Irresponsible homeowners vs. responsible banks

Banks vs. Homeowners I like to either start with a question or end with a question. Do you think its right that white collar crimes and failed financial institutions are rewarded while homeowners are branded as irresponsible? Let’s take embattled Bank of America CEO Ken Lewis as an example. He will receive $125 million dollars for failing the shareholders. Merryl-Lynch was bailed out. Bank of America, CitiGroup, and a host of other financial institutions, as well as AIG, the insurance giant. On that note, when it comes to people losing their homes, there are a variety of misperceptions, as I will note in this blog post.

Although much has been written about the current mortgage lending/foreclosure crisis, I’m going to add to the consensus.

The year of 2008 has been one of the most interesting, for good and bad. For students such as myself, this financial crisis has been a learning and teachable experience, i.e. Economics 101. Business, government and the economy often get muddled with too many partisan arguments. Don’t get me wrong, healthy debate is important, as long as we are getting to the root of the problem. Watching the markets go up and down, reading about the origins of the Federal Reserve Bank, and chairman Ben Bernanke, along with former and current Treasury Secretaries, the Senate’s Banking Committee Chair Sen. Chris Dodd and the House’s Financial Services Committee Chair Rep. Barney Frank, all becoming household names all gave me knowledge of some of the most in-depth complexities of economics. Yet, I still have more to learn, so out of the analysis is essentially me attempting to learn more.

The New Yorker article¹ touched briefly about the moral hazard way of approaching the economy, in particular healthcare, and it was then explained that a strategy of that way of thinking is flawed. The argument that the moral hazard strategy essentially argues that bailing out lenders or borrowers who have bad assets is committing economic suicide. The moral hazard strategy stifles businesses that are achieving an honest business enterprise through legitimate efforts and reaping rewards in an open way. Within this new era of a global economy, with mostly regulated markets and prices, this argument is neither sound nor strong.

Nobel Peace Prize winner for economics, Economist Paul Krugman, wrote an op-ed on August 17, 2008 in the New York Times², where he talked about the distinction between speculative lenders and hard-working borrowers. In the article, he compares third-world debtors with strapped mortgage holders in the U.S. In addition, he also argues that the market is not a moral calendar, no matter how well regulated.

In an op-ed published February 15, Krugman argued that there hasn’t been any wealth creation since 2000.³ Let us take a brief rewind and figure out how that happened before we get into discussing the housing crisis. During Keith Olbermann’s Countdown segment on MSNBC, a segment aired on January 15, 2009 titled Bush Presidency, 8 years in 8 minutes, Olbermann argues (and urges those to conduct research if they feel inclined to) that the Bush presidency left the U.S. with a “ten trillion in debt to pay for 31% more in discretionary spending, the Iraq War. A 1.3 trillion dollar tax cut, for the average American the median income went down by $2,000 [and]three-quarters of all income gains under Bush going to the richest one percent. Unemployment up from 4.2 to 7.2 percent; the Dow, down from 10,500 to 87 to 82 to 177; six million now more in poverty; seven million more now without health care.”⁴

Bloomberg reported in late January 2008 that 400 of the richest Americans prospered under Bush. “New IRS data shows the average tax rate paid by the richest 400 Americans fell by a third to 17.2 per cent, and their average income doubled to $263.3 million under the Bush administration.”⁵

We may argue that tax cuts were one part of the financial crisis, but so was the buying up assets that weren’t there (selling invisible money), falsifying the mortgage applications so that the loan underwriter would approve the loan, and then on the other side of this, mortgage lenders purposely targeted low income, uneducated people to swindle them into adjustable rate mortgages while telling them that they were purchasing a fixed mortgage, as well as deregulation. What happened?

Asset Buying

From my general understanding, the big banks purchased a lot of sub-prime mortgage rates, bundled them into portfolios that could be sold in a hidden way to showcase legitimate looking income producing assets, and this was because of the absence of regulation/oversight, leading these banks to unconscionably produce these risks. Nonetheless, mortgage debt was securitized, made into hedge funds and private equity firms, and then mutual funds could buy into it as an investment. Then all of the sudden, the housing market grinded to a halt; prices fell as well as construction, and over the last two years the foreclosure rates rose, and therefore the mortgage payments slowed – foreclosures began to rise. A question to ask ourselves, then, is how come within these investments in subprime mortgage take place? Why is it that when foreclosure goes up, it affects the financial industry like a domino effect? The short answer to the first question is George Bush’s tax cuts, as mentioned previously.

Tax Cuts

Tax cuts were born out of the 1980s from then president Ronald Reagan (supply-side economics) and championed by former Vice President Dick Cheney. The argument goes as followed, although I do believe that Mitt Romney, 2008 Republican presidential candidate and business entrepreneur (former governor of Massachusetts) argued the tax cut cause a lot more succinctly than his Republican colleagues. With investing, business productivity rises, and in turn so does employment. By protecting and producing more money into the incomes of those who do the saving and investing, cutting taxes, these businesses will be able to invest in their businesses that will in turn produce more workers. In turn, the tax cut investment will produce larger payrolls and more taxable incomes. Romney has argued that in his view, he feels as if it’s a punishment to tax businesses who are the sole proprietor of creating jobs. In his view, businesses hire workers, therefore they are the purpose of creating jobs. Trickle down wealth/economics is based on the employers hiring workers, and workers are making an income because the businesses supplied the jobs.

Like the labels on many of the drug products, supply-side economics has some side effects. First, during a recession, when tax cuts are given to the wealthy, they don’t spend it. Businesses take the tax cuts, and save versus invest. Over the past 20^th century, productivity and output declined in net investment. In Keynes economics, as income shifts away from work and productivity, it shifts toward capital (which is why the 400 richest people prospered under Bush – they took their tax cuts and invested). A shift away from consumption (spending on goods and services) and toward tax breaks/investment is not growth of jobs – all it is is money going to invest in more money. An example of that is the stock market crisis of 1926-29, but I don’t want to get into the stock market.

Secondly, tax cuts have yet to cause an increase in jobs or productivity. It hasn’t happened since the1920s until now, and the purest of that example is the past 8 years. I interviewed my microeconomics Professor, Michael Deluz, about this question regarding tax cuts to jolt an economy with economic growth, and this is what he had to say: “The record of tax cuts is evident, and regardless of tax cuts, though, net investment will fall. The argument can be made for economic growth without tax cuts because an increase in investment is not needed. With macroeconomics, productivity can be improved by replacing the capital that is already there – you don’t need to add to it. So to cut taxes for higher income bracket, they will put their incomes into the hands of investors who will take this new money and build it into more money – that’s not productivity. Don’t get me wrong, investing is important, but on the basis of tax cuts to grow the economy and businesses, it advances their incomes, and there may be a small percentage in growth, but with microeconomics, money invested into the hands of people who will buy it, the growth is higher.”⁶

Mortgage Applications

Brave News, an independent news blog, did a short five minute investigative clip regarding mortgage brokers targeting low-income home buyers.⁷

MSNBC reports: “They posted fliers in Section 8 housing, low-income apartment housing, really targeting people who were on the lower end and getting them into the exotic mortgages where the payments were really low at first. But when it reset, there was no way they cold afford the home.”⁹

It is no secret that mortgage brokers had a huge part in this foreclosure crisis, as evidenced through this small report investigated, with facts attached, by independent news source ThinkProgress.¹⁰ Many licensed and unlicensed mortgage brokers were operating as high volume call centers that pumped out loans to whoever had a pulse. What was the reason they did this? More money, i.e. commissions, per loan was made giving people mortgages they could not afford, nor repay, as opposed to placing the borrower in a mortgage they could afford. Simple greed.⁸

MSNBC also reported: “That was the reaction to the North County Times story that reported that a small group of brokers in the North County are responsible for a glut of foreclosures. “It really raises some serious questions about their selling practices,” said Zach Fox of the North County Times. Fox looked at 973 real estate brokers and found that 21 of them had foreclosure rates between 40 and 60 percent. Typically, a broker will see 2 to 4 percent of their buyers homes go into foreclosure.” He added that “some of these brokers, some of these sales people, really set up first-time home buyer programs and brought in people who obviously couldn’t afford them.”⁹

Solutions

Solutions for government:

If no one is prosecuted, ten or twenty years down the road, someone else will do this again
When markets don’t achieve efficiently, government intervention improves society’s welfare.¹¹
4% fixed mortgage on all households¹²
Go the route of CitiGroup (where Bank of America & J.P. Morgan follow their lead) and freeze all foreclosures¹³
True investigation into what went wrong
Better oversight & fines/punishment for those who break the law
Repeal Bush tax cuts

Solutions for businesses:

It’s interesting – if you have a gun and rob a bank, you go to jail, but when a bank robs an entire constituency of people, they are lauded by Congress
Establish a strong ethical culture where outside business firms educate and teach about business ethics by (1), adopting a code of ethics; (2), provide ethics training; (3), hire and promote ethical people; (4), correct unethical behavior, and that means if the CEO’s are fired for misdeeds instead of given a financial bonus; (5), protect whistleblowers; (6), empower and reward those with integrity (pg. 9-10)¹³
All banks should follow the lead of CEO of CitiGroup, halt the mortgage foreclosures and come up with a sound plan.¹⁴
Businesses accepting social responsibility for failures. “The three elements of social responsibility are market actions, externally mandated actions, and voluntary actions” (pg. 127).¹⁵
Responsible lending.¹⁶

In conclusion, I will highlight briefly three out of the top 25 people responsible for the financial meltdown, namely the mortgage crisis and deregulation.

Phil Gramm, former senator, lobbyist and Economic Adviser to John McCain 2008 Presidential campaign

As chairman of the Senate Banking Committee from 1995 through 2000, Gramm was Washington’s most prominent and outspoken champion of financial deregulation. He played a leading role in writing and pushing through Congress the 1999 repeal of the Depression-era Glass-Steagall Act, which separated commercial banks from Wall Street. He also inserted a key provision into the 2000 Commodity Futures Modernization Act that exempted over-the-counter derivatives like credit-default swaps from regulation by the Commodity Futures Trading Commission. Credit-default swaps took down AIG, which has cost the U.S. $150 billion thus far.¹⁷Included here is also President Bill Clinton for signing the Glass-Steagall Act.

Angelo Mozilo, co-founder of Countrywide

“The son of a butcher, Mozilo co-founded Countrywide in 1969 and built it into the largest mortgage lender in the U.S. Countrywide wasn’t the first to offer exotic mortgages to borrowers with a questionable ability to repay them. In its all-out embrace of such sales, however, it did legitimize the notion that practically any adult could handle a big fat mortgage. In the wake of the housing bust, which toppled Countrywide and IndyMac Bank (another company Mozilo started), the executive’s lavish pay package was criticized by many, including Congress. Mozilo left Countrywide last summer after its rescue-sale to Bank of America. A few months later, BofA said it would spend up to $8.7 billion to settle predatory lending charges against Countrywide filed by 11 state attorneys general.”¹⁷

Alan Greenspan

The Federal Reserve chairman — an economist and a disciple of libertarian icon Ayn Rand — met his first major challenge in office by preventing the 1987 stock-market crash from spiraling into something much worse. Then, in the 1990s, he presided over a long economic and financial-market boom and attained the status of Washington’s resident wizard. But the super-low interest rates Greenspan brought in the early 2000s and his long-standing disdain for regulation are now held up as leading causes of the mortgage crisis. The maestro admitted in an October congressional hearing that he had “made a mistake in presuming” that financial firms could regulate themselves.¹⁷

A law is not a law unless enforced. In essence, solutions to these problems for both government and business must rely in at least some oversight. Many in the business community often voice their concerns of having a “nanny state” run their lives. However, if a mandate and law was passed for drivers in New York not to drive while talking on the cell phone, decent regulatory measures both within government and business standards can be established.

During one of my professor’s for a former Political Science class, he mentioned that “it is only natural that the business might want to even suggest some laws or regulations on its own that it believed might be beneficial to itself or its industry.” (Will credit him by name until I get permission).

Lastly, I honestly don’t think that someone who is in need is asking for a handout. What’s odd, too, is that when it’s a corporation asking for a handout, the same outrage isn’t placed on the irresponsibility of the person who was running the company, instead, they are rewarded. Obviously I can understand that President Obama didn’t want to go down the same route that President Hoover did, and we know how that ended. His laissez faire, stay-out-of government, it will fix it itself transitioned into the Great Depression. Now, many of you may think I’m strange for saying this, but in the defense of President Hoover, at the time, he didn’t have the knowledge that we have know. With all intent and purpose, he probably thought that it was going to work out. But that’s what history is about though, looking back and learning from our mistakes so that we can change and get better. Am I happy about all this spending? No. But if it’s going to prevent a Depression, yes.

But let’s not contradict ourselves – if the argument is for no bailouts for homeowners, or even car dealerships, then there shouldn’t be bailouts for financial institutions either. And we have the evidence. The whole point for the bailout out was to get banks to lend money, and they didn’t – they paid their bills and as I mentioned above, the reinvested the money into… more money. I give credit to only one financial institution that actually did what they were supposed to, JP Morgan. They had the bailout money for a short time, and then they paid it off quickly. Of course, I’m sure you know how they did that, by raising credit card rates (ridiculous!), but at least they gave the money back to the government in a timely fashion.

Notes