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Questions and Thoughts on the Mortgage Settlement
If you missed the news (Obama actually made a “big” speech about it), the federal government, along with 49 state AGs, reached a settlement with the largest mortgage servicers over servicing violations. In some ways, what little detail has been offered raises more questions than answers.
Perhaps the biggest question is how much of the actual losses will be borne by the banks and how much will be passed along to investors, who were not even represented at the table. One hears that both first and second mortgages would be written down “in proportion” so that if the first loan is reduced 10%, then the second is also reduced 10%. Obviously this flies in the very face of what a first and second loan are. The first shouldn’t take any loss until the 2nd is completely wiped out. But since investors often hold the first while banks hold the second, it looks like Obama has blessed the banks sticking a good deal of their losses to the investors, which include pension funds, retirement accounts etc.
And while I was of course moved by the touching picture of a couple and their child featured so predominantly on the settlement’s website, I was also left wondering, what is the process for determining which foreclosed homeowners receive assistance. The settlement is actual quite clear that “$1.5 billion will be distributed nationwide to some 750,000 borrowers” but that such borrowers need not have actually been harmed. This really seems little more than a lottery trying to pass as consumer protection. But then I suspect your chances for getting a piece are bigger if you happen to live in a swing state (sorry California).
What really worries me is the massive payment to states. Of course they claim this is going to help “fund consumer protection” but then we also told that the tobacco settlements would help smokers; it instead turned into state government slush funds. Even more troubling is the high probability that such funds will flow to various non-profits, whatever the current incarnation of ACORN is calling itself.
Fortunately the entire settlement has to be approved by a federal judge. Given that these issues really should have been decided in the courts in the first place (separation of powers, anyone?), this is the opportunity for the courts to ask for the AGs and Obama to actually produce some evidence of wrong-doing. And also to ask that parties actually harmed be the ones compensated. Anything else would be a perversion of justice.
Which Way Is Inflation Headed?
First let me admit I do not have a crystal ball, nor does anyone I know, so given the limitations of economic forecasting, one can only attempt educated guesses as to the direction of any economic variable. That said, I found the chart below, taken from the most recent Bureau of Labor Statistics’ Consumer Price Index release, to be interesting in terms of the clear trend.
The lower line is core CPI, the Federal Reserve’s preferred measure of inflation, the upper line is the full CPI, which includes food and energy prices. The good news is that while still higher than I’d prefer, food and energy prices started to moderate in the fall of 2011. That moderation in food/energy prices, however, did not translate into a lower core CPI. In fact the core CPI continued its fairly steady increase. Since September 2011, core CPI has been, on an annualized basis, above the Fed’s target of 2 percent (let’s set aside, for the moment, whether this is the right target or if it is even measured appropriately). Remembering that monetary policy works with “long and variable lags” the time to worry about inflation is before it hits, not after. Given the clear upward trend in the government’s own charts, I’d say we are already past the point where we should start worrying.
Bernanke’s Anti-Stimulus
One of the direct results of the Federal Reserve’s zero interest rate policies has been a massive reduction in interest income going to households. Since 2008, household interest income has fallen by about $400 billion annually. That’s $400 billion each year that families have not had to spend.
Now of course you can also argue that families interest expenses have also fallen, and that would be true, but that just serves to illustrate that much of monetary policy is not about creating wealth, but re-distributing it. Since interest payments are one’s person expense and another’s income, Fed driven changes in the interest rate should not increase household income in the aggregate.
As interest income/expense is not the only item on the household balance sheet, the Fed does try to make us feel richer via changes in asset prices. The problem, however, is that the change in many asset prices can also have little more than distributional effects. If owners feel richer because their house prices have gone up, or not fallen as much as they would have otherwise, then renters are poorer as they need to save more to by the same house. The same holds for commodity prices. Monetary driven increases in the price of food might be great for farmers, or speculators, but it makes households poorer by the same amount it increases the wealth of commodity holders. If the Fed truly wished to help our economy get back to “normal” then it would allow the free choices of individual borrowers and savers to determine the interest rate. It would also end its implicit practice of picking winners and losers in our economy. Unlike Fed driven changes in asset prices and interest payments, voluntary exchange between savers and borrowers increases the welfare of all parties involved.
Was Obama Even Paying Attention during His Time in the Senate?
Perhaps I’m a little sensitive from having spent 7 years working in the Senate (rather than just using the Senate as a stepping stone), but when Obama makes statements in his State of the Union like:
Some of what’s broken has to do with the way Congress does its business these days. A simple majority is no longer enough to get anything – even routine business – passed through the Senate. Neither party has been blameless in these tactics. Now both parties should put an end to it. For starters, I ask the Senate to pass a rule that all judicial and public service nominations receive a simple up or down vote within 90 days.
I have to wonder if he even has the slightest clue what he is talking about. First, what’s with the “no longer”, the fact is that the Senate has operated under super-majority rules since before Obama was born. The vast majority of bills and nominations pass by unanimous consent, meaning that 100 votes are needed. As I’ve mentioned elsewhere, 95% of the nominations sent to the Senate in 2011 were confirmed.
And the rules aren’t to blame for “routine business” not getting done. It’s been over 1000 days since Senate Democrats passed a budget, but then you have to assemble one to pass one. In 2011 the Senate passed over 400 pieces of legislation, only about 20% below the average of the last 20 years. As someone who’d like to see government come to a halt, let me assure you, this isn’t it.
Setting aside the offensive nature of a President suggesting changes in the Senate rules (ever hear of the separation of powers?) the fact is that his proposal wouldn’t have mattered in the case of his recent “recess” nominations. First, Cordray was given a vote, with a required 60 for moving to consideration. He didn’t get 60. There’s nothing in the Constitution that defines Senate “consent” as a simple majority. Obama’s unconstitutional NRLB nominations weren’t even in the Senate for 90 days (his apparent standard).
Our founding fathers purposely created a system that made it hard, not easy, to legislate. The very existence of both a House and Senate is evidence they rejected simple majority rules for legislating. One of the many things I learned from working in the Senate, and having spent more time on the Senate floor than Obama, is that dealing in good faith can almost always get you to an broad agreement. If Obama feels his legislative agenda has come to a halt, he has himself to blame, not the Senate rules.
Sorry EPI, It’s Credit, Not Race, that Drives Mortgage Pricing
One would think that after a housing boom driven by cheap credit, we would have heard the end of the “minorities charged higher rates regardless of credit” narratives. But our friends at the Economic Policy Institute continue to spin the myth that it is really race, and not credit history, that determines a borrower’s interest rate.
EPI cleverly starts out by lumping most borrowers into the same category: “In recent years, Latino and African American consumers with good credit scores of 660 and higher have too often ended up with high interest rate mortgages, mortgages which are supposed to go to risky borrowers.” First of all, 660 is not a good credit score. We can debate whether it’s poor or mediocre, but it isn’t good. According to the Federal Reserve, loans with a FICO of around 660 default at a rate of almost nine times that of loans with a FICO of 720 or higher (see table below). To mix the two and claim they are the same risk is misleading, at best.
So let’s start with some basic facts:
For a variety of reasons, including differences in age, Latino and black borrowers have lower credit scores than white borrowers. This still holds even when you exclude loans to borrowers with credit scores below 660 or 620. Second, defaults continue to vary, by large magnitudes, even for rates above 660. To imply 660 is equal to 700 or that 700 is equal to 780 is false.
There have also been a number of studies that reject the claim of large, or even any, differences in mortgage pricing by race, when one includes relevant variables. A recent NY Federal Reserve Bank study concludes:
we find no evidence of adverse pricing by race, ethnicity, or gender in either the initial rate or the reset margin. Indeed, if any pricing differential exists, minority borrowers appear to pay slightly lower rates.
A recent study in the peer-reviewed Journal of Real Estate Research concludes
that up to 90% of the African American APR gap, and 85% of the Hispanic APR gap, is attributable to observable differences in underwriting, costing, and market factors that appropriately explain mortgage pricing differentials. Although any potential discrimination is problematic and should be addressed, the analysis suggests that little of the aggregate differences in APRs paid by minority and non-minority borrowers are appropriately attributed to differential treatment.
FHA and the Foreclosures of Tomorrow
The recently released Federal Reserve White Paper on the Housing Market has received considerable attention, at least for its policy proposals. I found one of the more interesting pieces of data in the paper to be the number of mortgages with negative equity, reproduced below (Figure 3 in the Fed paper).
What I found both interesting and distressing is that despite the fact that the Federal Housing Administration (FHA) was only about 2 percent of mortgages at the height of the bubble in 2005/2006, FHA is now over a fourth of total mortgages with negative equity. Of course this was all predictable (I actually predicted it). If you decide, as did our federal government, to get lots of borrowers into loans with very little equity, at a time when prices are falling, you will create a whole lot of loans with negative equity. Thank you FHA for creating a mess that was completely 100% avoidable. But who cares when you’re ultimately just sticking it to the taxpayer, right?
It Was the Republican Banker on the Fed Board Raising Concern about Housing
If you’ve followed Obama’s nominations to the Federal Reserve, he’s been pretty consistent, displaying a strong preference for coastal academics or politicos. Not one of his nominations came from the private sector (or “flyover country”), despite the very clear requirements of the Federal Reserve Act.
Recently released Fed transcripts reveal an interesting fact: it wasn’t the all-knowing, impartial Ivy League academics (like Bernanke and Yellen) or the long-term bureaucrats (like Geithner) that expressed concern about the housing and mortgage markets, it was the Republican banker from Tennessee, Susan Bies. Unfortunately it appears that the academics and bureaucrats on the Board treated Governor Bies’s concerns with their usual contempt for anyone who’s actually had to make payroll (or didn’t do their graduate work at Harvard or Yale).
In Obama’s defense, we are talking about the Federal Reserve Board as it existed in 2006. Bush was almost as bad about filling important economic positions with either New Keynesian academics (Mankiw, Bernanke) or Wall Street insiders (Paulson). Bush, however, did occasionally bow to some voices outside the Cambridge-Wall Street-Washington echo chamber, with Fed appointments such as Bies and the current Fed governor Duke.
The relevance for public policy choices facing us today? First, while a Board is no panacea, it does mean alternative voices are at least heard before they are dismissed (think the Consumer Financial Protection Bureau) and second, having a bunch of arrogant (and ignorant of real markets) academics run our economy is a recipe for disaster. And I’m not suggesting we turn our government over to corporate America, I’m suggesting we return our economy to the control and choices of free individuals.
If the ‘Volcker Rule’ Is So Great, Why Exempt Treasuries and Agencies?
One of the more controversial provisions of the Dodd-Frank Act is its restrictions on proprietary trading, contained in Section 619. Setting aside the fact that even Paul Volcker has said the provision would have done little to avoid to the recent crisis, the Act’s various exemptions illustrate the confusion and hypocrisy underlying the rule.
Foremost among these exemptions is the allowance of proprietary trading when the financial instrument in question is either a U.S. Treasury bill/bond or a security issued by Fannie Mae and Freddie Mac. These instruments are actually the bulk of proprietary trading. Remember the failed hedge fund Long Term Capital Management? Their signature trade was arbitraging on-the-run and off-the-run Treasuries. Ever hear of Bear Stearns? The largest single asset in Maiden Lane I, those Bear Stearn assets guaranteed by the New York Federal Reserve, were Fannie and Freddie securities.
Countries around the World, such as Japan and Canada, have already raised concerns that if their government debt is subject to the Volcker rule, the result will be less liquidity and higher funding costs. But then one has to suspect that former senator Chris Dodd (D-CT) and Rep. Barney Frank (D-MA) understood this, as they allowed an exemption for Treasuries and Agencies (Fannie/Freddie). While I’m no expert on trade policy, this may very well raise World Trade Organization questions since the Volcker rule, as proposed, favors U.S. debt over foreign debt. Of greater concern should be that the Volcker rule favors non-productive investment, that of the U.S. government and Fannie/Freddie, over productive investment, such as corporate paper.
As in so many other areas, Dodd-Frank does leave the actual decision-making to the bank regulators. (Is it too much to ask Congress to actually legislate?) Section 619 is very clear that regulators may exempt Treasuries and Agencies, which implies they also may not. The first best solution would be to just scrap the Volcker rule, but if we are going to have it, then apply it to everyone and all asset classes. Otherwise, one is just introducing additional distortions into our financial markets, some of the same distortions that actually lead to the financial crisis.
Commerce Clause Issues in the Regulation of Non-Bank Financials
If you believe that the Constitution’s Commerce Clause empowers Congress to do pretty much anything it wants (that is, if you believe that me scratching my nose impacts interstate commerce), then you can stop reading now—you’re beyond help.
If, however, one follows both the history of banking law and the wording of the Commerce Clause, which in Article I, Section 8 in listing the powers of Congress reads “To regulate Commerce with foreign Nations, and among the several States, and with the Indian tribes,” then there arises the possibility that Congress lacks the authority to regulate non-bank financials, such as payday lenders, in the manner envisioned by the Consumer Financial Protection Bureau (CFPB), as created by the Dodd-Frank Act.
After you spend over a decade reading federal consumer finance laws, as I have, you notice a trend. Terms like “federally related mortgage loan,” which appears in, among other places, the Real Estate Settlement Procedures Act, or “national bank,” which appears in lots of places, like the Home Owners’ Loan Act or the Federal Deposit Insurance Act, or “housing creditor” as defined under the Alternative Mortgage Transaction Parity Act, appear repeatedly. The commonality of these terms? They always tie back to deposit insurance or some sort of federal guarantee, such as those made by the Federal Housing Administration or Fannie Mae and Freddie Mac.
The structure of federal consumer finance laws has historically gotten around the Commerce Clause by tying said laws to the acceptance of some federal benefit. In the case of banks, the bargain is, Banks get deposit insurance, which is ultimately backed by the taxpayer, and in exchange they get stuck with a whole host of regulations, some relating to safety and soundness, many others not. This scheme has been expanded by trying similar restrictions to the ability to sell a loan to Fannie or Freddie.
While I think this arrangement has been a Faustian bargain for the banks, the fact is they don’t have to take deposit insurance or ask for any other type of bailout.
What is truly revolutionary (in a bad way) about the CFPB’s new powers over non-banks is that they go beyond this traditional framework. I assume, and hope, we aren’t going to start bailing out payday lenders or check-cashers or give them any sort of federal insurance scheme. So if there is no “bargain” here, as there is with federal depositories, then where exactly is the federal nexus? The vast majority of payday loan transactions, for instance, do not cross state lines. The states already have full power to regulate these activities, and already do. There’s no national marketplace for most of these products.
So if non-bank financials lack a federal nexus (due to the absence of any federal guarantee) and are not interstate commerce, then where exactly is the authority (or the need) to regulate them?
Now, I’m not a lawyer, but it’s hard for me to see how the regulation of activities like payday lending meet the three categories spelled out in United States v. Lopez. So in addition to the Appointments Clause challenges to the CFPB, I wouldn’t be surprised to also see a Commerce Clause challenge.
97% of Obama Nominations in 2011 Were Confirmed by the Senate
One of the rationales oft heard for Obama’s recent “recess” appointments is that the Senate is not “doing its job” or that Republicans have blocked his nominees and that our government “cannot function.” Putting aside the absurdity of the argument that somehow if Congress fails to “do its job” that empowers the President to take over its job, the simple fact is that the vast majority of Obama nominations have actually been confirmed by the Senate.
Between January 5, 2011, the beginning of the 1st session of the 112th Congress, and December 30,2011, the Senate received 20,517 nominations from the Obama Administration. Of those, 19,815 were confirmed by the Senate, which rounds up to 97 percent. And this ignores the fact that some nominations, like those to the National Labor Relations Board, were not received until December, hardly giving the Senate any time to consider and confirm said nominations.
One can argue that not all nominations are equal. For instance the majority of nominations are military positions. You can decide for yourself whether a general or admiral is equal to an assistant secretary or bureau director. If one wants to produce a “quality-adjusted” nominations index, they are free to do so. None of this changes the basic fact: President Obama has had the majority of his nominations confirmed by the Senate. Claims to the contrary are simply false.
How Good Are Government Deficit Forecasts?
In just a few weeks Washington enters that alternative universe called “budget season,” when the President delivers his budget proposal to Congress and Congress begins constructing its budget for the coming fiscal year (at least in normal years, don’t expect much budget action in 2012). Underlying the budget process will be government projections of the deficit. Such projections will be given considerable weight, both in Washington and among the press. So if said projections are way off, then budgeting decisions by Washington will also miss the mark.
Just in time to help frame this debate is a new paper from economists at the Federal Reserve Bank of St. Louis. The entire paper is well worth a read, and accessible to the general public. Below is a chart, reproduced from the paper, that expresses the basic point.
On the X axis is the Congressional Budget Office’s projected 5 year budget surplus/deficit, as a percent of GDP. The Y axis plots the actual budget surplus/deficit. An easy way to read the chart is that points below the 45 degree line are instances of where CBO was too optimistic. Points above the 45 degree line are where CBO was too pessimistic. If CBO’s errors were random, then the number of points below and above the 45 degree line would be about equal. As you can see, however, CBO’s errors were not randomly distributed. They were biased in the direction of being too optimistic. So when you see the next round of CBO budget forecasts, take them with a huge grain of salt. The truth is likely to be much worse.
Unconstitutional Recess Appointments Haven’t Helped Obama in the Polls
It has just been over a week since President Obama made his “recess” appointments to the Consumer Financial Protection Bureau and the National Labor Relations Board. I suggested last week that this might turn out to be Obama’s “Court-Packing” moment, where he begins to discover that (some) Americans actually do care about the Constitution. While its clearly too early to say anything with certainty, it appears I may have been correct.
On January 3th, the day before the appointments, Obama’s job approval ratings, according to RealClearPolitics, averaged 47.2 approval and 47.8 disapproval. Basically a tie.
Today, his job approval is at 44.5 and disapproval is 50.3. Moving over the course of a week from a tie to a spread of almost 6 percentage points.
Usually we have not seen such large changes over the course of a week. Now obviously one cannot contribute all this decline to the recess appointments, but there were no other big Presidential announcements or even big economic news over the last week that could account for such a slide in support. So while this doesn’t prove anything, it does suggest these appointments, even if they are making his base happy, are coming at the expense of the support of independents.
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