The San Francisco Chronicle published on Sunday a grossly irresponsible opinion
piece from one Sean Olender, headlined "Interest
rate ‘freeze’ – the real story is fraud". I would dearly like to hold
someone at the Chronicle to account for printing this incendiary and meretricious
column: it sheds much more heat than light on the issue, and spreads a lot of
misinformation and outright falsehoods in the process. Mark Thoma today says
that "I don’t know if there’s anything to these accusations or not":
let me assure him (and Tyler
Cowen, for that matter) that there isn’t.
Olender sets the tone for his piece right at the beginning:
New proposals to ease our great mortgage meltdown keep rolling in. First
the Treasury Department urged the creation of a new fund that would buy risky
mortgage bonds as a tactic to hide what those bonds were really worth.
This simply isn’t true. The MLEC, for that is the only thing he can be referring
to here, was specifically designed to buy only high-quality assets: the whole
point of it was that it would not buy any risky mortgage bonds at all.
In any event, the point was not to buy bonds for more than they were worth:
the point was to provide liquidity to a market which was suffering from a major
liquidity shortage.
Olender continues:
Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans,
even if it was clear that U.S. taxpayers would eventually be stuck with the
bill.
I have no idea which idea Olender thinks he’s talking about here. Fannie and
Freddie buying private-label subprime mortgages on the secondary market? I don’t
recall any plan like that, certainly not anything which was embraced by anybody
in government.
Olender then says that the mortgage-freeze plan is just as bad, if not worse:
"the "freeze" is just another fraud," he writes. Yes, fraud:
he’s saying it’s illegal.
The sole goal of the freeze is to prevent owners of mortgage-backed securities,
many of them foreigners, from suing U.S. banks and forcing them to buy back
worthless mortgage securities at face value – right now almost 10 times their
market worth.
It’s worth noting the "foreigners" hiding out in this sentence: it’s
a good indication that Olender is rather out to lunch. Why on earth would the
nationality of bondholders make any difference either way? But in any case,
we’re beginning to see what Olender’s thesis is here. Apparently he thinks that
(a) US banks might be forced to buy back subprime mortgages at par; and that
(b) the mortgage-freeze plan will somehow prevent that from happening. Neither
of these things is true.
The ticking time bomb in the U.S. banking system is not resetting subprime
mortgage rates. The real problem is the contractual ability of investors in
mortgage bonds to require banks to buy back the loans at face value if there
was fraud in the origination process.
The real problem here is that Olender never makes the crucial distinction between
subprime mortgage originators, on the one hand, most of whom were not banks
at all, and the investment banks, on the other hand, who pooled and tranched
and sold off the subprime mortgages to bond investors. The originators are required
to buy back fraudulent loans, but most of them have gone out of business at
this point. The investment banks are just middlemen: they are not required
to buy back anything.
Despite Thursday’s ballyhooed new deal with mortgage lenders, does anyone
really think that it can ultimately stop fraud lawsuits by mortgage bond investors,
many of them spread out across the globe?
Er, no, nobody thinks that, Sean. In fact, you’re the only person who thinks
the deal was even designed to prevent such lawsuits in the first place. But
never mind, you’re about to wax apocalyptic:
The catastrophic consequences of bond investors forcing originators to buy
back loans at face value are beyond the current media discussion. The loans
at issue dwarf the capital available at the largest U.S. banks combined, and
investor lawsuits would raise stunning liability sufficient to cause even
the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts
of Fannie and Freddie, and even FDIC.
Olender uses the term "originators" here, rather than "banks",
originally, but immediately elides that into "banks". The fact is
that "the largest U.S. banks combined" really didn’t originate much
in the way of fraudulent subprime loans. Most of that origination happened at
companies like Ameriquest, which have long since closed their doors. The US
banking system simply doesn’t bear the liability that Olender thinks it does.
And I think that Olender is saying that not only the originators but also the
investment banks have criminal liability here:
What would be prudent and logical is for the banks that sold this toxic waste
to buy it back and for a lot of people to go to prison. If they knew about
the fraud, they should have to buy the bonds back.
It seems as though he’s talking about investment banks here, not about
originators. But investment banks were just the middlemen, funneling subprime
mortgages from originators to investors who were desperate for yield. I don’t
see how they should suddenly be forced to buy back all those mortgages at par,
and I’m quite sure that they have no legal obligation to do so. But Olender
isn’t finished yet:
The goal of the freeze may be to delay bond investors from suing by putting
off the big foreclosure wave for several years. But it may also be to stop
bond investors from suing. If the investors agreed to loan modifications with
the "real" wage and asset information from refinancing borrowers,
mortgage originators and bundlers would have an excuse once the foreclosure
occurred. They could say, "Fraud? What fraud?! You knew the borrower’s
real income and asset information later when he refinanced!"
The key is to refinance borrowers whose current loans involved fraud in the
origination process.
This is where Olender reveals that he’s really living in cloud-cuckoo land:
he simply doesn’t grok the difference between a loan modification – which
is the centerpiece of the mortgage-freeze plan – and a refinance. The
whole point of the mortgage freeze is that it does not involve refinancing
any loan – the loan is simply modified, and the bondholders retain all
their legal rights.
But wait – Olender isn’t done yet. No column as crazy as this one would
be complete without taking a page from Ben Stein’s book and drawing out the
Paulson-Goldman connection:
Ultimately, the people in these secret Paulson meetings were probably less
worried about saving the mortgage market than with saving themselves. Some
might be looking at prison time.
As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed,
in the mortgage securitization process during the halcyon days of mortgage
fraud from 2004 to 2006…
If a mortgage bond investor sues Goldman Sachs to force the institution to
buy back loans, could Paulson be forced to testify as to whether Goldman Sachs
knew or had reason to know about fraud in the origination process of the loans
it was bundling?
At this point it’s clear that Olender is operating under the delusion that
investment banks, rather than originators, can be forced to buy back loans.
After all, Goldman never originated any subprime mortgages itself. In any case,
Olender finishes with a flourish:
We’re talking about criminal fraud here. We are on the cusp of a mammoth
financial crisis, and the Federal Reserve and the U.S. Treasury are trying
to limit the liability of their banking friends under the guise of trying
to help borrowers. At stake is nothing short of the continued existence of
the U.S. banking system.
I honestly think that Olender is accusing Hank Paulson of criminal fraud. And
I’m really unclear as to what Olender thinks should be done to ensure
"the continued existence of the US banking system" – should
we force banks to buy back subprime mortgage bonds at par, or not?
The whole piece suffers from an acute case of conspiracytheoryitis, shot through
with some very damaging misunderstandings about where legal liability lies in
the securitization process. It’s the kind of thing which would be easily ignorable
on a blog somewhere, and I’m not surprised that something along these lines
has been written. But I am extremely surprised that the editors of the San Francisco
Chronicle, whose job is to filter out the nutcases, somehow let this one through
and printed it on the front page of the C section on Sunday. Shame on them.