Draconian Measures

by digby

This foreclosure fraud scandal has erupted. And people are finally beginning to talk about how to fix the system. The solutions aren't easy. Yesterday I talked about a real cramdown system to help people stay in their homes. Dday (who's work on this has been amazing) fills that out with a bigger list of solutions:

They should be familiar to anyone reading here for the past year – fixing the predatory lending scheme known as HAMP, adding cramdown to it to provide a stick along with the carrot, having mandatory mediation or otherwise taking the loan modification process out of the hands of the banks (or doing something similar to NACA, writing binding agreements and bringing the lenders and borrowers together), or instituting right-to-rent. These are all very positive solutions that would provide benefits for homeowners rather than just the banks (though they would be aided as well – this would reset the housing market and both reduce foreclosures and much of the banks’ liability for their faulty processes).
In my post yesterday I mentioned Iceland's rather radical solution. (They are proposing to wipe all debt clean and start over.) Here's economist L. Wrandall Wray who's been thinking along similar lines:

This is a complete mess. What President Obama must understand is that fraud is endemic at every level of the home finance food chain. We were long told that securitized mortgages cannot be modified because of the complexity involved—modification of most mortgages would require consent of the holders of the securities that each have a piece of the mortgage. But actually it is impossible to tell how many—if any—of these securities holders have a legitimate claim on any of the mortgages. Simply imposing a moratorium will not be enough—it will just give the banks time to manufacture false documents, encouraging even more fraud. Meanwhile, half of all homeowners with mortgages are already underwater or are within spitting distance of being underwater. Many of these are drowning because the epidemic of fraud perpetrated by financial institutions destroyed our economy and caused housing prices to collapse.

The President needs to try a different approach, consisting of the following series of steps:

1. Declare a national bank holiday that would close the biggest financial institutions—say, the top dozen or so. Send in the supervisors to examine their books to uncover fraud. Determine which ones are insolvent and resolve them. While resolving them, net their claims on one another (including derivatives). Do not allow any insolvent institutions to reopen, and do not use the resolution process to merge institutions (we don't need even bigger “too big to fail” banks). Prosecute the crooks and jail the guilty.

2. Stop all foreclosures. Investigate and prosecute all institutions that have been selling or buying fake documents to be used in foreclosures. Prosecute the crooks and jail the guilty.

3. Announce that all homeowners who occupied their homes on October 1, 2010 will be allowed to remain in their homes indefinitely. Create a national mediation board to adjust all mortgage payments to “owner's equivalent rent”—the fair value of rent for the home. Establish a fund to provide rental assistance to keep low income homeowners in their homes.

4. Give purported mortgage holders 30 days to produce the original notes; if they cannot find them, hand the homes over to the owner-occupants—free and clear of debt.

5. Create a process to allow securities holders to sue for recovery of value. This must be national—state courts will not be able to handle the case load.

6. Direct the GSEs to refinance mortgages at a low fixed rate. Mortgages would be provided against real estate appraised at fair market value to any borrower for a primary residence. The GSEs would pay holders of existing mortgages only current fair market value. Those holding these mortgages can seek redress through the process outlined in step 5. Only in the case of borrower fraud would the homeowner be held responsible for losses attributed to the refinancing.

7. There will be fall-out from losses. It is better to deal with the collateral damage directly than to prop up the control fraud banks. For example, pension funds hold toxic waste securities as well as equities in the control fraud banks, and by all reasonable accounting the Pension Benefit Guarantee Corporation is already insolvent. But it is better to directly bail-out pensions than to maintain the charade that fraudulently created securities have value.

Bill Black likes to joke that economists are afraid to use the “F” word (fraud). The President must come to realize that there is no other word that can be applied to the US home finance system. Until we deal with the fraud we will never resolve this financial crisis.

Regardless of whether or not any of these things come to pass, there's little doubt that this is a scandal of epic proportions that won't be swept under the rug. I have zero ideas about how it's going to play politically. It's fraught with danger for Democrats since it's happening right in the middle of the administration. But if they see it this time as a problem for citizens rather than a problem for banks and the markets, they might just find some political support for their actions.

Update: The bankers won't make it easy. Here's dday again:
[T]he banksters who committed these atrocities, who crashed the economy once and now maybe twice, who brought untold suffering upon millions if not tens of millions, think you punks are to blame.

Wall Street’s reaction to the allegations that some banks cut corners while foreclosing on 3 million homes since 2007: Pay your mortgage in the first place [...]

“If you didn’t pay your mortgage, you shouldn’t be in your house. Period. People are getting upset about something that’s just procedural,” said Walter Todd, portfolio manager at Greenwood Capital Associates.

Some said the issue is one of personal responsibility for one’s own debts.

“Everyone’s responsible for following the law. If we all don’t have to pay our mortgage, should we just stop paying taxes, too?” said Anton Schutz, president of Mendon Capital Advisers. “Your mortgage didn’t get to a robo-signer by accident, it’s because you’re not paying.”

That could be the most arrogant article I’ve ever seen in an American newspaper. These ingrates think they shouldn’t dare be challenged. And the line “everyone’s responsible for following the law” in the context of making excuses for not following the law is pretty rich.

I think Krugman's puts it best in his column today:
To me, this evokes the days when noblemen felt free to take whatever they wanted, knowing that peasants had no standing in the courts. But then, I suspect that some people regard those as the good old days...