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U.S. Loan Effort Is Seen as Adding to Housing Woes

By PETER S. GOODMAN

The Obama administration’s $75 billion program to protect homeowners from foreclosure has been widely pronounced a disappointment, and some economists and real estate experts now contend it has done more harm than good.

Since President Obama announced the program in February, it has lowered mortgage payments on a trial basis for hundreds of thousands of people but has largely failed to provide permanent relief. Critics increasingly argue that the program, Making Home Affordable, has raised false hopes among people who simply cannot afford their homes.

As a result, desperate homeowners have sent payments to banks in often-futile efforts to keep their homes, which some see as wasting dollars they could have saved in preparation for moving to cheaper rental residences. Some borrowers have seen their credit tarnished while falsely assuming that loan modifications involved no negative reports to credit agencies.

Some experts argue the program has impeded economic recovery by delaying a wrenching yet cleansing process through which borrowers give up unaffordable homes and banks fully reckon with their disastrous bets on real estate, enabling money to flow more freely through the financial system.

“The choice we appear to be making is trying to modify our way out of this, which has the effect of lengthening the crisis,” said Kevin Katari, managing member of Watershed Asset Management, a San Francisco-based hedge fund. “We have simply slowed the foreclosure pipeline, with people staying in houses they are ultimately not going to be able to afford anyway.”

Mr. Katari contends that banks have been using temporary loan modifications under the Obama plan as justification to avoid an honest accounting of the mortgage losses still on their books. Only after banks are forced to acknowledge losses and the real estate market absorbs a now pent-up surge of foreclosed properties will housing prices drop to levels at which enough Americans can afford to buy, he argues.

“Then the carpenters can go back to work,” Mr. Katari said. “The roofers can go back to work, and we start building housing again. If this drips out over the next few years, that whole sector of the economy isn’t going to recover.”

The Treasury Department publicly maintains that its program is on track. “The program is meeting its intended goal of providing immediate relief to homeowners across the country,” a department spokeswoman, Meg Reilly, wrote in an e-mail message.

But behind the scenes, Treasury officials appear to have concluded that growing numbers of delinquent borrowers simply lack enough income to afford their homes and must be eased out.

In late November, with scant public disclosure, the Treasury Department started the Foreclosure Alternatives Program, through which it will encourage arrangements that result in distressed borrowers surrendering their homes. The program will pay incentives to mortgage companies that allow homeowners to sell properties for less than they owe on their mortgages — short sales, in real estate parlance. The government will also pay incentives to mortgage companies that allow delinquent borrowers to hand over their deeds in lieu of foreclosing.

Ms. Reilly, the Treasury spokeswoman, said the foreclosure alternatives program did not represent a new policy. “We have said from the start that modifications will not be the solution for all homeowners and will not solve the housing crisis alone,” Ms. Reilly said by e-mail. “This has always been a multi-pronged effort.”

Whatever the merits of its plans, the administration has clearly failed to reverse the foreclosure crisis.

In 2008, more than 1.7 million homes were “lost” through foreclosures, short sales or deeds in lieu of foreclosure, according to Moody’s Economy.com. Last year, more than two million homes were lost, and Economy.com expects that this year’s number will swell to 2.4 million.

“I don’t think there’s any way for Treasury to tweak their plan, or to cajole, pressure or entice servicers to do more to address the crisis,” said Mark Zandi, chief economist at Moody’s Economy.com. “For some folks, it is doing more harm than good, because ultimately, at the end of the day, they are going back into the foreclosure morass.”

Mr. Zandi argues that the administration needs a new initiative that attacks a primary source of foreclosures: the roughly 15 million American homeowners who are underwater, meaning they owe the bank more than their home is worth.

Increasingly, such borrowers are inclined to walk away and accept foreclosure, rather than continuing to make payments on properties in which they own no equity. A paper by researchers at the Amherst Securities Group suggests that being underwater “is a far more important predictor of defaults than unemployment.”

From its inception, the Obama plan has drawn criticism for failing to compel banks to write down the size of outstanding mortgage balances, which would restore equity for underwater borrowers, giving them greater incentive to make payments. A vast majority of modifications merely decrease monthly payments by lowering the interest rate.

Elizabeth Warren: America Without a Middle Class

Posted: 2009-12-02 18:35:41 UTC-08:00

? Washington’s Blog.

A 2005 letter in premier scientific journal Nature reviews the research on trust and economics:

Trust … plays a key role in economic exchange and politics. In the absence of trust among trading partners, market transactions break down.
In the absence of trust in a country’s institutions and leaders,
political legitimacy breaks down. Much recent evidence indicates that
trust contributes to economic, political and social success.

Forbes wrote an article in 2006 entitled “The Economics of Trust”. The article summarizes the importance of trust in creating a healthy economy:

Imagine
going to the corner store to buy a carton of milk, only to find that
the refrigerator is locked. When you’ve persuaded the shopkeeper to
retrieve the milk, you then end up arguing over whether you’re going to
hand the money over first, or whether he is going to hand over the
milk. Finally you manage to arrange an elaborate simultaneous exchange.
A little taste of life in a world without trust–now imagine trying to
arrange a mortgage.

 

Being able to trust people might seem like a pleasant luxury, but
economists are starting to believe that it’s rather more important than
that. Trust is about more than whether you can leave your house
unlocked; it is responsible for the difference between the richest
countries and the poorest.

 

“If you take a broad enough definition of trust, then it would
explain basically all the difference between the per capita income of
the United States and Somalia,” ventures Steve Knack, a senior
economist at the World Bank who has been studying the economics of
trust for over a decade. That suggests that trust is worth $12.4
trillion dollars a year to the U.S., which, in case you are wondering,
is 99.5% of this country’s income. ***

 

Above all, trust enables people to do business with each other. Doing business is what creates wealth. ***

 

Economists distinguish between the personal, informal trust that
comes from being friendly with your neighbors and the impersonal,
institutionalized trust that lets you give your credit card number out
over the Internet.

Similarly, market psychologists Richard L. Peterson M.D. and Frank Murtha, Ph.D. wrote in October:

Trust is the oil in the engine of capitalism, without it, the engine seizes up.

Confidence is like the gasoline, without it the machine won’t move.

Trust is gone: there is no longer trust between counterparties in the
financial system. Furthermore, confidence is at a low. Investors have
lost their confidence in the ability of shares to provide decent
returns (since they haven’t).

And two professors of finance write:

The
drop in trust, we believe, is a major factor behind the deteriorating
economic conditions. To demonstrate its importance, we launched the
Chicago Booth/Kellogg School Financial Trust Index. Our first set of
data—based on interviews conducted at the end of December 2008—shows
that between September and December, 52 percent of Americans lost trust
in the banks. Similarly, 65 percent lost trust in the stock market. A
BBB/Gallup poll that surveyed a similar sample of Americans last April
confirms this dramatic drop. At that time, 42 percent of Americans
trusted financial institutions, versus 34 percent in our survey today,
while 53 percent said they trusted U.S. companies, versus just 12
percent today.

 

As trust declines, so does Americans’ willingness to invest their
money in the financial system. Our data show that trust in the stock
market affects people’s intention to buy stocks, even after accounting
for expectations of future stock-market performance. Similarly, a
person’s trust in banks predicts the likelihood that he will make a run
on his bank in a moment of crisis: 25 percent of those who don’t trust
banks withdrew their deposits and stored them as cash last fall,
compared with only 3 percent of those who said they still trusted the
banks. Thus, trust in financial institutions is a key factor for the
smooth functioning of capital markets and, by extension, the economy.
Changes in trust matter.

They quote a Nobel laureate economist on the subject:

“Virtually
every commercial transaction has within itself an element of trust,”
writes economist Kenneth Arrow, a Nobel laureate. When we deposit money
in a bank, we trust that it’s safe. When a company orders goods, it
trusts its counterpart to deliver them in good faith. Trust facilitates
transactions because it saves the costs of monitoring and screening; it
is an essential lubricant that greases the wheels of the economic
system.

Americans clearly don’t trust the big banks and financial companies.

Indeed, as leading economists have pointed out, the big financial institutions don’t even trust each other,
because they know that all of the other companies might have hidden
toxic assets in SIVs, overvalued their assets, gamed their books, or
otherwise tried to bury their problems.

For example, Anna Schwartz – co-author with Milton Friedman of the leading monetarist book on the Great Depression – told the Wall Street Journal:

We
now hear almost every day that banks will not lend to each other, or
will do so only at punitive interest rates…This is not due to a lack
of money available to lend, Ms. Schwartz says, but to a lack of faith
in the ability of borrowers to repay their debts. “The Fed,” she
argues, “has gone about as if the problem is a shortage of liquidity.
That is not the basic problem. The basic problem for the markets is
that [uncertainty] that the balance sheets of financial firms are
credible.” 

So even though the Fed has flooded the credit markets with cash,
spreads haven’t budged because banks don’t know who is still solvent
and who is not. This uncertainty, says Ms. Schwartz, is “the basic
problem in the credit market. Lending freezes up when lenders are
uncertain that would-be borrowers have the resources to repay them. So
to assume that the whole problem is inadequate liquidity bypasses the
real issue”…

 

In the 1930s, as Ms. Schwartz and Mr. Friedman argued in “A Monetary History,” the country and the Federal Reserve were faced with a liquidity crisis in the banking sector…

 

But “that’s not what’s going on in the market now,” Ms. Schwartz
says. Today, the banks have a problem on the asset side of their
ledgers — “all these exotic securities that the market does not know
how to value.”

 

“Why are they ‘toxic’?” Ms. Schwartz asks. “They’re toxic because
you cannot sell them, you don’t know what they’re worth, your balance
sheet is not credible and the whole market freezes up. We don’t know
whom to lend to because we don’t know who is sound.”

As financial writer Will Hutton says:

“Such
was the break down in trust and sense of panic that some of the most
familiar names in British high street banking would not lend to each
other at all or, at best, just overnight. Instead, the Bank of England
had to supply tens of billions to banks who found the normal sources of
funds blocked.

***

Unless there is a radical and government-led change in ownership,
structure, regulation and incentives so that the principles of fairness
are put at the heart of the Anglo American financial system -
proportionality of reward and fair distribution of risk – there is no
chance of the return of trust and integrity upon which long-term
recovery depends.”

Economist and former Secretary of Labor Robert Reich agrees that Wall Street’s biggest problem right now is the collapse of trust:

The
problem is, government bailouts, subsidies, and insurance aren’t really
helping Wall Street. The Street’s fundamental problem isn’t lack of
capital. It’s lack of trust. And without trust, Wall Street might as
well fold up its fancy tents.

Reich also writes:

Despite
all the money going directly to the big banks, despite all the
government guarantees and loans and special tax breaks, despite the
shot-gun weddings and bank mergers, despite the willingness of the
Treasury and the Fed to do almost whatever the banks have asked, the
reality is that credit is not flowing.

 

Why? Because the underlying problem isn’t a liquidity problem. As I’ve noted elsewhere, the
problem is that lenders and investors don’t trust they’ll get their
money back because no one trusts that the numbers that purport to value
securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years — the derivatives, credit default swaps, collateralized debt instruments, and so on — has undermined all notion of true value.

 

Many of these fancy instruments became popular over recent years
precisely because they circumvented financial regulations, especially
rules on banks’ capital adequacy. Big banks created all these
off-balance-sheet vehicles because they allowed the big banks to carry
less capital.

In other words, I would argue that our economy is not
fundamentally stabilizing (notwithstanding a couple of temporary “green
shoots”) because the government and the financial giants are taking
actions and releasing data which encourage more distortion and less trust.

The
crisis will deepen unless honest and transparent accounting is used,
investments become transparent and understandable again, and the
government stops gaming the system for the benefit of the big boys.

As structured finance and derivatives expert Janet Tavakoli says, lack
of transparency, lying and fraud which “we’ve seen massively in the
financial system” has undermined trust, so no one wants to buy our
financial products.

As John Carney writes:

“We’re probably making things worse. Allowing insolvent
institutions to fail and requiring worthless and worth less assets to
be fully written down would provide transparency to the market.
Instead, we’re dedicated to the post-Lehman proposition of “Never
Again.” The various programs of our government continue to obscure
asset pricing and conceal insolvency. This means that you can’t trust
the market to tell you which firms are failing.

 

Twisting the arms of bankers to lend to institutions that may be
insolvent is a recipe for deepening the crisis. We’ve just been through
a period of malinvestment–we spent too much borrowed money on junk.
Borrowing more to spend on junk only digs us in deeper.

 

Bank lending won’t get going again until trust in the markets can
be restored. Fighting a Great Depression era problem probably won’t
help. More transparency, which means more write-downs and failures, is
probably necessary if we’re going to get through this. Unfortunately,
we’re still sailing in the opposite direction.”

Happy Talk: Then and Now

It
is true that consumers and small investors drive a large portion of the
economy. And it is true that consumers and small investors, in turn,
are largely driven by their perception of what is happening.

But
I would also argue that all of the happy talk in the world won’t turn
the economy around when the fundamentals of the economy are lousy, or
there has been a giant bubble and vast overleveraging, or there has
been massive fraud, or the government has gone so far into debt that it
has formed a black hole.

Happy talk did not work during the first couple of years of the Great Depression, once the speculative bubble and leverage of the Roaring 20′s burst, leading to the inevitable crash.

As economist Irving Fisher pointed out (as recounted by economist Steve Keen):

Hobbled
by this naive belief in equilibrium, the economics profession was as
unprepared for today’s crisis as it had been for the Great Depression.
Now that the crisis is well and truly with us, all
conventional “neoclassical” economists can offer is the hope that the
crisis can be overcome by a good, strong dose of confidence.

From [Irving] Fisher’s point of
view, such a belief is futile. In an economy with an excessive level of
debt and low inflation, he argued that confidence was irrelevant–and in
fact dangerously misleading, as he knew from painful personal experience.

University of Maryland professor economics professor and former Chief
Economist at the U.S. International Trade Commission Peter Morici wrote in 2006:

The
speculative frenzy of recent years is causing a major adjustment, and
the happy talk of realtors is prolonging the process. The absence of
realistic analysis about the extent of overvaluation is characteristic
in an industry that sees nothing but an upward progression for values,
but houses like any other asset can be overpriced.

Things are likely to get worse before they get better.

Morici was pointing out that there was a bubble in housing, and happy talk would not keep the bubble from bursting.

As Washington Post business writer Steven Pearlstein predicted in August 2007:

Despite
the happy talk from Washington and Wall Street investment houses –
eerily reminiscent, by the way, of the early days of the
savings-and-loan crisis of the late ’80s — these shocks [the subprime
and credit crises] will have serious consequences …

And economist James Galbraith is saying now (just as his father economist John Kenneth Galbraith said 50 years ago) – that “happy talk” won’t solve the crisis.

Indeed, the chair of the congressional oversight committee of the bailouts (Elizabeth Warren) and the senior regulator
during the S & L crisis (William Black) both say that hiding the
true state of affairs and trying to put a happy face on an economic
crisis just prolongs the length and severity of the crash

Donald
W. Riegle Jr. – former chair of the Senate Banking Committee from 1989
to 1994 – wrote (along with the former CEO of AT&T Broadband and
the international president of the United Steelworkers union) wrote recently:

It’s
almost as if the [Obama] administration is opting for a
rose-colored-glasses PR strategy rather than taking a hard-nose look at
actual consumer and employment figures and their trends, and modifying
its economic policies accordingly.

In short, happy talk and fake confidence-building exercises (like the stress tests, which Time Magazine called a con game) don’t work.

Indeed, I believe that trying to instill false confidence will actually backfire on Summers, Geithner, Bernanke and the boys and make the crisis worse.

Why?

Well, initially, as Yves Smith points out:

Team Obama has made it clear that it sees restoring confidence as paramount, when anyone
with consumer marketing experience will tell you that advertising
campaigns that make exaggerated claims about the product often don’t
simply fail (as in customers see through the hype) but often backfire
(buyers discount future ad messages about the product). The
press has had a manipulated feel, with readers on sending news stories
that have misleadingly positive stories with Panglossian headlines and
upbeat initial paragraphs that are often undercut by other material in
the same article.

So in our new branding, “the economy is no longer in a freefall” has
become “recovery.” The self-congratulatory tone among US financial
regulators (who should instead be engaging in serious
self-recrimination for failing to foresee and prevent this crisis) is
premature.

In addition, psychologists say that – until
government and business leaders prove they can behave responsibly, and
until the perpetrators of financial fraud are held accountable – real
trust will not be restored and the economy will not recover

For example, one of the leading business schools in America – the Wharton School of Business – has written an essay
on the psychological causes and solutions to the economic crisis.
Wharton points out that restoring trust is the key to recovery, and
that trust cannot be restored until wrongdoers are held accountable:

According to David M. Sachs, a training and supervision analyst at the Psychoanalytic Center of Philadelphia, the
crisis today is not one of confidence, but one of trust. “Abusive
financial practices were unchecked by personal moral controls that
prohibit individual criminal behavior, as in the case of [Bernard]
Madoff, and by complex financial manipulations, as in the case of AIG.”
The public, expecting to be protected from such abuse, has suffered a
trauma of loss similar to that after 9/11. “Normal expectations of what
is safe and dependable were abruptly shattered,” Sachs noted. “As is
typical of post-traumatic states, planning for the future could not be
based on old assumptions about what is safe and what is dangerous. A
radical reversal of how to be gratified occurred.”

 

People now feel more gratified saving
money than spending it, Sachs suggested. They have trouble trusting
promises from the government because they feel the government has let
them down.

 

He framed his argument with a fictional patient named Betty Q.
Public, a librarian with two teenage children and a husband, John, who
had recently lost his job. “She felt betrayed because she and her
husband had invested conservatively and were double-crossed by
dishonest, greedy businessmen, and now she distrusted the government
that had failed to protect them from corporate dishonesty. Not only
that, but she had little trust in things turning around soon enough to
enable her and her husband to accomplish their previous goals.

 

“By no means a sophisticated economist, she knew … that some
people had become fantastically wealthy by misusing other people’s
money — hers included,” Sachs said. “In short, John and Betty had done
everything right and were being punished, while the dishonest people
were going unpunished.”

 

Helping an individual recover from a traumatic experience provides
a useful analogy for understanding how to help the economy recover from
its own traumatic experience, Sachs pointed out. The public will need to “hold the perpetrators of the economic disaster responsible and take what actions they can to prevent them from harming the economy again.” In addition, the public will have to see proof that government and business leaders can behave responsibly before they will trust them again, he argued.

Note that Sachs urges “hold[ing] the perpetrators of the economic disaster responsible.” In other words, just “looking forward” and promising to do things differently isn’t enough.

Are the “perpetrators of the economic disaster” being held accountable?

So
far, Obama, Summers, Geithner, Bernanke and the crew have tried to
paper over the cause and severity of the financial crisis, instead of
honestly addressing them. They haven’t lifted a finger to hold anyone
accountable (other than a Madoff or two), but have actually thrown
billions of dollars at the perpetrators (or else appointed them to
government posts).

Indeed, William Black says that “the [government's] entire strategy is to keep people from getting the facts”.

Economist Dean Baker made a similar point, lambasting
the Federal Reserve for blowing the bubble, and pointing out that those
who caused the disaster are trying to shift the focus as fast as they
can:

The current craze in DC policy circles
is to create a “systematic risk regulator” to make sure that the
country never experiences another economic crisis like the current one.
This push is part of a cover-up of what really went wrong and does
absolutely nothing to address the underlying problem that led to this
financial and economic collapse.

 

The key fact that everyone must always remember is that the story
of the collapse was not complex. We did not need great minds sifting
through endless reams of data and running incredibly complex computer
simulations to discover the underlying problem in the economy. We just
needed some people who understood the sort of arithmetic that most of
us learned in 3rd grade.

 

If the people at the Fed, the Treasury, and in other key positions
had mastered arithmetic, and were prepared to act on their knowledge,
they would have taken steps to stem the growth of the housing bubble.
They would have prevented the bubble from growing to the point where
its inevitable collapse would bring down both the U.S. economy and the
world economy…

 

We didn’t need some super-genius to solve the mystery. We just
needed an economist who could breath and do arithmetic. But the DC
policy crowd tells us that if only we had a systematic risk regulator
this disaster could have been prevented.

 

Okay, let’s do a thought experiment. Suppose we had our systematic
risk regulator in 2002. Would this person have stood up to Alan
Greenspan and said that the country is facing a huge housing bubble the
collapse of which will sink the economy?…

 

Alan Greenspan said that there was no housing bubble; everything
was just fine. Would our systematic risk regulator have said that
Greenspan was nuts and that the whole economy was a house of cards
waiting to collapse?

 

Anyone who believes that a risk regulator would have challenged
the great Greenspan knows nothing about the way Washington works. The
government is run by people who first and foremost want to advance
their careers.

 

And, the best way to advance your career in Washington is to go
along with what everyone else is saying. If that was not completely
obvious before the collapse of the housing bubble, it certainly should
be obvious now.

 

How many people in government have lost their jobs because they
failed to see the bubble? How many people even missed a promotion? In
fact, the top financial officials in the Obama administration, without
exception, completely missed the housing bubble. One might think it was
a job requirement.

This lack of accountability among economists and economic analysts is the core problem that must be tackled.
Unless these people are held accountable for their failures in the same
way as custodians and dishwashers, there will never be any incentive to
buck the crowd and point out looming disasters like the housing bubble.

The reality is that we have a systematic risk regulator. It is called the Federal Reserve Board. They blew it completely. We
will do far more to prevent the next crisis by holding our current risk
regulator accountable for its failure (fire people) than by pretending
that we somehow had a gap in our regulatory structure and creating
another worthless bureaucracy.

Remember also that the Wharton study pointed out that
“the public, expecting to be protected from such abuse, has suffered a
trauma of loss similar to that after 9/11.”

Trying to put a happy
face on a grim situation, continuing to do things which are transparent
attempts to instill false confidence, and leaving in power the people
who caused the crisis reinforces the market’s convictions that (1)
government and business leaders are behaving irresponsibly instead of
addressing the fundamental problems and (2) there is no accountability.

Keeping
quiet about how bad things are won’t help. As numerous leading
independent economists and financial experts agree, the three things
that will help are:

1. Honestly addressing the causes of the crisis;
2. Honestly addressing the necessary – if bitter – medicine needed to get out of the crisis; and
3. Holding responsible those who caused the crisis.

Postscript: Time Magazine notes:

Traditionally, gold has been a store of value when citizens do not trust their government politically or economically.

In other words, the government’s political actions affect investments, such as gold.

It is interesting to note that Americans no longer trust their politicians, the justice system, their ability to obtain liberty, or the media. Americans know that the boys launched the war in Iraq (which will end up costing $3-5 trillion dollars) based upon justifications which turned out to be untrue. Many Americans have read that the government imported communist Soviet Union torture techniques and then said “we don’t torture”. Many Americans also know that the government spied on American citizen (even before 9/11 … confirmed here and here) while saying “we don’t spy”, and that the government apparently planned both the Afghanistan war (see this and this) and the Iraq war before 9/11.

This
is an economic, not a political, essay. But I think the lack of trust
in government concerning political issues poses an interesting
question. Specifically, is it possible that the American people’s
distrust of the government concerning the above-described issues also
bleeds over into a lack of trust in the government’s economic actions
and statements? In other words, if people discover that a government is
lying about political issues, do people trust the government’s
pronouncements about economic issues less?

I
don’t know the answer, but analyzing the possibility could provide a
researcher with an interesting project (or a PhD candidate with a
potential doctoral thesis).