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This Time Isn’t Different Because the Banks Made That Decision

Ezra Klein has a very long kind of apologia of the political class (or rather, he’s bringing to light an apologia from the political class) for why they failed to return the nation to prosperity after the financial crisis and Great Recession of 2008. I think the article is very good in capturing a point of view of the Administration and its defenders and their litany of excuses.

Basically, it adds detail to the Reinhart and Rogoff analysis of their book “This Time is Different,” which argues that financial crises follow similar paths and take long periods of time to climb out of, partly because of predictable failures of politics. There was also a failure of forecasting, as the Bureau of Economic Analysis underestimated the level of the recession by an almost-incredible amount, which led to the underwhelming and insufficient response.

There’s a lot to talk about in the article, including the fact that policymakers like Tim Geithner foresaw the bad politics that came with the necessary policies proceeding financial crises – the entire point of the story – and said at the time that they would “take pain now against pain later,” which they subsequently completely failed to do. But since I’ve focused so much on housing for the past couple years, I thought I would confine myself to that part of the story.

It’s become clear that we’re in something of a balance sheet recession, and that massive debt relief is a key to stronger growth. Of course, debt relief is implicitly tied to mortgage debt. And yet, the housing policies that would have brought this debt relief completely failed. Why? Here’s Ezra:

Today, few on the Obama team will mount much of a defense of its housing policy.

Its efforts to heal the troubled market at the core of the financial crisis are widely considered weak and ineffective. The Home Affordable Modification Program, which proposed to pay mortgage servicers to renegotiate with financially stressed homeowners, couldn’t persuade the servicers to play ball and so has left most of its $75 billion unspent. The Home Affordable Refinance Program was projected to help 5 million underwater homeowners. It has reached fewer than 1 million.

Even so, the administration rejects the more radical solutions that are occasionally floated. The problem, it says, is that the choices are mostly between timid and unworkable.

There are two problems floated here. One is that the Federal Housing Finance Agency is controlled by a Bush Administration appointee, and that this stopped the agency from allowing Fannie and Freddie to do refinancing for underwater borrowers, or more important, principal reductions. First of all, DeMarco has been an acting director of FHFA since all the way back in 2009; the White House has had two years to replace him. Their initial replacement wasn’t named until late 2010 (well after the conclusion of the 60-vote Democratic Senate), and Senate Republicans blocked the appointment. The term “recess appointment,” which Obama could make any time he wants, is operative here. So is the fact that Treasury put DeMarco in place and they can take him out, as a collection of House Oversight Committee Democrats demanded late in the week. The fact that there’s no refinancing plan two months after the President announced it in his American Jobs Act address before Congress is reason enough for dismissal.

DeMarco, acting director of the Federal Housing Finance Agency (FHFA) — an agency independent of the White House — met Thursday with 17 House Democrats in the Capitol, ostensibly to brief them on FHFA’s enhanced efforts to help struggling homeowners. Instead, he revealed that the agency doesn’t yet have such a plan.

“I said to him twice, ‘Mr. DeMarco, if you cannot do this job — or if you don’t feel like you’re capable of helping the people that we represent — maybe you should move to the side and let somebody else come and replace you,’” Rep. Elijah Cummings (D-Md.) told reporters after the meeting. “That’s just fair.” […]

“Either do something or get out of the way,” Cardoza said. “And if you’re incapable of doing it, then find somebody who isn’t.”

But even an FHFA regulator dedicated to improving the situation for homeowners would not have helped, according to Ezra’s narrative.

But when talking about what might have worked on a massive, economy-wide scale — that is to say, what might have made this time different — you’re talking about something more drastic. You’re talking about getting rid of the debt. To do that, somebody has to pay it, or somebody has to take the loss on it.

The most politically appealing plans are the ones that force the banks to eat the debt, or at least appear to do so. “Cramdown,” in which judges simply reduce the principal owed by underwater homeowners, works this way. But any plan that leads to massive debt forgiveness would blow a massive hole in the banks. The worry would move from “What do we do about all this housing debt?” to “What do we do about all these failing banks?” And we know what we do about failing banks amid a recession: We bail them out to keep the credit markets from freezing up. There was no appetite for a second Lehman Brothers in late 2009.

Which means that the ultimate question was how much housing debt the American taxpayer was willing to shoulder. Whether that debt came in the form of nationalizing the banks and taking the bad assets off their books — a policy the administration estimated could cost taxpayers a trillion dollars — or simply paying off the debt directly was more of a political question than an economic one. And it wasn’t a political question anyone really knew how to answer.

On first blush, there are few groups more sympathetic than underwater homeowners or foreclosed families. They remain so until about two seconds after their neighbors are asked to pay their mortgages. Recall that Rick Santelli’s famous CNBC rant wasn’t about big government or high taxes or creeping socialism. It was about a modest program the White House was proposing to help certain homeowners restructure their mortgages. It had Santelli screaming bloody murder.

Let’s set aside this alibi of “bad politics” and look at the facts here. The Administration set aside $75 billion through TARP for HAMP, and to date have used $1.6 billion or so on a program that is effectively irrelevant at this point (and they have cleverly revised history to claim that it was only a $50 billion allotment, to make this look a little better). Without any need to clear Congress, the Administration had all the authority they needed to put this $75 billion to work, including the ability to punish servicers who failed to comply with guidelines. They didn’t have to design the program as voluntary on the part of the banks to begin with.

Then, for two years, Treasury swore up and down there was nothing they could do to punish servicers who didn’t comply. Finally, a few months ago, they started withholding incentive payments for noncompliance, as if they just magically acquired the power. It turns out, as Paul Kiel from Pro Publica displayed in a story this week, that Treasury wasn’t even checking on servicer compliance for at least the first year of the program. AG Catherine Cortez Masto of Nevada is suing Bank of America in part for claiming to work with borrowers on loan modifications while foreclosing on them at the same time. This is well within the Justice Department’s purview if they chose to use the authority, and at the least, Treasury could force compliance with their own contracts.

If the theory is that no bank would agree to the terms of the contracts if they included the ability to be punished, then there’s certainly ways to use the full $75 billion rather than 2-3% of it by simply increasing the incentives to reverse the clear incentives by mortgage servicers to foreclose, or by using the funds entirely on third-party counseling and mediation programs, which have been massively more successful on the local level than anything from HAMP.

The truth that emerges from all of these facts is that the Administration had no interest whatsoever in using more than a token amount of the TARP authority they had already husbanded for mortgage relief and foreclosure mitigation. They wanted to run, and did run, an extend and pretend scheme, a form of predatory lending, to squeeze out additional payments from borrowers on whom banks would eventually foreclose. The one fly in this ointment is that the banks had no way to prove ownership of the underlying loans. If they didn’t break the residential housing market in this fashion, that would have “worked,” to the detriment of millions of homeowners whose life savings were taken away to prop up zombie banks.

You can call this the function of bad politics, but I’d say it was more an extension of bank policy, a policy to preserve the wonderful sub-1 percent growth and still-vulnerable financial system we have going for ourselves. The shell-shock that comes from Rick Santelli’s proto-Tea Party rant happening to be about mortgages, as if the Tea Party wouldn’t have started from Obama bowing to the wrong leader or the auto bailout or the first details of health care or literally anything else, is the ultimate in Democratic Party fatalism tinged with a total misdirection, as if the touchy politics was the reason to design a predatory lending scheme for banks to get well off their own customers.

Even today there are programs that could be scaled up to work for the mass of homeowners. They aren’t being done not because of some Tea Party-fueled backlash, but because Wall Street would face trouble. If you actually took seriously the fact that 60 million mortgages have no reliable chain of ownership, that litigation will drain the banks for the next decade or more and make it impossible for them to retain anything approaching a level of strength, that this was all known based on the fabrication of mortgage documents as far back as 2003 according to a FHFA IG report this week, then you as a policymaker might not work so hard to preserve such an industry.

The idea that policymakers are protecting banks from insolvency on the grounds that it’s cheaper to preserve the shitty economy banks are helping to provide, millions of people be damned, stands as a pretty good reason why thousands of people are occupying public spaces all over the country right now, to protest the corrupt partnership of finance and government, at their expense.

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David Dayen

David Dayen