manager capitalism and the financialization of commodities", Levy Public Policy Brief No 96, October 2008b, at www.levy.org. Also see: Wray, "The rise and fall of money manager capitalism: a Minskian approach", Cambridge Journal of Economics, 33(4) July 2009 p. 807-828.
Resource for those facing foreclosure.