Bringing it all back home: how to save main street, ignore K Street, and thereby save Wall Street.

• Author: Hockett, Robert

Introduction I. Where We Are and How We Got Here II. Where We Were and How We Got There III. Bringing It All Back Home Conclusion INTRODUCTION

After a number of heady false starts, against the backdrop of threatened financial catastrophe, Congress and the White House enacted a stopgap financial "bailout" plan early in October 2008. (1) The so-called "Troubled Asset Relief Plan" ("TARP," "the Plan") is remarkable in a multitude of respects. As a fiscal matter, the Plan's sheer size--$700 billion, with no assurance that this will be all--appears to be unprecedented. It dwarfs even the costs of the savings and loan ("S&L") cleanup nearly two decades ago, remarkable as those were in their own day. As a legal matter, the sheer breadth of barely reviewable discretion that the TARP confers upon the Treasury presses hard against Constitutional limits on Executive Branch authority. Indeed, lawyers largely agreed that the original, three-page version of the Plan might well have delegated authority in excess of what the Constitution permits, while the amended, 400-page version squeaks by at best. (2)

At least as striking as the TARP's fiscal scale and delegated executive scope, however, has been the remarkably restless character of the Treasury's actions taken under the Plan since its enactment. Messrs. Bernanke, Bush, and Paulson originally projected the TARP, late in September 2008, as a proposed "buy-up" of mortgage-backed securities ("MBSs") said to be clogging the credit markets. (3) The Treasury next began speaking instead, about mid-October 2008, of "buying-in" to financial institutions. (4) This, it was said, would make lendable funds more immediately available to lenders, hence restoring liquidity to credit markets more expeditiously. (5)

By early November, the Treasury was reporting that the buy-in plan would entirely supplant the earlier buy-up plan. (6) About mid-November, however, the Treasury abruptly announced it would enter the short-term debt markets as well, once again "buying-up," in order to get commercial paper circulating again. (7) Then, near the end of November, the Plan changed again: now, we were told, the Treasury would resume purchasing "toxic" assets, but more kinds than MBSs. (8) Finally, in early December, talk had turned toward employing some of the TARP monies to tide over automakers as well, a course of action that indeed began by the new year. (9)

Throughout all of the on-a-dime pivots and changes of direction, a few voices softer than the Treasury's have been offering proposals aimed at the primary cause of our present financial worries--the ongoing mortgage foreclosure crisis afflicting our post-bubble real estate markets. (10) With time and continued tumult, these proposals have gradually come to be more widely heard. Sheila Bair, Republican Chair of the FDIC, can be added to the list of those arguing that mortgage foreclosures lie at the core of our woes--a list that since autumn has included not only progressive housing advocates, but also financiers and economists as ideologically diverse as the Democrats George Soros and Joseph Stiglitz, and the Republican Glenn Hubbard. (11) Even former Federal Reserve Chair Bernanke and former Treasury Secretary Paulson acknowledged the need to stabilize freefalling mortgage markets.

It is very good news that so many, at last, are now looking to stemming the foreclosure crisis as the best means of addressing the present financial crisis. However necessary the "transfusion" supplied by the first half of the Treasury's new $700 billion was to keep the "patients" that are our national and global financial systems alive on the table, the fact is that these patients--and the public rise--will continue to hemorrhage until we stanch the flow of foreclosures that is still underway. The only real question is how best to do that.

A brief bit of forgotten institutional history, I believe, supplies our answer: the most effective--as well as the most constitutionally sound--way to solve the mortgage crisis, and thereby a looming national and indeed global financial crisis as well, is to direct the new Treasury under the Obama Administration and Secretary Geithner to administer the TARP through twinned institutions we already have. These originally were, and still are established precisely to deal efficiently with low-end mortgage financing and refinancing. (12) Indeed, they were founded to do so precisely to deal with that real estate crisis which immediately preceded (one shudders to say it) a certain notorious Wall Street contraction--one that commenced in October of 1929. Our present woes, moreover, stem directly from intrusions upon these institutions' original missions by under-regulated private firms, first in the lead up to, then during, the near-decade-long housing bubble that grew from the late 1990s to about 2006.

The institutions to which I am referring are the Federal Housing Administration ("FHA"), working in tandem with its originally government-sponsored and recently re-federalized sibling enterprises ("GSEs"), Fannie Mae and Freddie Mac. Any properly focused plan for financial bailout will critically involve what amounts to these institutions' original, and now recently restored, bailiwick. To show why and how this is so, Part I briefly reviews the cause of the problems with which we are presently dealing. Part II then briefly reprises the founding and functioning of our newly restored team of mortgage finance institutions. Part III closes with a sketch of how TARP should now be channeled through these institutions.

1. WHERE WE ARE AND HOW WE GOT HERE

   Let us begin by noting that there are two salient components of the present crisis. The first, what I'll call "core" component, is the doubtful value of an uncertain number of "subprime," "Alt-A," and "jumbo ARM" MBSs. These are held in varying quantities by a large number of financial institutions ("FIs") worldwide, many of which do not yet appear to have fully reported the sizes of their holdings. (13) These securities, moreover, underlie financial derivative commitments on the part of yet more FIs worldwide, with notional values that similarly appear to be underreported. (14) The MBSs, for their part, are now widely perceived to be "toxic" because many--though certainly not all and indeed not even a majority--of the mortgages backing them are troubled. (15)

   Many of the mentioned mortgages are troubled, in turn, because they were imprudently--or in some cases "predatorily"--extended by participants in the shadow industry of scarcely regulated "mortgage banks" that developed and then grew in the vacuum left by those S&Ls lost in the 1990s. (16) These institutions, most of which are not, legally speaking, banks at all--they take no deposits and are not regulated as depository institutions-proliferated rapidly with, and indeed helping to fuel, our recent Fed-enabled real estate bubble. (17) Naive, non-credit-checked, and in some cases clearly uncreditworthy borrowers not only received loans from these institutions, but often were lured with offers of newfangled adjustable rate mortgages ("ARMs") featuring low front-end "teaser" payments that later "ballooned." (18) Understanding how this could have happened will take us straight to the second, penumbral component of our present crisis, as well as to how to best solve it.

   Ordinarily, neither borrowers nor lenders would likely have expected anything good to come of loans on such terms. But fees, risk-transferability, and especially speculative asset bubbles have a funny way of changing people's calculations. Borrowers reasonably assume they can regularly refinance inexpensively on the strength of the underlying collateral's apparently inexorable appreciation. Primary and secondary lenders naturally assume likewise. Again, such assumptions seem normal while the bubble is growing. Federal Reserve Chairman Greenspan himself said as much at the time, saying the buyers would be irrational not to take up ARMs. (19)

   Borrowers, then, need not be profligate to "get in" what later proves "too deep" when it comes to levered asset purchases. Lenders, for their part, need not be venal: they can reasonably endorse borrowers' best hopes, even when lured by origination and loan servicing fees, and by the easy sale of resultant mortgages to secondary holders. The secondary holders only add to the pressure. Often they prod loan originators on, as seems to have happened quite widely this time. Why? Perhaps partly because they assume the originators have done the due diligence. But they are lured in any event, by the returns on investments that are there to be had while a bubble is inflating, even if there be defaults here and there. The highest rewards are always associated with some risk, after all.

   For a time in these cases--often for years--virtually everyone wins. The process takes on a self-fulfillingly prophetic, spontaneous "chain letter" or Ponzi-like character. More are drawn into the market as prices keep rising. Some hope to clear speculative profits by "flipping" the assets they borrow to buy. Others, more innocently perhaps, reasonably judge they can prudently purchase to hold, but on more highly leveraged terms than they might otherwise have accepted. Still others are mixed cases of holder-cum-speculator. (20) In any event, as the new entrants keep entering, the prices do keep rising, effectively validating the judgments of those who act upon the expectation of continued ascent.

   As this process continues, some begin to believe, and others perhaps labor to convince themselves, that we have entered upon some permanent "new era," from which point onward asset values quite generally "can only go up." Others, somewhat more modestly, convince themselves simply that the particular asset in question--land or petroleum, say--is in finite supply. Since populations and long-term demand know no limits, they conclude--not implausibly--that this one...