The other shoe

by John Quiggin on October 15, 2010

The bailout of the US financial sector through the Troubled Assets Recovery Program (TARP) looks to have been fairly successful on its own terms – the banks have become profitable again and the final estimated loss to the government is relatively small. That doesn’t change the fact that the government took on huge risks for negative returns, without any reason to expect that the future behavior of the banks will change.

But all of that was based on assumptions of an orderly resolution of the mortgage crisis. Those assumptions now look very dubious, as the legal consequences of the practices of the financial sector during the bubble, ranging from sloppiness to outright fraud, manifest themselves.

First, foreclosure proceedings have ground to a halt as it has proved impossible to produce proper documentation. Even more striking is the latest scandal discovered by Felix Salmon (hat tip Brad DeLong).

It turns out that the Wall Street investment banks did perform due diligence on the mortgages they were being sold for repackaging into CDOs and other derivatives, and found that as many as half of those in typical samples were defective. Instead of killing the deal, they lowered the price they paid to the originating banks, and went ahead to sell the securities to investors, without telling them how bad the mortgages were.

Salmon gives chapter and verse on this and concludes “It’s going to be a very long time, I think, before the banking system is going to be free and clear of the nightmare it created during the boom.”

{ 25 comments }

1

Z 10.15.10 at 9:36 am

Very interesting! Not much else to say unfortunately.

2

Steve LaBonne 10.15.10 at 10:12 am

You know, if you or I committed this kind of fraud in order to steal a few thousand bucks, we’d surely go to jail. But if you do it on a gigantic scale to rake in billions? We’ll see, but I’m not holding my breath.

3

Barry 10.15.10 at 11:09 am

This has pretty much finished my faith off in any real financial reform. I expect both massive losses (with us taking the majority of the hit), and repeated financial crises from here on out. Until one hits where either there’s an actual ‘small government’ believer in power, who can block a bailout, in which case we have another Great Depression, or one hits which is simply to big to deal with by the government, in which case we again have another Great Depression.

4

Brett Bellmore 10.15.10 at 11:21 am

Essentially, as a nation, we’re like somebody who’s been on a long bender, living on junk food, and just vegging out in front of the TV. There’s no magical fix for this. “Stimulus” is what got us here to begin with. It’s just more “hair of the dog”.

And, sure, the guy who chucks you into the drunk tank is probably going to get blamed for the hangover. But benders can’t go on forever, the hangover was inevitable. Trying to stave it off with a few more rounds will just make tomorrow even worse.

Let’s stop while we’ve still got SOME borrowing power left, we might have an emergency where we need it.

5

ogmb 10.15.10 at 11:29 am

To understand the American banking system it helps to read up on the business practices of the Sicilian water mafia, with the obvious translation of “water” into “liquidity”.

6

Steve LaBonne 10.15.10 at 12:03 pm

“Stimulus” is what got us here to begin with. It’s just more “hair of the dog”.

Even by Brett’s low standards this is remarkably clueless.

The American people haven’t been on a bender; the plutocrats have. They’ve just managed to figure out how to stick us with the hangover.

And yes, there is a massive shortfall of demand and massive stimulus is needed. We won’t get it because there are so many idiots who spout Brett’s kind of propaganda.

7

Pete 10.15.10 at 12:38 pm

Indeed, it’s not massive national malfeasance, it’s specific crime by specific people – albeit on a large scale.

It’ll be fun watching the response of the “contract law fixes everything” sort of libertarian to this, where a chain of contracts is disrupted by fraud and negligence.

8

Kieran 10.15.10 at 12:43 pm

Interesting to see the “It’s bit a crime to sucker the suckers” defense emerge within the space if a few comments at Salmon’s blog.

9

Kieran 10.15.10 at 12:44 pm

Not a crime. Stupid phone autocorrect.

10

P O'Neill 10.15.10 at 2:00 pm

Another angle that needs more attention is the title insurance “industry”. They’ve sat there for years as one of the nastiest and least understood transactions cost of buying a house, with the presumption that they are doing some actual title/lien searches for each property before a deal goes through. Yet now they appearing to be running for the hills once a bunch of defective titles actually emerge. But they’ve also spent years opposing simpler title systems — like Australia’s — that might have made some of this paperwork easier to handle.

11

Cryptic Ned 10.15.10 at 2:01 pm

“It’s not a crime to sucker the suckers” is the entire basis of our economy. Can be rephrased as “You fucked up! You trusted us!”

12

Dewey 10.15.10 at 2:22 pm

Hey, Quiggin. The gauntlet has been thrown. Erick Erickson has officially co-opted Zombie Economics for the right:

“We keep having the problems we’re having because people forget. They forget just how terrible the economic policies of Keynes and Marx actually are and inevitably after a twenty year gap or so they come back in full force and screw things up again.

They’re zombies.
[…]
Zombie Keynesian continues to steer government bureaucrats off the rails and keep us in a rut. “

I can only pray that the combined intellectual might of Crooked Timber can neutralize Erick the Red (State).

13

tim serbo 10.15.10 at 2:45 pm

“It’s not a crime to sucker the suckers” is the sort of thinking that earns one a diagnosis as a psychopath.

14

Lemuell Pitkin 10.15.10 at 3:04 pm

This is looking like the big story of the year. In addition to Salmon, the go-to guy is Mike Konczal. Anyone who wants to get up to speed on the world of foreclosure fraud should start there.

15

Lemuel Pitkin 10.15.10 at 3:05 pm

(Oops, using a different computer and misspelled my own nym.)

16

Bruce Wilder 10.15.10 at 4:47 pm

If you manage to overlook the cost of redeeming Fannie and Freddie, then, TARP just looks like just another bad deal, which could have been worse.

http://www.housingwire.com/2010/09/15/fhfa-estimates-gses-final-cost-to-taxpayers-could-reach-400-billion

This is $400 billion passing through Fannie and Freddie to the banks and investors in mortgage-backed-securities gone bad.

17

Lemuel Pitkin 10.15.10 at 5:01 pm

The go-to guy on this is Mike Konczal at Rortybomb. This is a big, big story.

18

novakant 10.15.10 at 6:21 pm

The American people haven’t been on a bender …

Oh yes, they have been and the same goes for the UK and Ireland. It takes two to tango.

19

JM 10.15.10 at 6:38 pm

Instead of killing the deal, they lowered the price they paid to the originating banks

I blame ACORN.

20

Barry 10.15.10 at 7:17 pm

“It takes two to tango.”

A favorite saying of the fraud crowd.

21

Bill Posters 10.15.10 at 8:58 pm

The other thing exposed by this is the shoddy nature of the US land title system. There is no land titles office or similar registering and determining title, as happens in Australia (and the rest of the developed world). Instead, local government simply “records” title claims, leaving determination to the courts.

This means US landbuyers generally have to pay someone to insure the title.

Madness.

22

musical mountaineer 10.16.10 at 1:36 am

I blame ACORN.

No, no, no! I blame ACORN!

23

musical mountaineer 10.16.10 at 1:31 pm

(You should ignore that, of course.)

24

tps12 10.18.10 at 1:18 am

And, sure, the guy who chucks you into the drunk tank is probably going to get blamed for the hangover.

?!?!

25

Emma in Sydney 10.19.10 at 4:01 am

@Bill Posters: “The shoddy nature of the US land title system”

Thanks, that explains a lot to a non-American. I was wondering how this kind of mess got going. As you point out, here in Australia land titles are all publicly available through the land titles office, and can be searched quickly and easily. When property changes hands or is mortgaged, those transactions are registered with the LTO, and are there for anyone to see. Useful for historians too — lots of local history utterly depends on LTO records.

Comments on this entry are closed.