Your eyes on California Government

OCT. 12, 2011

By WAYNE LUSVARDI

California Attorney General Kamela Harris is playing with political fire. Last week she backed out of nationwide discussions with banks for a financial settlement to resolve alleged abuses of mortgage loans and foreclosures. The banks were Bank of America, J.P. Morgan, Chase Bank and Citibank. Her reason for backing out was that California’s share of the proposed $25 billion settlement would be too small.

Harris has manufactured the belief that there is public legitimation to shake down banks and demand settlements or reductions of loan principal for those facing foreclosure.  But to do so she must rob bank creditors — savers and pensioners — and transfer that wealth to borrowers, a dubious legal action that may backfire on her.

Thus, Harris believes you can fight fire with fire; that it is justified to use the same means as the so-called perpetrators.  If banks handed out “predatory loans” and used questionable foreclosure practices, that is justification enough for her to confiscate the savings accounts and pensions of third-party savers and transfer that wealth to the so-called victims of scapegoated institutional loan sharks. Harris wants to portray herself as a modern day Robin hood, robbing from the bourgeoisie and giving to the proletariat.

This is governmental extortion without due process.  While banks were a reluctant participant in the mortgage meltdown, they were hardly unilateral perpetrators.  There were so many house “flippers,” homeowners using equity loans like bank ATMs, and buyers filling in fraudulent loan applications coached by ACORN, that it would be a stretch to call them victims. And what about all those minority homeowners who sold their homes for wild profits and moved to the suburbs?  They didn’t suffer from redlining, but reaped a windfall from lining their pockets with green cash. Former Bank of America fixed income analyst David P. Goldman calls this “The People’s Ponzi Scheme.”

To affix blame solely, we first have to understand how the mortgage market melted down.

Mortgage Meltdown Began in Europe, Not Wall Street

By late 2007, the United States found itself in a financial mess because of a gigantic flood of trillions of dollars of foreign capital into our country from all over the world starting in the early 2000s.  Globally, the welfare state in Europe was no longer sustainable because of low birth rates and insufficient family formations. Thus, European investors were desperately looking for speculative double-digit returns on investments to bail out the welfare state.

Prof. Rawl Abdelal wrote a book, “Capital Rules: The Construction of Global Finance,” two years before the meltdown. He told how French socialists — not Wall Street, the U.S. Treasury, or credit rating firms such as Standard & Poors — liberalized global finance to flood the United States with money. Abdelal could find no evidence of “American leadership, Wall Street enthusiasm, the U.S. Treasury’s guidance, Rightist politicians, or neo-liberal economists” in making up the new deregulated rules of global finance.

Contrary to the American media, it wasn’t the investment rating houses — S&P, Moody’s, Fitch — that unilaterally liberalized rating practices. The U.S. Congress accepted the replacement of the liberalized European Basel II Accords for the Moody’s, S&P and Fitch credit rating systems.

California as Ground Zero for Foreign Money Infusion

Domestically, the huge wave of foreign money flowing into the United States couldn’t have found a more fertile ground than California.  In 1999, the California Legislature passed SB 400, which that increased public pension benefits both retroactively and in the future.

Projecting that the pension system wouldn’t be able to fully meet expanded pension obligations solely from worker contributions, CalPERS began seeking riskier investments to plug any future black hole.  Along came the wave of money from Europe and elsewhere seeking safe returns in the American Dream of home ownership.  After all, proverbial home values only go up in California.

Only the public pension systems had enough market power to influence Congress and the whole food chain of real estate finance to liberalize lending rules.  Additionally, the dot-com bubble of the late 2000s burst and pushed investors out of the stock market and into the “safe haven” of mortgages.

The problem was there was too much money chasing too few safe real estate investment opportunities.  The pool of homebuyers had to be expanded.  The Community Reinvestment Act, meant to combat bank loan “redlining,” became an unintended convenient vehicle to deregulate banking rules and conventional loan underwriting practices to expand homeownership to renters who had no equity for down payments.  For those wanting to blame deregulation, look no further than the Community Reinvestment Act.

New mortgage instruments had to be created to rapidly absorb the wave of money: subprime loans, collateralized mortgage bonds, derivatives and securitization. The automation of the mortgage loan process cut the waiting time for a loan from months to days, but loosened old-fashioned loan underwriting standards. Because everyone tacitly knew that government policy was to give away as much money as quickly as possible, sometimes with no down payment and for negative interest (free money), a moral hazard was created of borrowers fudging on loan documents to get in on the gravy train.

California became one gigantic Bubble machine with huge mortgage banks — Countrywide, Indymac and Fannnie Mae, all headquartered in the same city, Pasadena, the modern day Bedford Falls.  All things start in California and spread elsewhere. So did the Real Estate Bubble.

The only way to suck up that much money quickly was to create a Bubble and that is what happened. One of the key facets to the Bubble was Fannie Mae, a quasi-government bank, buying up a political quota of subprime loans.  If subprime loans were predatory, why did Fannie Mae buy them up?

CA’s Foreclosure Crisis

California has more homeowners whose home values are “underwater” than any other state. Home values have typically fallen by 20 to 40 percent, depending on location. Only Florida has more borrowers behind in mortgage payments or in foreclosure.

Foreclosure Rates by Loan Type

Source: http://www.aei.org/docLib/AEI-White-Paper-FINAL-3-22-11.pdf 

Today, it is difficult to stabilize foreclosures because so much of owner-occupied housing has changed to absentee-owner housing occupied by renters and owned by investors. Credit rules exclude foreclosed homebuyers from buying another home for seven years. There are not enough first-time homebuyers with approved credit to fill the existing foreclosure inventory.

Loan principal reductions and loan modifications will only result in many neighborhoods changing into renter-occupied single-family rental home zones. It will be hard to change these neighborhoods back into owner-occupied zones. This was definitely not “Smart Growth.”

What Kamela Harris is peddling is a new entitlement: implied government-provided home-value insurance. If you buy a new car you lose, say, 25 percent of the value when you drive it off the lot.  Since when does the law guarantee a homeowner a write-down of loan principal that effectively wipes out their loss?

But Kamela Harris may want to run for governor of California next term and she knows that “the government that robs Peter to pay Paul can always count on the support of Paul.”

Playing With Fire

Harris is playing with political matchsticks. It was the Revolt of the Bourgeoisie creditor class against the predations of borrowers that resulted in the Tea Party takeover of Congress in 2010.

The current rapacious zero-interest-rate policy of the Federal Reserve Board is already robbing millions of savers of their life savings and pensions. Kamela Harris and Federal Reserve Board Chairman Ben Bernanke believe the innocent should pay for the sins of the guilty — all in the name of “social justice.”

The “Occupy Wall Street” protesters have joined in the government raid on savings and pensions by calling for forgiveness of government loans. But the savings that funded home and student loans are already gone. How long will it be before the youthful protesters realize that it is their future inheritances that are being plundered by liberal foreclosure and interest rate policies?

The fire may spread in a different direction than those organizing and subsidizing the Wall Street protests hope for.  Those organizing the protests are likely those arbitrageurs and hedge-fund players who stand to lose if the “easy money” policy of the Real Estate Bubble finally comes to an end.

Kamela Harris should take the advice of 15^th Century political writer Niccolo Machiavelli, who warned in Chapter 17 of his book “The Prince” what happens to politicians who grab their constituents’ property:

Upon this a question arises: whether it be better to be loved than feared or feared than loved? It may be answered that one should wish to be both, but, because it is difficult to unite them in one person, is much safer to be feared than loved, when, of the two, either must be dispensed with…. And that prince who, relying entirely on their promises, has neglected other precautions, is ruined; because friendships that are obtained by payments, and not by greatness or nobility of mind, may indeed be earned, but they are not secured, and in time of need cannot be relied upon; and men have less scruple in offending one who is beloved than one who is feared, for love is preserved by the link of obligation which, owing to the baseness of men, is broken at every opportunity for their advantage; but fear preserves you by a dread of punishment which never fails. 

Nevertheless a prince ought to inspire fear in such a way that, if he does not win love, he avoids hatred; because he can endure very well being feared whilst he is not hated, which will always be as long as he abstains from the property of his citizens and subjects and from their women. But when it is necessary for him to proceed against the life of someone, he must do it on proper justification and for manifest cause, but above all things he must keep his hands off the property of others, because men more quickly forget the death of their father than the loss of their patrimony. Besides, pretexts for taking away the property are never wanting; for he who has once begun to live by robbery will always find pretexts for seizing what belongs to others…”

Tags: Ben Bernanke, housing crisis, Kamala Harris, Machiavelli, Real Estate Bubble, SB 400, Wayne Lusvardi