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An Expansion of Terms Used in the Coffee Party Article by RP

by mous Saturday, Apr. 16, 2011 at 8:22 PM

I apologize for the weak structure in this article. I was hoping to write something that explained some of the material in the story, but ended up going a bit afield with the information. This article attempts to be neutral and nonpartisan, or at least not shrill, and avoids too much analysis. The nature of the Great Recession is difficult to sum up in a few pages, because it's a failure of a complex system with many parts, and many related behaviors, that led to the near-collapse of capitalism.

Note to Leftists and others: this article makes references primarily to business or “bourgeois” references, blogs, and explanations.  I’m not a pro at financial issues and have to learn by watching and doing.

Bank of America

It is the second largest bank in the US.  Its main competitors are Wells Fargo, JP Morgan Chase, and Citigroup.  BofA received $20 billion of TARP bank bailout money.

Underwater Mortgages

A mortgage is a loan with a claim on the underlying property as collateral (collateral is something you give to the bank if you fail to pay back a loan) - if the mortgage payments are not made, the bank can exercise its right to take the property.  This is called foreclosure.

An “underwater” mortgage, aka an “upside down” mortgage, is one where the value of the underlying property is less than the outstanding balance of the loan, because the value of the property declined.  These loans are said to have “negative equity”.

In 2006 the price of houses stopped rising, and in 2007 prices started to decline, and prices have generally declined (in California) for the past four years.  As of March 2011, nearly a third of all mortgages are are underwater.

When a mortgage is underwater, the borrower has some leverage to renegotiate the terms of the loan.  This is because if the borrower defaults, the lender loses money.  The faster the house value falls, the more leverage the borrower has, and the more motivation the borrower has to make a “strategic default.”  A strategic default is an intentional stoppage of mortgage payments, typically to cut losses.  The house is foreclosed, and the bank gets the house.

The Home Affordable Modification Program (HAMP) is supposed to help underwater borrowers by pressuring and paying banks to renegotiate loans.  Houses that were severely underwater were excluded from this law; only homes slightly underwater qualified.  So California, which suffered 10% to 40% losses each year, was virtually excluded from HAMP.  And what HAMP-qualified situations were out there, the borrowers had less leverage because they weren’t so deep in the hose.

Banks were stonewalling, or delaying, or pushing borrowers through a modifcation process not regulated through HAMP. [FDL]  The mortgage servicers didn’t own the loans, and thus were not motivated to settle.  They screwed up and allowed foreclosures.

Also, the renegotiated terms were generally lower interest rates for longer periods of time.  They did not lower the principal of the loans.

HAMP was supposed to help modify 3 million loans, but it has only modified 600,000.  Due to this failure, two pieces of legislation have been proposed recently: the HAMP Termination Act, from the right, and the Homeowner Advocacy Act of 2011, from the left.  The former terminates HAMP, and the latter oversees modifications. More on the latter below.

Predicted Second Foreclosure Crisis

According to the Coffee Party, the reforms to decrease speculation were too weak the current market is going to collapse, again.  CP member Heather Meyer said:

“As we were watching the financial reform take shape in Congress we believed that the root cause of the economic collapse was not being properly addressed (no real curb on the gambling, no serious regulations on mortgages, no real oversight on the home modification programs, etc.); therefore, we also believe there is going to be a second market crash via foreclosures.”

Real estate bloggers say that “shadow inventory” - bank owned properties, and properties with delinquent payments that can be foreclosed upon - will cause house prices to drop even further as they enter the market.  That, in turn, will trigger defaults, particularly by people purchasing via the FHA loans, which require a small 3.5% downpayment.

Regulations on Mortgages and Curb on Gambling in Finance

Dodd–Frank Wall Street Reform and Consumer Protection Act was the main legislation passed to rein in the finance business in the Great Recession.  Dodd-Frank has been mostly criticized from the financial business as overreaching, and compromises were made to pass it.  

The main disagreements from the left (and some on the libertarian right) is that it doesn’t address the problem of “too big to fail”, where a few banks are so large that they cannot be allowed to become insolvent and be bought up by other banks.  That puts the government in the position of propping up the bank with infusions of money when they have a large amount of failing assets.

The act created the Bureau of Consumer Financial Protection in the Federal Reserve Bank, and that is led by Elizabeth Warren.

Home Modification Oversight

According to critics, banks have been avoiding performing loan modifications, blaming borrowers for being uncooperative.  To introduce transparency in the process, senators Franken, Snow, Mendez and Rockefeller have proposed creating an Office of the Homeowner Advocate to oversee the HAMP process.  

Gambling On Mortgages

The housing bubble was caused, in part, by the existence of unregulated “derivatives”.  A derivative is a financial contract that pays based on the performance (or non-performance) of another asset.  The most common kind of derivative is insurance - for example, if you buy auto insurance, your contract will pay if your car is damaged.

The impact of the foreclosure crisis was magnified by these derivatives, because as these financial products failed, money had to be transferred out of the large banks that created these derivatives.  This, in turn, pushed banks toward insolvency.  (Complex explanation of insolvency here.)

If all mortgage money were fully separated from all other kinds of money, the foreclosure crisis could have been “firewalled” in real estate.  That’s not how the system works today.  Indeed, the entire system can be condensed into a short history ranging from 1932 to today.

In 1932 the Federal Home Loan Bank Act established a bank for mortgages and laws that made home ownership possible for more people.  Savings and loans trusts (S&Ls) were formed across the country to sell mortgages and accept deposits.  Wikipedia has a good article about the rise and decline of S&Ls in the American financial system.

Over the years, regulations have been removed.  Generally, this has helped to grow the economy, and risk was mitigated by new products, generally insurance or derivatives, that allowed banks to trade risk for steady returns.  Risk reduction was partially privatized and regulated (rather than having the government or FRB directly managing the money).  Alan Greenspan evoked this ethos when he suggested that government financial regulation was no longer necessary.

However, in hindsight, we know risk was not really redistributed.  Rather, it only appeared to be, but it was still present.  So, the upshot was that risk was not mitigated, and the money that should have been spent on managing risk, was spent on purchasing investments.  (It’s like buying $10,000 of insurance on a $50,000 car, and spending the money saved on beer.)

Some commentators have pinned the blame for the bubble and crash on the repeal of Glass-Steagall Act (GSA) in 1999.  The GSA put a “firewall” between consumer banks and investment banks - and its repeal allowed consumer banks to use customers’ deposit money to invest in riskier products.  The repeal helped make investment banks wealtheir, and also led to the consolidation of the big banks. However, blaming the repeal of the GSA ignores the fact that many provisions of the law had been removed since the 1970s, and that the financial business has changed since the 1930s. It also ignores the dysfunction of the regulatory agencies - laws without regulation are nothing.

The mortgage market has also been undergoing deregulation ever since the New Deal. In 1932 the Federal Home Loan Bank Act established a bank for mortgages and laws that made home ownership possible for more people.  Savings and loans trusts (S&Ls) were formed across the country to sell mortgages and accept deposits.  Wikipedia has a good article about the rise and decline of S&Ls in the American financial system.

US Uncut (

An organization inspired by UK Uncut.  It demands that corporations pay their fair share of taxes, and that public services not be cut to balance budgets.

US Uncut is having a demonstration on Tax Day, April 18, Noon, at the BofA at Hollywood and Highland.

Criticisms of Pinning the Blame Only on Finance

Doug Henwood of the Left Business Observer argues that blaming finance for everything is ignoring the growing wage inequality that causes profits to increase, but wage increases do not follow, and personal debt grows.

Some, like Paul McCulley, said the crash of 2008 was a Minsky Moment, named after economist Hyman Minsky who said that asset holders who have borrowed money to speculate in a rising market find that their investments are failing, and must then sell their assets, at a reduced price, to cover their debts.

Many right wing commentators say that unwise borrowing (by the working class) caused the instability in the markets that led to the collapse of the mortgage market.  Specifically, they blame the FHA, Fannie Mae, and Freddie Mac. (This is refuted by the bubble in commercial real estate, which has no support from the government.)

Some California commentators blame Proposition 13 for exacerbating the bubble in California.  They say that Prop 13 causes real estate to be a tax shelter, and that, in turn, causes a constriction of the supply of houses and commercial real estate that is sold in the market.  Rather than sell, the owners will rent out the property, or live in the property.  (This is partially supported by the huge bubble in Florida real estate.  Florida property taxes have two exemptions - one for all owner-occupants worth $50k off the assessed value, and another called Save Our Homes that limits increases in the assessed value of a house to 3% per year.)

I suspect many people would agree: underpaid workers, excessive speculation, overextended credit, and robotic anti-tax laws all contribute to economic problems.  And when the banks are doing all these things, it’s going to be ten times worse, because they’re doing it with our money.

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