Saturday, March 15, 2008

Wall Street loves it's Hand Outs

Pain relievers should share the pain
By Julian Delasantellis

Wrongly attributed to New York Tribune publisher Horace Greeley in 1865 (the actual author was Indiana newspaperman John B L Soule in 1851) "Go West, young man, and grow up with the country" defines not only the American expansionary spirit of the latter 19th century, but, to a certain extent, the philosophical ethos that forever has defined American society, from the pilgrims at Plymouth Rock to the present.

Got a problem, be it with your work, your community, your church hierarchy, your family, even your spouse? The solution was always to pack up stakes and strike out towards the frontier, towards the plentiful open space of the boundless West, towards the limitless new dreams guaranteed to be just over the horizon, available to all free men just by virtue of their birthright as Americans.

Until now. Because of the spreading and intensifying effects of the subprime mortgage crisis, almost 9 million American households (by comparison, there were only 4 million slaves in the American South at the beginning of the US Civil War) are now indefinitely tied down as tightly as Russian serfs to their plots of land, as the turbofinance of the 21st century puts into place a breathtakingly oppressive new financial feudalism that, as much as any poor 19th century peasant toiling on the banks of the Volga, limits their options, their mobility, ultimately their very freedom.

Like a cancer metastasizing through the body invading vulnerable organs one by one, the subprime mortgage crisis is now showing up in yet another doleful manifestation of the closing of the American dream. This time, it's the almost 9 million American homeowners who now owe more on their properties than their properties are worth, who are, in mortgage industry jargon, "under water" on their properties.

The American economic and governing elite, those who rule in the name and for the benefit of the people, is certainly springing into action to address the problem. Last week, Countrywide Financial, the now nearly bankrupt Pied Piper of subprime whose golden flute now appears to have led a good portion of the world's financial markets right off a cliff, hosted a posh "eat drink and be merry, for tomorrow we die" ski soiree (actually, it's probably more accurate to say that the atmosphere was along the lines of "eat, drink and be merry, for tomorrow we'll all get fired" after the pending buyout of Countrywide by Bank of America goes through) for what's left of the mortgage origination industry in Vail, Colorado.

And down there on those private islands in the Caribbean, the places where, you know, only the right sort of Gulfstream G550s are allowed to land, America's business and political elite are obviously burning with desire to assist the nation's endangered homeowners.

Hey, boy. Rub some oil on my back.
Much in the same way that longstanding cultural traditions make those who suffer the coming-of-age ceremony that is female genital mutilation welcome this torture, in America, the formal ceremony that accompanies the legal transfer of real estate from seller to buyer, called a closing, is a traditional torture that Americans have come to accept as an inevitable right of passage along the way to the American dream of home ownership.

Usually occurring at the offices of the specialized professional parasites called real estate lawyers, a closing involves bringing buyer and seller together with lawyers and bankers for hours of paper signings that codify into contract the changes in the parties' ownership and status.

For the buyer, who foots the bill for all parties providing the day's entertainment, the closing involves a formal acknowledgement that, although he may be now on record as the legal owner of the property, his continued ownership is always conditional on keeping current on the mortgage financing obtained to acquire the property.

For the seller, the closing involves signing pounds of paper relinquishing his ownership claim in the property, and, in return, receiving a nice big check in payoff. But first, before the seller receives a penny of proceeds from the property, he must make a one-time payoff of the remaining balance of the mortgage; the difference between what the buyer is paying and what the bank takes out is what the seller walks away from the closing with.

With the traditional pattern of American real estate price appreciation, closings are usually fairly pleasant for the sellers - the rising prices means that the mortgages can be paid off with still healthy chunks of cash left over.

Of course, there's not much that the seller can do with his newfound bounty, for, although he may then have a nice big check in his pocket, he also has no place to live.

Unless he wants to reside in a refrigerator box or move out of his local real estate market into a cheaper one, the riches obtained in selling his old property will be eaten up at the purchase closing of his new property. In this, the varying real estate prices and valuations of America's individual, localized real estate markets work very similarly to the floating rate regime of the international foreign exchange markets.

If you own property in a high-value real estate market, say San Francisco or Boston, you can, in much the same way that European tourists were able to travel to New York this last holiday season to snatch up bargains with their strong euros, sell that overvalued property to get a lot more value in areas with less expensive real estate. Fargo, North Dakota currently lists for sale over 250 three-bedroom, two-bath houses under US$200,000 , while Sunnyvale, California, south of San Francisco, lists, of course, none.

Sellers in pain
It's not at all uncommon for the buyer to have to bring money to the closing, either as the down payment, or to pay the 5-10% of the purchase price that are the useless expenses, called "closing costs", that the actors in the system, collecting what economists would call a "monopoly rent", bleed from out of the open veins of the buyers. But, up until recently, it was unheard of for the seller to have to bring money to the closing.

This would be the case if the selling price of the house was not sufficient to pay off the remaining balance on the mortgage. This would happen if, in between the time of the house's purchase and its sale, its value declined below that of the outstanding mortgage. This situation would be more likely if the seller, instead of paying down the mortgage and building equity in the house, continually re-leveraged the property with second and third mortgages and/or home equity loans.

If the value of the home selling price falls short of the mortgage balance by say, $50,000, then that's $50,000 worth of pain to be deposited on the head of the seller. Even though he no longer owns the house, he still has the same mortgage obligation to pay down the debt; if he doesn't, the bank can go to court to have his wages garnished or assets seized in order to collect it. The only real alternative the poor borrower has then is to declare bankruptcy, and in doing so, resign himself to at least seven years of existence in the shadowy, credit restricted American netherworld known as the cash economy.

Obviously, what most homeowners will do in this situation is to not sell the house; they will continue to live in it and make the payments as best as they can, in the hope that someday the house's value will rise enough that they won't have to keep living their lives as indentured servants to it. This, of course, makes their relationship with the house the most central aspect of at least their financial, and frequently their personal, lives. (A couple going through a divorce in this situation may well find that, even after the relationship they have with each other is legally dissolved, the relationship they continue to have with the house and its mortgage keeps the two of them still bonded and living together in unending, doleful personal embrace.)

In contrast to the supposed sclerotic nature of the West European economies, the American economy is said to be "flexible" and amenable to rapid change. In terms of American companies' human relations policies, that means that most companies view their work staff as interchangeable and disposable as tissue paper. For a worker who thus gets laid off but who can't move to an area with better employment prospects because he can't sell his house, the American promise of unlimited freedom and liberty will ring very hollow, as will it for the worker who, for the same reason, can't accept a promotion or a better job in a new city.

Due to the subprime mortgage crisis, almost 9 million American households are currently in the situation described above, being under water on their mortgages.

Not all of these unfortunates are subprime borrowers. With the quickening pace of foreclosures and subsequent foreclosure property auctions, the added supply of homes onto the market is driving down prices. Also, the tightening lending standards in the mortgage finance industry, with prospective buyers who previously qualified for loans now shut out of the market, are thus further suppressing both demand and prices.

In addition, during the go-go real estate boom of the past few years, many prospective homebuyers and home equity borrowers were allowed to borrow right up to the then inflated assessed value of their property, leaving them almost no cushion of safety should, as is the case now , values start to fall.

Last week, different proposals emerged from both government and the banking system as to how to deal with the crisis of the submerged sellers.

Avatars of ideology
The banking industry is proposing a fairly simple solution to this, and most of the other problems arising from out of the subprime crisis. Much like the nationalization of the Northern Rock bank in stodgy old supposedly socialist Great Britain, these avatars of free-market ideology in the finance trade are, essentially, calling for the nationalization of the entire subprime mortgage industry.

Here is the core difference between advocating for capitalism and supporting capitalists. Capitalism is a system that heralds the innate, natural superiority of the market over government; as for the capitalists themselves, they're just fine with as much government support and largesse that they can get their hands on-well; who says no to found money?

Proposals being floated from the financial community are calling for the government to buy up just about every single subprime, and a whole lot of the now endangered Alt-A higher quality mortgages as well. If the government wanted to then show a measure of forbearance or mercy to the borrowers that the private sector is now choosing not to, it then could - it's no skin off my back then, say the lenders.

This approach is evocative of the Great Depression era US Home

Owners' Loan Corporation, set up by president Franklin D Roosevelt and Congress at the start of the New Deal in 1933.

One might find it surprising that these bankers are turning to the example of FDR and the New Deal for their salvation, as, for most of them, their only real connection to that former president and liberal icon is seeing his name alongside obscenities on the walls of the men's room at their country club. Obviously, in deciding between ideology and real money, ideology is being thrown a ball and told to play outside.

If the private financial industry's solution to these problems is to have the government pay to fix them, it shouldn't be all that surprising that government's solution to these problems is, of course, to have the private financial industry pay to solve them.

Floated from out of the US Office of Thrift Supervision (OTS) last week was a new way to deal with the under-water homeowners. In essence, instead of having homeowners either head to bankruptcy court or stay in their houses until they were grey and grizzled, homeowners could get out of this situation by refinancing their mortgage, and having their mortgage holder issue what is called a "negative amortization certificate" for the difference between the remaining mortgage and the home's now lower, assessed value.

"Few details about the plan have been settled" according to the description of the proposal on, and that's the problem. Once the "negative amortization certificate" pops out of the printer, it's not at all clear just who then would have what to do with it.

If the homeowner wants to stay in his home, then, for him at least, negative amortization certificates are clear winners. When, a few years ago, most of the subprime borrowers got into their mortgages on their overpriced properties with the low initial "teaser" mortgage rates that the banks dangled in front of their eyes like a worm lure on a fishing line, they were promised that they could always spare themselves the pain of the resets to higher rates and payments by using the house's inevitable increase in market value as the equity required to refinance into more affordable fixed-rate financing.

As home prices fell, the home equity needed to refinance evaporated, so the subprime borrowers were left defenseless against to full gale force pain of the resets, and the subprime crisis commenced.

For these borrowers, negative amortization certificates provide a clear benefit - they get a much lower monthly mortgage payment. At least temporarily, the holders of the mortgage will do worse, for a good part of the value of their ownership in the mortgage has been now converted into the certificate. The plan's originators at OTS say the banks and other holders of the mortgages, since they will save the average $50,000 it costs to foreclose on a delinquent borrower, will be fine and on board with this.

Sure they will.

When things really get hazy is if the homeowner wants to sell the house. Now he can, his mortgage balance has been reduced, so he won't have to face a Freddy Krueger like figure at the closing table demanding tens of thousands of dollars to wake from his nightmare.

What about the negative amortization certificate? Since its creation it has become a sort of semi-secured lien on the property. When the house sells, any difference between the re-financed mortgage amount and the selling price, up to the value of the original mortgage, supposedly goes back to the holder of the certificate, the mortgage holder, after which the certificate then goes out of existence.

No recovery - what then?
But what if the house's selling price does not recover? Who carries that debt, the value of the negative amortization certificate created when the original mortgage was refinanced? The buyer, for all eternity, like a borrowing Original Sin, paying for a financial mistake he made in his 20s all the way to the nursing home? Or does the holder of the negative amortization certificate just eat the loss, laugh it off with a hale and hearty guffaw, "win some, lose some"? Yeah, right.

The real problem underlying all these solutions is, of course, that in media- and image-sodden America, it's more important to look like you're solving a problem than to actually be solving one. Since the subprime crisis slammed into the markets like a planet-killing asteroid in mid-summer, various other well-trumpeted and fanfared solutions have been advanced that promised to solve the troubles.

From Countrywide's September offer to voluntarily re-finance most of the subprime mortgages under its purview (an offer which, like the subprime mortgages themselves, failed upon reading of the fine print) to the US Treasury’s "Hope Now" (see Hope Now - Sorry, wrong number, Asia Times Online, December 12, 2007)and "Project Lifeline" initiatives, the public relations company and media consultant vetted but ultimately pointless and failing efforts by the governing elite to solve the problem grow ever more feverish and frenetic, as the plight of those actually caught up in the crisis grows ever more desperate and dire.

In 1992, Bill Clinton got votes by saying that he "felt your pain" to those Americans suffering the early 1990s' economic woes brought about by the Savings and Loans crisis. Today, it might help if our current elite actually felt and shared in the pain of those caught up in this economic crisis. That they could do by, instead passing all the cost of solving the problem to someone else while still grabbing for all the credit, they actually put some of their own money, some scratch on the table, to feel the same pain of sacrifice that millions of Americans are now being forced to suffer.

Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at

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