Five realities about the current financial and economic crises.

• Author: Carr, James H.
• Position: Consumer Law Symposium

It would be difficult to overstate the dire condition of the U.S. economy as inherited by President Barack obama on January 20, 2009. at that time, the economy stood on the precipice of collapse. over the past year and a half, a combination of economic stimulus spending and continued bank bailouts successfully averted a second Great depression and returned the major banks to profitability. But the challenge of laying the foundation for a more promising long-term economic future for america remains largely unaddressed. in fact, despite recent positive GdP and employment data, the foreclosure crisis that initially imploded the credit markets and undermined the economy continues to worsen. and many characteristics of the current recovery are cause for concern.

This paper presents five key points about the recent near collapse of the financial system and the efforts to rein in foreclosures and reinvigorate the economy. it concludes with recommendations to ensure a robust and sustainable economy that serves working americans more effectively and that limits the prospects of a repeat of the financial misconduct that led to the crisis.

1. THE FORECLOSURE CRISIS WAS AVOIDABLE

   one of the most dispiriting aspects of the Great recession is that it was largely avoidable. For more than a decade before the recession began, financial institutions increasingly engaged in practices intended to mislead, confuse, and otherwise limit a consumer's ability to judge the value of financial products offered in the market and to make informed decisions. Nowhere was this more evident than in the subprime home mortgage market. (3) Excessive mortgage broker fees, irresponsible loan products, inadequate underwriting, bloated appraisals, abusive prepayment penalties, and fraudulent servicing practices were major aspects of the problem. (4)

   over the past couple of years, some have attempted to lay the problems at the doorsteps of low and moderate income and minority households--arguing that public policies to promote homeownership were responsible for the foreclosure crisis. According to the Center for Responsible Lending, less than 10% of subprime loans originated between 1998 and 2006 were for first-time homeownership. (5) The majority of subprime loans originated during that period were for refinancing. Moreover, the current crisis was not, as some argue, a result of pressure on lenders to extend loans to unqualified borrowers due to the Community Reinvestment Act (CRA). The Federal Reserve Board reports that only 6% of high-cost subprime loans made to low and moderate income households were covered by CRA. (6) The majority of subprime loans were originated outside of the CRA regulatory framework.

   The potential dangers of and damages caused by abusive subprime lending were documented, discussed, and debated for more than a decade, only to be dismissed by the federal regulatory agencies responsible for protecting the consumer rights of the American public. (7) Organizations such as the National Community Reinvestment Coalition, (8) Center for Community Change, (9) National Consumer Law Center, (10) National Fair Housing Alliance, (11) and Consumer Federation of America, (12) to name a few, published research on the risks of subprime lending and other exotic mortgage products for up to or more than a decade. The Fannie Mae Foundation published two papers in 2001 on various aspects of predatory lending in distressed communities. (13) The peer-reviewed journal Housing Policy Debate devoted an entire special issue to risky, high-cost lending in 2004. (14) And in 2006, the Center for Responsible Lending warned of the impending foreclosure crisis when it estimated that 2.2 million foreclosures would take place in the next eighteen months. (15) In short, this crisis was not only predictable, it was predicted.

   Federal regulatory agencies were aware of the problems and had the authority to act. The Federal Reserve, for example, was given authority to regulate reckless, high-cost mortgage loans in 1994, but did not do so until 2008. (16) On the rare occasions when federal regulators did intervene, they preempted and set aside state laws intended to protect borrowers from deceptive and unsustainable loan products. The Office of the Comptroller of the Currency (OCC), for instance, preempted North Carolina's groundbreaking 1999 anti-predatory lending law. Since 1999, OCC has preempted state-level consumer protection laws in North Carolina, Georgia, New York, New Jersey, and other jurisdictions. (17)

   The consumer protection deficiencies that characterized the subprime mortgage market were indicative of the loose regulation of the financial system more broadly. inadequate oversight of the bond ratings agencies, for example, enabled those firms to stamp investment grade on hundreds of billions of dollars of securities that were little more than junk bonds. A shadow financial industry as large as the regulated financial sector traded unregulated derivative products so complex that their risks were often not fully understood, even within the institutions that packaged and sold them. No systemic risk regulator existed to intervene and potentially take control of financial firms whose reckless behavior posed a risk to the entire financial system.

2. THE BANK BAILOUTS HAVE NOT FULLY SUCCEEDED

   The loans, capital infusions, and guarantees that collectively constitute the banking "bailouts" add up to more than $23 trillion, according to Neal Barofsky, the Department of the Treasury's Special Inspector General for the Troubled Asset Relief Program (TARP). (18) The bank bailouts helped avert a total collapse of the nation's largest financial firms and return them to profitability. But the bailouts did not stem the foreclosure crisis and have not encouraged those firms that received the greatest public support to increase lending. As a result, the bailouts can be seen as only a partial success. indeed, seven of the ten largest U.S. banks returned to profitability in 2009. Several posted record-breaking quarterly profits and near-record annual profits. Wall Street paid out bonuses at near-record levels, including at banks that lost money. (19) At the same time, however, consumer lending contracted in each of the four quarters of 2009. The 3% decline between the second and third quarters is the largest drop since the Federal Deposit Insurance Corporation (FDIC) started tracking lending levels in 1984. Total lending fell 7.5% in 2009, (20) and banks that received bailout funds cut lending more aggressively (-9.2%) than firms that did not receive government money. (21) Anemic lending by the major banks has continued into the first quarter of 2010. (22) Janet Yellen, President of the Federal Reserve Bank of San Francisco, called the flow of credit from large financial firms to small businesses "extremely weak." (23) Stated otherwise, as profits and bonuses at the largest banks have gone up, lending has gone down.

   Moreover, although the largest firms have enjoyed a tremendous comeback, the banking industry as a whole remains remarkably weak. In 2009, the FDIC depleted its insurance fund in the process of taking 140 banks into receivership. As of March 2010, an additional 775 depository institutions remained on the at-risk list, which is a nonpublic inventory of the specific banks that are in imminent danger of failure. (24) FDIC Chairwoman Sheila Bair said in December 2009 that she anticipated more bank failures in 2010 than 2009. (25) As of May 17, 2010, 72 banks had failed. (26)

   One reason for the relative paucity of lending may be that the problem that triggered the near implosion of the financial system continues to worsen. Foreclosures have continued to increase annually, with more than six million since 2007. Yet nearly 3.5 million (27) additional foreclosures are expected to occur in 2010. (28) Attempting to resolve the financial crisis by bailing out the banks but largely ignoring growing numbers of foreclosures was "tantamount to trying to fill a bathtub [without] the stopper." (29) The result of these efforts is the precarious and struggling economic recovery we have today. More aggressive efforts to help borrowers remain in their homes would have stabilized households, communities, banks, and the economy as a whole.

   In fact, the current expansion is largely characterized as a "jobless recovery." GDP grew by 5.6% in the fourth quarter of 2009, (30) then slowed to 3.7% in the first quarter of 2010 and just 1.6% in the second quarter; meanwhile, the unemployment rate remains at nearly 10%. (31) over the past two years, the economy has shed more than eight million jobs. (32) Although March and April 2010 posted strong jobs gains (230,000 and 290,000 jobs created, respectively), the unemployment rate has nevertheless increased, as signs of economic recovery lure people back into the labor market. (33) The government's measure of "expanded unemployment," which includes discouraged workers and those employed part-time despite desiring full-time work, is 17% of the civilian labor force. (34)

   Experts anticipate that the unemployment rate will remain near 10% for the majority of 2010. In fact, the Federal Reserve Bank of Kansas estimates that it will take a decade for unemployment to return to pre-recession levels. (35) Many of the problems now gripping the U.S. economy have been in the making for more than three decades. The long-term loss of well-paid manufacturing (and more recently service) jobs to other countries combined with productivity gains in the U.S. translates into the need for increasingly fewer employees. The results of this process can be seen in the reality that each successive recovery since the 1980s has produced fewer jobs. Recovery from the 2001 recession yielded particularly weak job growth, generating only 100,000 jobs per month, (36) far fewer than necessary just to absorb new entrants into the labor market today. (37)

   What's worse...