Friday, October 03, 2008

Bailout Bill Politics

Maybe a good argument can be made that the Senate should be allowed to originate a taxing bill, but as it stands Constitutionally, they cannot. So how did the Senate pass the recent "bailout bill" before the House? Enter RI-D Rep. Patrick J. Kennedy's "Paul Wellstone Mental Health and Addiction Equity Act of 2007". From The Providence Journal:

In order to get around the Constitution, the leaders turned to the time-honored stratagem of finding a live but dormant House bill -- Kennedy’s mental-health parity bill -- to use as a shell.

"They take out the entire text" of Kennedy’s old bill, "and then, by amendment, they substitute the other bill," said Don Ritchie, an assistant Senate historian. Two bills, in this instance: the emergency rescue bill and the tax provisions and the final version of Kennedy’s mental-health parity wrapped inside.

And that is how Kennedy of Rhode Island became the original lead sponsor — in name only — of one of the most hard-fought financial bills in congressional history.

Add to that the fact the bill is being pushed through and it becomes very attractive for earmarks. From "Billions in earmarks in Senate's bailout bill" (with more details at TCS):
Wooden arrows: This tax break, backed by Oregon's two senators, would benefit an Oregon manufacturer of wooden arrows for children by $2 million over 10 years.

Racetracks: Earmark would allow auto racetrack owners to depreciate their facilities over seven years, saving the industry $100 million over two years.

Rum: Offers rum producers in Puerto Rico and the Virgin Islands a rebate on excise taxes worth $192 million over two years.

Wool: Reduces tariffs for U.S. makers of wool fabric that use imported yarn, worth $148 million over five years. The measure was pushed by Reps. Louise Slaughter, D-N.Y., and Melissa Bean, D-Ill.

Exxon Valdez: Plaintiffs in the suit over the 1989 oil spill could spread their tax payments on punitive damages over three years, cutting their tax bill by $49 million. The measure was backed by Rep. Don Young, R-Alaska.

American Samoa: Allows certain corporations to reduce their tax liability on income earned in American Samoa, at a cost of $33 million over two years.

Hollywood: Extends a tax break for film and TV companies that keep their production in the United States, worth $478 million over 10 years. The provision was originally pushed by Rep. Diane Watson, D-Los Angeles.

In case you're curious, here's the latest version of the bill as of 10/2/2008, and a section by section analysis.

I know this stuff happens all the time but it just seems wrong. What's more, I would imagine that the vast majority of people would agree that it is wrong, yet it continues.

My question: Is this just reflective of the nature of negotiation and compromise? Is there no better way? Should we just accept these tactics? Am I just being too persnickety in letting this annoy and frustrate me? :)

btw, I'm still struggling to understand the economics, but this looks like a decent summary: Making Sense of Our Financial Mess.

Kevin

P.S. Both McCain and Obama voted for the bill. I think this reflects the difficulties that McCain will have in keeping his remarkable promise to veto any bills with earmarks as President when he believes the bulk of the bill is vital.

17 comments:

MamasBoy said...

"P.S. Both McCain and Obama voted for the bill. I think this reflects the difficulties that McCain will have in keeping his remarkable promise to veto any bills with earmarks as President when he believes the bulk of the bill is vital."

I thought presidents have a line item veto these days. Is that not true? I must confess to my ignorance on the matter.

Kevin said...

The Line Item Veto existed briefly under Clinton (from 1996) but was ruled unconstitutional in 1998. There's a fair argument that it gave the President too much power, but its failure seems to have left the underlying problem unaddressed.

MarkC said...

Kevin,

I just wanted to say that the link you posted to the PajamasMedia summary of the financial situation was extremely helpful to me. I've been really struggling to understand the situation because I didn't understand the terminology involved or the history. That article helped me a great deal. Thank you!

Mark

Kevin said...

You're welcome! I feel the same way about it.

steviepinhead said...

I strongly disagree that a '70s law in reaction to redlining mandated lower lending standards or in any significant way way led up to an economic meltdown forty years later.

Here's this: http://www.slate.com/id/2201641/

Kevin said...

Stevie,

Thanks for your comment and the link!

If we limit consideration to the language and direct effects of the CRA (which has been revised repeatedly since 1977) I think you're probably right. However, in most of what I've read, the blame isn't limited to the CRA but it is rather used as a representative starting point of the incentives for making subprime loans. Other laws have similar goals to the CRA and, for example, if Fannie or Freddie will buy your subprime loan, then that's probably incentive enough to make them.

But in the article you link, Gross seems to minimize even this larger category and instead places more of the blame on "lending money recklessly to obscenely rich white guys". This seems counterintuitive to me since I'd expect the rich to be more credit worthy... unless, of course, their assets were based upon subprime loans or inflated real estate. I don't know if his claim is true, but it seems that we should be able to statistically analyze loan defaults and their precursors to determine such blame.

Of course, even if defaulting correlates with minority or low-income status there may be additional criteria or means to render those correlations less relevant by effectively narrowing down to a subset who are more credit worthy.

Gross makes a fair point that microlending successes shows that it is possible to find and use such criteria or means, even without government involvement. That was probably the original intent of the CRA, et al., but they were gradually corrupted from those humble beginnings in a domino effect with complex feedback involving the government and the market. The argument seems to be the degree to which such corruption is enabled by the various central controls.

Part of the terrible irony is that even bailouts serve to encourage excessive risk and false valuations. It is seeming to me that responsibility for decisions must be tied closer to decision makers and that the markets should be allowed to cope with the results.

Kevin

steviepinhead said...

Hi, Kevin!

Sorry, my end-of-the-day comment didn't allow for much nuance, admittedly. I certainly would not adopt all of the opinion in the linked piece. If we had something more closely approaching a "quote" function on our (beloved) little blog here, I hope I would've done a better job of guiding the reader to the couple of paragraphs that made factual claims, which others could then have (should they have so chosen) pursued and verified -- or "fact-checked" as they now say.

But even as to the "obscenely rich white guys," let's take Lehman Bros. (please!). These guys (rich white guys, by and large; I'm not sure there is such a thing as "obscenely" rich) were trading in mortgage-backed securities on margin (which means borrowing, which means somebody was lending them money). Because they were not a regulated bank, but a supposedly wealthy and sophisticated brokerage, the regulations allowed them to borrow at something like 30:1, instead of the much more conservative leverages that were allowed for other financial institutions or investors.

So I think even that statement is justifiable.

What drove the subprime market, in my humble opinion, was not initially-lax lending standards (for poor people in poor neighborhoods, or anyone else) but a progressive cycle in the last few years. This cycle of increasingly lax standards (no documentation of income, no documentation of credit, no requirement of down payment, etc., etc.) was in turn driven by demand for more and more mortgages.

Mortgages (so long as they don't default) throw off streams of income, just like Treasury bills, savings accounts, certificates of deposit, high-rated bonds (essentially just notes representing the borrowing and repayment obligations of corporations), or other relatively-conservative forms of investment.

The reason that mortgages weren't, in times past, considered alongside other such relatively-conservative investments, was that -- relative to the creditworthiness of a government, municipality, highly-rated corporate borrower, and so on -- individual mortgages are subject to messy lack of predictability: even a responsible homeowner can lose a job, suffer an expensive health crisis, get caught up in a messy divorce, fail to repair an initially-small roof leak, etc.

But over the decade of the '00s, a lot of "new" money was sloshing around the world, hunting for "conservative" investments. Think of all that money that American and European consumers have been sending to China to buy lead-painted toys or plasma TVs, to India to buy IT customer service, to Saudi Arabia and Russia and Venezuela and Nigeria and Iran to buy oil...

Uncle Sam, in the form of T-bills, is the traditional safe investment, but so many sources were lending to conservative Uncle Sammy to get some little bit of return on all this money that would otherwise just be sitting there, that Sammy was only paying a percent or two (also another consequence of low U.S. interest rates promulgated by the not-so-omniscient former Federal chairman). Likewise, CDs and savings accounts...

So somebody got the bright idea of packaging up MANY mortgages in one bundle: mortgage-backed securities. Paying -- even after subtracting the commissions of the bundlers (everybody from Lehman et al. all the way down to the local real estate salespeople and mortgage offices) -- not one or two percent, but four and five percent! Whoopee!

And the "risk" was supposedly minimised, not only by virtue of the "bundling" (who cares if one or two homeowners in a bundle of a 1,000 has a fire, flood, or divorce, or loses his job?), but by subdividing the bundles and divvying them up across many buyers.

And by another instrument (acronym temporarily forgotten) that allowed purchasers to insure the payment stream, for a small premium.

And because the payment stream was secured by the value of the underlying asset, the American home with picket fence and hot tub.

And because value of American homes appeared to be steadily rising -- who cares if the homeowner defaults in some small percentage of cases: kick the family out and somebody else will pay even more to move in and take out another mortgage?

But, of course, some of that ever-increasing price rise (true, over the long-term, but not always ever-rising in particular markets during the short term) was phony, in that the huge demand of the sloshing global money (sovereign wealth funds, etc.) was driving the local real estate and mortgage people to invent ever-more-lax mortgage lending schemes to rope in ever more marginal buyers.

So there's a way -- I won't claim it's the only way, but a defensible way -- to view this crescendo of poor mortgage lending practices, not as the initiating cause of the crisis, but as a response and effect of lots of global money seeking a new, supposedly-safe, slightly higher-paying "home."

It's a housing crisis, all right, but a "money shelter"-driven crisis, not a domicile-driven crisis.

Just my $0.02!

And, for better or worse, most of that sloshing global wealth (70-plus trillion of liquidity bt some estimates, hence the, er, sloshing terminology) us still out there. That's the kind of money that a few trillion in lost "unrealized gains" on the dropping stock market doesn't really put a dent in.

And it's STILL looking for places to sit and earn a few percent.

Which is why Uncle Sam probably won't have any huge difficulty printing (i.e., borrowing) several trillion to deal with the current "crisis."

Kevin said...

Hi Stevie! :)

It makes sense that gobs of money and trading on high margin would exacerbate the problem, but as you concluded, I don't think it caused the problem, in part because those don't seem like fundamentally new or unique factors to market dynamics (granted, the specific global sources of funds may be "new").

To me, the culprit seems to be the artificial mechanisms which inflated the value of bad loans. After all, why would anyone buy a loan which (e.g.) had no effective credit check? Even global slosh money looks for good investments.

Kevin

steviepinhead said...

These were marketed -- very successfully, for a time -- as "safe" non-risky investments. Why? Because regardless of the homebuyer's creditworthiness, the house itself was viewed as a conservative investment, unlikely to fall in value. These were secured loans.

And the global slosh money wasn't buying any particular house or loan, but a bundle of them. And that bundle was further subdivided, so that certain purchasers got the first cut of the payments for a higher price, and later purchasers got the right to recieve later payments, above the first cut, for a lower price, etc.

The first wave of mortgage-backed securities to hit the market were pretty safe investments, bundles of mortgages sold to buyers who did have to document income, creditworthiness, etc. As more and more money flooded in to the game, the loan packagers got less choosy, the mortgage sellers more flamboyant, ...

...but, in these very complex instruments, the increased degree of risk wasn't identified or quantified (though you would think that a purchaser reading the news would have had to wonder...).

Additionally, the risk of default was insured by instruments called credit-default swaps (or something like that) which seemed to insulate purchasers who paid for this protection from whatever risk was perceived.

Yet these instruments were even more poorly understood.

Here's where AIG, one of the world's largest insurers, bit the big one!

A good many of these bundles of mortgages probably still include a fair number of paying homebuyers...

The problem (well, one of a very large number of problems!) is that all the mortgage-backed securities have been tainted by the bad ones, such that there is no more market to get rid of them.

Hence, lacking a market, the difficulty in valuing them.

Lack of transparency (due to the lack of regulation and partly due to the international character of many of the players, making regulation difficult by any one sovereignty) in the international finance community makes even those banks who are in fairly good position reluctant to loan to other banks who may (or may not) be holding onto some unknown amount of these poisioned assets.

That drives up the interbank loan rate (the LIBOR), which drives up the cost of credit generally, which is what has had the spillover impact on the granting of commercial credit to large and small corporations, consumers, etc.

Presumably, over time, as the banks and (surviving) finance firms begin to unwind some of these transactions, and come to understand how to value them -- as some sort of market or auction comes into play, partly involving the use of all that play money the Fed and Congress have been tossing around (itself financed at low interest rates by the remaining, still very large global slosh of liquidity that is STILL hunting for "safe" investments)-- the banks will feel more and more confident that they know who is a safe borrower and who isn't, and things will begin to work through the system.

There are some tentative signs of this (the LIBOR rate has begun to drop, for example)...

So maybe things will begin to percolate again.

In any event, while there is causation and fault to be assigned at many different levels, I think the scenario I've tried to paint -- not based on any great expertise of my own, but just on my efforts to keep my ear to the ground during this entire travail -- makes more sense of the timing of this phenomenon than does harking back to a 40-year-old antiredlining bill, however many times amended.

I have heard that most of the loans actually made by community banks to the poor people, who were the intended targets of the redlining-type bills, used classical lending criteria and that these are not disproportionately the loans that have run into trouble.

The loans that are disporportionately affecting the system are newly ginned-up products issued over the last several years to feed the demand of the mortgage-backed securities market dreamt up by the big Wall Street firms, international banks, etc., and in turn designed to feed that world slosh fund which doubled in value over the last eitht to ten years.

That's my alternative version of events and so far it's what makes the most overall sense of things to me.

Kevin said...

Stevie,

Your descriptions are generally consistent with what I've read, except that they elide the numerous organizations, laws, and policies (Fannie, Freddie, Ginnie, HUD, etc.) developed by the government to push home ownership and liquidity in the MBS market, including purchasing, packaging, securitizing, rating, and guaranteeing mortgages.

See Wikipedia's Subprime crisis impact timeline and this section on Fannie and Freddie.

Stevie wrote: "I have heard that most of the loans actually made by community banks to the poor people, who were the intended targets of the redlining-type bills, used classical lending criteria and that these are not disproportionately the loans that have run into trouble."

Do you mean that the bad loans do not correlate with low-income? Or is your emphasis on those "community banks" which have been more conservative in their practices?

I have read conflicting information, but one study's sample indicated that CRA banks were substantially less likely than other lenders to make bad subprime loans, which correlates favorably with the CRA.

Stevie wrote: "The loans that are disporportionately affecting the system are newly ginned-up products issued over the last several years to feed the demand of the mortgage-backed securities market dreamt up by the big Wall Street firms, international banks, etc., and in turn designed to feed that world slosh fund which doubled in value over the last eitht to ten years."

I'm interested in those statistics regarding the bad loans: the source, the packagers, the guarantors, the raters, etc. The source of the bad loans are certainly to blame, but I just don't understand why anyone would buy them.

It seems that somehow bad loans were encouraged and their relative risk and value were hidden. Maybe this was largely a deception by the big Wall Street firms rather than an outgrowth of the government's vast affordable housing framework and policies?

Fannie and Freddie owned or guaranteed about half of the U.S.'s $12 trillion mortgage market, but maybe the other private portion overwhelmingly bought and guaranteed the bad loans?

Kevin

steviepinhead said...

Hi, Kevin.

I should've said "credit default swaps" instead of whatever I did say a post or two back up (credit deficit swaps?). Apparently those who backed mortgages issued by WaMu with credit default swaps found out today that their liability will not be as bad as feared. Which is probably a good datum, in terms of eventurally pulling out of this mess. Putting a price on all the debts and liabilities, and figuring out which entities have how much exposure is a key to putting this behind us -- to restoring confidence in interbank and corporate lending.

Yes, I did mean that community banks had, in general, stuck to their lending criteria. As to whether most of the defaults are of "poor" people, that's obviously relative. A lot of people of all income levels got into houses that they couldn't afford, long-term, based on whatever their income was.

In retrospect, it's easy to see that mortgages based on relaxed lending standards couldn't possibly be "conservative" or "safe," even when bundled up

I see that in his recent remarks, former Fed chair Alan Greenspan had this http://www.msnbc.msn.com/id/27335454/ to say:
"Greenspan told the House Oversight Committee he was wrong in believing that banks would be more prudent in their lending practices because of the need to protect their stockholders."
* * * *
“'My question for you is simple,' Waxman told Greenspan. 'Were you wrong?'

“'Well, partially,' Greenspan said.

"But he went on to assign the blame on soaring mortgage foreclosures on overeager investors who did not properly take into account the threats that would be posed once home prices stopped surging upward.

"He said what had been 'a critical pillar to market competition and free markets did break down. And I think that, as I said, shocked me. I still do not fully understand why it happened.'”

I continue to think it's too simplistic to simply blame this on federal legislation intended to assist poor and minority homebuyers. I doubt you will find that the demographics of the foreclosures are confined to those categories. The "hot spots" for foreclosures include places like the upper Central Valley of California (Modesto, Stockton). I'm pretty familiar with these communities, with two sisters in Stockton and an aunt, uncle, and cousins in the Modesto area. Poor and minority they are not.

Liewise for the Gold Coast of Florida, some of the more-troubled areas of Southern California, and so forth...

This is not to say that homebuyers didn't make foolish decisions, but the products that they were being offered and the degree of relaxation of lending standards were not mandated by federal legislation...

steviepinhead said...

Oops, that paragraph that started out about "retrospectively" should have concluded with a reference to the rating agencies, who also played a role in this debacle.

A lot of the mortgage-backed secutities were rated AAA.

That allowed investors who were otherwise required -- by statute or rule or fund management guidelines or simply predisposition -- to invest "conservatively" to invest in instruments that turned out to be quite risky.

Kevin said...

Hi Stevie,

Sorry for my slow response! :)

Greenspan can be an enigma to me, but it does seem clear that investors did not account for the actual risk of their MBSs. The question is, why? Did they not care, or did it appear that MBSs based upon poor loans were still low risk? If the latter, what factors hid or distorted the risk?

As I understand it, the securitization of mortgages transferred responsibility of a loan from the lender onto MBS investors who relied upon guarantors (Fannie, etc.), insurers (e.g. CDSs, though I'm not sure how this mixes with the guarantees), and rating agencies (who had only oblique interest in the securities they rated?). Somewhere in (or throughout) that protracted abstraction, it seems to me that reasonable risk assessment was lost.

Stevie wrote: "I continue to think it's too simplistic to simply blame this on federal legislation intended to assist poor and minority homebuyers. I doubt you will find that the demographics of the foreclosures are confined to those categories."

I don't think it's simple by any means, but it does seem like a reasonable and artificial factor in the large and complex crisis. Of course, given that blame could ultimately be attributed to the government's very construction of the MBS market, it seems that the allotment of blame is relative to many assumptions.

I'd also expect the demographics of foreclosures to extend beyond the poor. e.g. Speculators and builders also invested in homes, believing demand to be greater than it actually was. I've even read that some people defaulted not because they couldn't pay but because the loan was so much more than the value of their home that it didn't make fiscal sense to keep it.

Stevie wrote: "This is not to say that homebuyers didn't make foolish decisions, but the products that they were being offered and the degree of relaxation of lending standards were not mandated by federal legislation...

Federal legislation or policies may not have directly mandated lax lending behavior, but it seems that they did indirectly encourage it, e.g. through counting purchases of subprime loans as affordable housing credit. see How HUD Mortgage Policy Fed The Crisis and How Government Stoked the Mania.

Kevin

steviepinhead said...

I appreciate those links, Kevin. But the terms of debate seem to have shifted somewhat from the notion that anti-fedlining legislation originally passed by the Dems in the late '70s (and revised over the ensuing years) somehow lay at the core of the crisis, and what the articles you linked are saying.

For example, on p. 2 of your first linked article about HUD, it becomes clear that the wraps really came off during the Bush years. Having already been warned (in 2001) that investing in subprime loans was dangerous, by 2004--
"when HUD next revised the goals, Freddie and Fannie's purchases of subprime-backed securities had risen tenfold. Foreclosure rates also were rising.

"That year, President Bush's HUD ratcheted up the main affordable-housing goal over the next four years, from 50 percent to 56 percent. John C. Weicher, then an assistant HUD secretary, said the institutions lagged behind even the private market and 'must do more.' "

"For Wall Street, high profits could be made from securities backed by subprime loans. Fannie and Freddie targeted the least-risky loans. Still, their purchases provided more cash for a larger subprime market."
[My bolding.]

And, from your second linked article--
"For 1996, the Department of Housing and Urban Development (HUD) gave Fannie and Freddie an explicit target -- 42% of their mortgage financing had to go to borrowers with income below the median in their area. The target increased to 50% in 2000 and 52% in 2005.

"For 1996, HUD required that 12% of all mortgage purchases by Fannie and Freddie be "special affordable" loans, typically to borrowers with income less than 60% of their area's median income. That number was increased to 20% in 2000 and 22% in 2005. The 2008 goal was to be 28%. Between 2000 and 2005, Fannie and Freddie met those goals every year, funding hundreds of billions of dollars worth of loans, many of them subprime and adjustable-rate loans, and made to borrowers who bought houses with less than 10% down."

Did government play a role in facilitating this meltdown? Sure.

Did the original (or even amended) anti-redlining legislation compel banks to offer uneconomic and (frequently) fraudulent mortgage products to unsuitable buyers? Not so much.

Did HUD, under both Democratic and Republican administrations (but primarily while Republicans held control of Congress) over the last ten or twelve years, encourage irresponsible lending practices? Yes, that appears to have been one of several different important factors that wrapped together to catalyze a crisis.

This has been a good discussion. I hope we all have gained a broader appreciation of the complex factors that played a role.

While it's possible to track one strand of this skein back to the original anti-redlining legislation, again the wheels didn't really begin to fall off until post-1994, when the Republicans -- courtesy of the Gingrich Revolution -- took over control of the House.

I'm not trying to demonize one party or one group of homebuyers here, because that would not accord with the facts.

But likewise, it would not accord with the facts to demonize the other party. Or some other group of homebuyers.

As the masthead says: "Our goal is to learn together, in the midst of our disagreements." I've certainly done that along the way on this thread, and I hope that's true for some of the rest of you.

Er, us.

Kevin said...

Hi, Stevie,

I'm not sure there is a single "core" issue, but I think HUD's policies were directly impacted by "anti-redlining" legislation, e.g. Federal Housing Enterprises Financial Safety and Soundness Act of 1992.

To be clear, fair lending to credit-worthy minorities and low-income people makes perfect sense. If this is "anti-redlining," then I'm all for it. It's only when credit standards are artificially lowered and purchase of such loans is artificially pushed that I see a potential problem since it distorts the market. I think this has also been considered part of "anti-redlining" which, to me, is very different.

I haven't investigated partisan blame, but I agree that policies and regulations under Bush caused significant problems related to the crisis. And it happened under Republican majority, so, at least in theory, they could have prevented it. But I've also read quotes even by Democrats that they obstructed reform, e.g. of Fannie and Freddie.

My primary interest is understanding the principles and key factors that caused the crisis. My general sense at this point is that politically diverse goals and ideologies collided over time to gradually create a complex, opaque, and fragile system. I blame corruption, a lack of transparency and accountability, and misapplied principles more than any party. I don't blame the homebuyers.

Stevie wrote: "Did the original (or even amended) anti-redlining legislation compel banks to offer uneconomic and (frequently) fraudulent mortgage products to unsuitable buyers? Not so much."

I agree with your answer given the way that you framed the question with "compel" and "fraud" (I haven't read much about fraudulent products, do you have a link?), but I think it is true that affordable housing policy and legislation (including some anti-redlining) did require purchase of subprime MBSs and encourage higher risk lending.

Stevie wrote: "As the masthead says: "Our goal is to learn together, in the midst of our disagreements." I've certainly done that along the way on this thread, and I hope that's true for some of the rest of you."

Absolutely! I'm so glad you've taken the time to discuss this with me since I think it is important and I don't understand it nearly well enough. I greatly appreciate your opposing argument. I just wish we had more statistics and clear evidence to rely upon and learn from. I do worry that I rely too much on summaries since the truth can be so complex and easy to twist by overemphasis on one part or another.

Kevin

steviepinhead said...

I agree with pretty much all you said above, Kevin.

I don't have a link for "fraud," though I've certainly heard a fair amount about it. I expect that it will eventually turn out that fraud took place on several different levels, from homebuyers inflating their ability to pay to mortgage lenders literally packagin up loans to dead people (heard on an NPR explanation of the crisis a month or so back), to banks and financial institutions failing to adequately disclose risk to investors, etc.

I expect that by the time we actually unwind and achieve a halfway-effective understanding of this financial crisis, we'll be deep into another. But it's probably worth the effort anyway. Understanding past mistakes won't always help us avoid future ones.

But at least we won't be making the SAME mistakes.

Kevin said...

I'm glad we roughly agree, Stevie. :)

Thanks for mentioning the loans to dead people. I hadn't heard that before.

I sure hope we do learn the right lessons, but I'm not yet confident that will happen.

I think we are about on par in our optimism, too! :)