Cioffi’s Bubble

The following is an excellent excerpt from the book “HOUSE OF CARDS: A Tale of Hubris and Wretched Excess on Wall Street” by William D. Cohan from Part III: “The End of the Second Gilded Age” from Chapter 25 “Cioffi’s Bubble” on page 293 and I quote: “But there were storm clouds brewing on the distant horizon.  In a February 2005 speech at Stanford University little noticed at the  time, former Fed Chairman Paul Volcker, then seventy-seven years old, made a plea of sorts for politicians and regulators to begin to take action (though he did not specify what) to let some of the air out of the balloon.  “There has been a lot of good news in the past couple of years,” he said, but “I have to tell you my old central banking blood still flows.  Under the placid surface, at least the way I see it, there are really disturbing trends: huge imbalances, disequilibria, risks–call them what you will.  Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot.  What really concerns me is that there seems to be so little willingness or capacity to do much about it.”  Volcker’s observations came some four months after [Alan] Greenspan gave a speech in Washington where he allowed that although “pockets of severe stress within the household sector. . . remain a concern,” the likelihood of “housing price bubbles” appeared small.

Volcker voiced his concern about Americans’ low rate of savings and acknowledged the growing danger of the inflating housing bubble, although he did not explicitly refer to it as one.  “We are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security,” he said.  “I will suggest to you big adjustments will inevitably come, and they will come long before the Social Security surpluses disappear or even before we cut the federal budget in half.  And as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change. . . . I think we are skating on increasingly thin ice.”  A month later, Fed Governor [Ben] Bernanke proclaimed there was a “global savings glut,” especially in China and other developing countries where consumption was low, helping to fuel a high global demand for the debt of the United States, keeping interest rates low.  “In retrospect, we didn’t have a global savings glut,” explained Stephen Roach, the chairman of Morgan Stanley Asia, “we had an American consumption glut.  In both of these cases, Bernanke was complicit in massive policy blunders on the part of the Fed.”

Eight months later, in October 2005, Meredith Whitney, the well-regarded financial services research analyst, published a report where she claimed that “10% of the population is at risk of recession: and that “constrained liquidity on both the borrower as well as lender level will be the catalyst to spark this credit and economic downturn. . . It is important to keep in mind that historically, rising rates have not sparked recessions, credit or otherwise.  Constrained liquidity has been the catalyst for most credit busts, both corporate as well as consumer.”  She wanted investors to know that in the mortgage market, credit rating agencies were requiring more collateral than they had previously to maintain higher credit ratings on mortgage-backed securities–an indication of a deterioration in the credit quality of the underlying assets.

Alone on Wall Street at this time, Whitney had realized that, prior to 1994, home ownership levels in the United States were fairly static at around 64 percent of the population.  “That level changed fairly dramatically after 1994,” she observed, “when the standards by which an individual could qualify for a mortgage and the required down payment levels became much more liberal.  Due to such changes in guidelines, 1.5 million new homeowners were created and homeownership rates rose relatively steeply to 69% where they stand today. . . . The incremental 5% of new homeowners would not have qualified for a mortgage prior to 1994.”  She noted in a speech a few weeks earlier, Greenspan had said he was worried that this incremental 5 percent of homeowners had current loan-to-value ratios exceeding 90 percent and that these recent new homeowners were the most highly leveraged.

According to conservative Dennis Sewell, writing in the London journal The Spectator, one can look to the early years of the first Clinton administration to account for this dramatic–and ultimately quite troubling–increase in home ownership.  In 1993, Roberta Achtenberg took the job as Assistant Secretary for Fair Housing and Equal Opportunity at the Department of Housing and Urban Development (HUD).  She began implementing the Clinton agenda to “increase home ownership among the poor, and particularly among blacks and Hispanics.”  Standing in the way of her mission “were the conservative lending policies of banks, which required such inconvenient and old-fashioned things as cash deposits and regular repayments–things the poor and minorities often could not provide,” Sewell wrote.  “Clinton told the banks to be more creative.”  Achterberg set up a series of regional offices, manned with investigators and attorneys, to seek out any discriminatory lending  practices among mortgage lenders, with an eye toward prosecuting them if necessary if there was even a whiff of bad behavior.  “From the mid-1990s,” Sewell wrote, “they began to abandon their formerly rigorous lending criteria.  Mortgages were offered with only three percent deposit requirements, and eventually with no deposit requirement at all.  The mortgage banks fell over one another to provide loans to low-income households and especially minority customers.”

Then there were the changes the Clinton administration made to the Community Reinvestment Act of 1977, whereby banks were rated based on how much lending they did in low-income neighborhoods.  “A good CRA rating was necessary if a bank wanted to get regulators to sign off on mergers, expansion, even new branch openings,” Sewell wrote.  “A poor rating could be disastrous for a bank’s business plan.”  At the same time, the Clinton administration pushed Fannie Mae and Freddie Mac to expand mortgage loans to those who might not have previously qualified for them, and it put into place new rules allowing the two companies to get involved in the securitization of subprime loans.  The so-called strengthening of the CRA in 1995 caused an 80 percent increase in the number of bank loans going to low- and moderate-income families.

The first such securitization of subprime loans–for a total of $385 million–was underwritten in October 1997 by Bear Stearns and First Union Capital Markets (which became part of Wachovia, which in turn is now part of Wells Fargo).  Freddie Mac and its implied AAA rating guaranteed the payments on the securities.  A press release commemorating the historic event captured a moment of unbridled optimism and greed coated with idealism.  “The securitization of these affordable mortgages allows us to redeploy capital back into our communities and to expand our ability to provide credit to low and moderate income individuals,” explained Jane Henderson, managing director of First Union’s Community Reinvestment and Fair Lending Programs.  “First Union is committed to promoting home ownership in traditionally underserved markets through a comprehensive line of competitive and flexible affordable mortgage products.  This transaction enables us to continue to aggressively serve those markets.”  Her colleague Owen Williams, on the fixed-income side of the bank, hailed the seemingly limitless investor demand for the securities.  “We are extremely pleased by how well this transaction was received by investors as many of the tranches were significantly oversubscribed,” he said.  “This offering is further proof of investors’ desire for a diverse range of collateral.”  Added Brian Simpson, a managing director in the structuring department, “Securitizing assets enables First Union to continue to grow its loan portfolio, while at the same time generate additional fee income”–the holy grail–“[and] we also have been very successful in providing innovative asset finance services to clients.  We believe there is opportunity to expand our CRA loan securitization capabilities to other companies in the market.”

Naturally, the success of the securitization of the CRA loans–the first deal and many subsequent ones were several times oversubscribed–led to an explosion of such deals.  The buyers of the loans, according to Dale Westhoff in a May 1998 article in Mortgage Banking, “were money managers and insurance companies buying the loans strictly because of their investment appeal,” offering yields in excess of 7.5 percent, which in a low-interest-rate environment looked very attractive.  Sewell saw the direct linkage from HUD’s political pressure to the fissure in the credit markets a decade later.  “So that’s how we get from there to here,” he wrote, “from crude attempts at social engineering during the early, heady days of the first Clinton administration to the turmoil on Wall Street.”

Sewell did not contact Achtenberg before he wrote his diatribe.  After she read it, she said in an interview that Sewell’s “assertions are laughable to me” and “quite inventive and preposterous.”  She said that with “all humility” she was “just a bit player” in her role as assistant secretary at HUD from 1993 to 1995, nudging the unregulated mortgage lenders to voluntarily improve their “best practices” and to make sure there was no discrimination going on in mortgage lenders.  She said that any deterioration in underwriting standards among mortgage lenders or banks “had nothing to do” with her office and she was “not sure how they came to pass.  She said the goal of increasing home ownership had been a bipartisan effort and pointed to President George W. Bush’s American Dream Downpayment Initiative, passed into law in December 2003, which provided up to $200 million to encourage home ownership among low-income first-time home buyers by helping to pay closing costs and down payments.  Lawrence Lindsay, Bush’s first chief economics advisor, told the New York Times, in December 2008, that from the president on down, there was no incentive to try to limit home ownership.  “No one wanted to stop the bubble,” he said.  “It would have conflicted with the president’s own policies.”  But Achterberg wishes they had.  “This is a serious crisis,” Achterberg said, “and it requires serious analysis.  I think it is very important to figure out what parts of the crisis are attributable to what action, including the failure to regulate and the failure of deregulation and how that played a role.  To the extent that underwriting criteria changed, that is important to know.  But that was not part of my purview.”

Other commentators who shared Sewell’s conservative political views also shared his analysis.  Russell Roberts, for one, a professor of economics at George Mason University, wrote in the Wall Street Journal that in 1996 HUD gave Fannie Mae and Freddie Mac “an explicit target” that 42 percent of their mortgage financing had to be made to borrowers “with income below the median in their area.”  The targets were increased to 50 percent in 2000 and to 52 percent in 2005.  He pointed out that after Bear Stearns underwrote its first CRA deal, in October 1997, the firm issued an additional $1.9 billion of CRA mortgages backed by Fannie Mae or Freddie Mac during the next ten months.  “Bear Stearns is seeking to develop interest and support for loans issued to low-and moderate-income home buyers and is actively pursuing CRA loan portfolios for future securitization, including portfolios as small as $25 million,” one of the firm’s press releases stated in August 1998.  In a separate interview, Roberts said that the 1995 changes to the CRA revised “how it was enforced and it put a wad of power in the hands of community organizations to damage banks that they felt weren’t doing enough for poor people.  These community organizations became the dispensers of money for zero-down mortgages for poor people, again a lovely thing, but it didn’t turn out so well.”

When combined with Greenspan’s low-interest-rate policies and the Taxpayer Relief Act of 1997, which increased the capital gains exclusion on the sale of a home to $500,000, the HUD policies dramatically increased the demand for housing and the price of housing, Roberts wrote.  “Between 1997 and 2005, the average price of a house in the U.S. more than doubled,” he explained.  “It wasn’t simply a speculative bubble.  Much of the rise in housing prices was the result of public policies that increased the demand for housing.  Without the surge in housing prices, the subprime market would never have taken off.”  He rightly pointed out, as had Whitney, that home ownership had increased by the millions.  “This was mostly the result of loans to low-income, higher-risk borrowers,” he wrote.  “Both Bill Clinton and George W. Bush, abetted by Congress, trumpeted that rise as it occurred.”

Then there was the outright fraud committed by greedy mortgage lenders and brokers looking to make a quick fee by preying on unsuspecting potential borrowers.  It was not uncommon for mortgage lenders and real estate brokers to fictionalize a loan application in order to make sales and get fees.  Consider, as but one example among hundreds of thousands, the case of Kellie S. and Gregory C., who together wanted to buy a home at 123 North Potomac Street, in the inner city of Baltimore.  At the time, Kellie was thirty-one years old and lived on monthly disability checks of $600.  Gregory, who suffered from epilepsy, also lived on his monthly disability checks.

At an open house, Kellie met a real estate agent, Esmeralda J. Villareal, from the Long and Foster agency in Baltimore.  Villareal offered to show Kellie a property in Baltimore, for which she represented the seller, a fact she failed to mention to Kellie.  When Kellie told Villareal that she and Gregory could together afford a mortgage payment of between $900 and $1,000 per month, Villareal told Kellie, “I can get that for you.  I know a place that can get that for you.”  Villareal then showed Kellie the house on North Potomac Street, and eventually Kellie agreed to buy the house, although there did not appear to be any evidence that  a purchase price for the house had been discussed or agreed to.  The house also needed repairs, which Kellie and Villareal discussed.

At the closing, the various agents and lawyers asked Kellie if she had a job, and she replied no.  She asked them again whether the monthly payment for the mortgage would be between $900 and $1,000 per month, and the real estate agent responded they would check Gregory’s credit to see if they could “work something out.”  But Gregory’s income and net worth never would have qualified him to receive a mortgage where the payments would have been $1,000 per month.  They then checked Kellie’s credit and decided that if they lowered the purchase price of the house, her credit would be sufficient for her to get a “loan you can afford.”  When Kellie asked again about the monthly mortgage payment, the broker finally said, “Yes, it will be between the payments.”  Without reading the documents, Kellie signed them, which added to her troubles.

The documents were rife with material misstatements of the facts surrounding Kellie’s life.  The loan application stated she had been employed at the signing date as the office manager of Always Exquisite, in Randallstown, Maryland, even though Kellie was unemployed.  The employer’s phone number was a nonexistent cell phone.  The application listed her monthly salary as $5,000, even though her monthly disability checks totaled $600.  The application stated she had $158,000 in liquid assets (including two bank accounts at M&T Bank, $31,200 in Exxon stock or bonds, and a 2001 Ford Taurus worth $6,000), $5,039 in unpaid liabilities, and a net worth of nearly $153,000.  The loan application stated that Kellie had agreed to a monthly mortgage payment of $1,811.94 per month (which she said she did not agreed to), had made a $75,000 down payment of the house plus another $12,000 in closing costs (when she had actually made only  a payment of $500), and had agreed to take a mortgage of $285,000.  She had put no money down on the house and the mortgage was grossed up to include around $13,000 in closing fees.  The appraisal of the home came in at $360,000–the purchase price–even though the previous three sales of the home had never exceeded $150,000 and the average price of a home of the block was $191,000.  MortgageIt, Inc., wrote the original $285,000 mortgage and then sold it to GMAC, which by then had been purchased by Cerberus, a large New York City hedge fund and private equity fund.  GMAC then sold the loan to Wells Fargo Home Mortgage.

As for the renovations the house needed, Kellie and Villareal discussed the costs associated with them after the closing.  Villareal agreed to pay for all the renovations, according to a tape of their conversation.  The renovations were never completed.  Within three months, Kellie could no longer afford the mortgage payments on the house.  After five months of nonpayment, Wells Fargo sold Kellie’s mortgage to EMC Mortgage, a subsidiary of Bear Stearns that originated and serviced mortgage loans of all kinds and sold them to investors.  Soon thereafter, the home was put back on the market, again through Long and Foster, at a price of $225,000–some $75,000 below the outstanding mortgage balance of about $300,000.  The sale was subject to an agreement by EMC to permit what was known as a “short sale,” for an amount less than the mortgage.  Kellie also informed EMC that she would not be able to pay the $75,000 balance, assuming the sale happened.  “Kellie keeps a journal of her seizures,” according to a document detailing her ordeal, “which reported that she experienced an increase in seizures throughout the mortgage process.  She had also experienced feelings of betrayal, fear, stress, humiliation, and frustration.  Kellie and Gregory have experienced a serious strain on their relationship throughout this process.  Gregory has upgraded his asthma medication due to increasing frequency and severity of asthma attacks, which he attributes to stress.”

Although it may be only part of the story, Russell Roberts, the George Mason University economist, sees this kind of deceitful behavior as the natural outgrowth of the government mandates.  “It’s not that much of a tragedy,” he said.  “People talk about it for political gain.  But many of the people who’ve lost their homes never had them in the first place.  A lot of our young people bought their homes with no money down.  In fact, you can find Countrywide press releases where they brag about their special 103 percent loan: ‘We don’t just cover your mortgage, we’ll lend you your closing costs, too.’  And [the borrower] walks into a house and six months later they’re having trouble making the payments.  Then they, quote, lose their home, unquote, but they lose no equity; they were renters before.  Now, they’re really renters.  I don’t want to diminish [foreclosure].  It’s embarrassing.  It’s humiliating.  There’s probably shame and dispair and you maybe thought you were going to own the house but you don’t.  But it’s not like they were thrown out on the street after they lost their equity.  They didn’t have any equity in these houses to start with.  It’s  a very strange situation.”

Henry Cisneos, the former mayor of San Antonio, Texas, was Clinton’s Secretary of Housing and Urban Development from 1993 to 1997.  In the midst of the financial crisis, in October 2008, the New York Times caught up with Cisneros to ask him about his role in encouraging home ownership among a group of people who would have been better off financially if they had remained renters.  He said, “I have been waiting for someone to put all the blame on my doorstep.”  He appeared not to be joking.  In the Times Cisneros argued that it was “impossible to know in the beginning that the federal push to increase homeownership would end so badly” and that once the housing boom started, the regulators did not have the tools to stop it.  “You think you have a finely tuned instrument,” he said, “that you can use to say: ‘Stop! We’re at 69 percent homeownership.  We should not go further.  These are people who should remain renters.’  But you really are just given a sledgehammer and an ax.  They are blunt tools.”  He said that people “who should not have been homeowners” had been lured by “unscrupulous participants–bankers. brokers, secondary market people. . . . The country is paying for that, and families are hurt because we as a society did not draw a line.””

(THE FOLLOWING IS ABOUT THE AUTHOR AND I QUOTE:

WILLIAM D. COHAN, a former senior Wall Street investment banker, is the bestselling author of The Last Tycoons and the winner of the 2007 Financial Times/Goldman Sachs Business Book of the Year Award.  He writes for Financial Times, Fortune, the New York Times, the Washington Post, the Daily Beast, and appears frequently on CNBC.”

THE FOLLOWING ARE MY COMMENTS AND I QUOTE: THIS CHAPTER 25 STARTED OUT WITH PRESIDENT BILL CLINTON EASING THE CREDIT FOR OWNING A HOME FOR THE MIDDLE CLASS AND THE LOWER CLASS WITH HELP FROM FED CHM ALAN GREENSPAN, HUD SECRETARY HENRY CISNEROS, NEW YORK FED PRESIDENT TIMOTHY GEITHNER WHICH LATER LED INTO A MUCH BIGGER PROBLEM WHEN GEORGE W. BUSH BECAME PRESIDENT AND AFTER EIGHT YEARS, LED TO THE 2008 FINANCIAL DEBACLE AND HOW TREASURY SEC HANK PAULSON, FED CHM BEN BERNANKE, AND NEW YORK FED PRES GEITHNER ENGINEERED THE $700 BILLION TARP BANK BAILOUT PROGRAM.  THIS LED TO THE FRIGHTENING MOVIE, “TOO BIG TO FAIL,” AND SHOWED THE U.S. TAXPAYER JUST HOW DUMB THE DEREGULATION OF THE BIG INVESTMENT BANKS WAS WHICH THE REPUBLICAN-CONTROLLED CONGRESS WANTS MORE DEREGULATION.  THAT’S WHY AFTER THE NEW YORK PRIMARY ELECTION, IT LOOKS LIKE HILLARY CLINTON WILL BE RUNNING AGAINST DONALD TRUMP IN THE NOVEMBER ELECTION FOR PRESIDENT IN 2016.  CAN WE STAND ANOTHER BIGGER FINANCIAL CRASH THAN WE HAD IN 2008?

LaVern Isely, Progressive, Overtaxed, Independent Middle Class Taxpayer and Public Citizen Member and USAF Veteran

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About tim074

I'm a retired dairy farmer that was a member of the National Farmer's Organization (NFO). Before going farming, I spent 4 years in the United States Air Force where I saved up enough money to get my down payment to go farming. I also enjoy writing and reading biographies and I write about myself as well as articles and excerpts I find interesting. I'm specifically interested in finances, particularly in the banking industry because if it wasn't for help from my local Community Bank, I never could have started farming which I was successful at. So, I'm real interested in the Small Business Administration and I know they are the ones creating jobs. I have been a member of Common Cause and am now a member of Public Citizen as well as AARP. I have, in the past, written over 150 articles on the Obama Blog (my.barackobama.com) and I'd like to tie these two sites together. I'm also on Twitter, MySpace and Facebook and find these outlets terrifically interesting particularly what many of these people did concerning the uprising in the Arab world. I believe this is a smaller world than we think it is and my goal is to try to bring people together to live in peace because management needs labor like labor needs management. Up to now, that hasn't been so easy to find.
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