It Could Happen Here, Bruce Judson's Blog http://itcouldhappenhere.com/blog Wed, 02 Jan 2013 23:51:34 +0000 http://wordpress.org/?v=2.9.2 en hourly 1 A Leadership Moment http://itcouldhappenhere.com/blog/a-leadership-moment/ http://itcouldhappenhere.com/blog/a-leadership-moment/#comments Wed, 02 Jan 2013 23:51:34 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1076

President Obama campaigned on the promise that in his second term he would bring leadership to our polarized nation.


The President’s first term was, in part, stymied by a polarized Congress. At the same time, many astute observers contended that the President lacked the grit to fight for the values he espoused and the policies he promised in his campaign.


In the moments before the Senate opens it’s new session on January 3, President Obama will have a once-in-two-years moment to show that he has every intention of taking a far tougher, far less conciliatory attitude with the new 113th Congress.


When the gavel drops on January 3 to end the 112th session of Congress in the Senate, Obama will have — as far as I understand existing precedent — a rare opportunity to make recess appointments. Right now, one analysis of the White House Web site shows 170 nominations pending before the Senate. Under the recess appointment power provided by the Constitution to the President he could, if he chose, install all of these individuals in office for the next two years.


There are a variety of interpretations of the reason for the recess appointment power of the President. My analysis is that the overarching purpose of the provision is to ensure that the govern can function by allowing the President to fill open positions where the Senate has failed to act.


In addition to ensuring that his Administration can function, and that much needed members of the Judiciary are added to the Bench, a sweeping set of appointments by the President would have extraordinary symbolic value.


According to the Congressional Research Service, President Bill Clinton made 139 recess appointments. President George W. Bush made 171 recess appointments, and as of January 5, 2012, President Barack Obama had made 32 recess appointments. In essence, Obama has used this power far less than his predecessors from both sides of the aisle. By demonstrating that he now intends to use the full powers of his Office, President Obama would send an important message to the Congress and citizenry. He would demonstrate the he intends to lead–with all of the powers at his disposal.


Teddy Roosevelt provides the historical precedent for such appointments. As noted by The Washington Post,

“At high noon on Dec. 7 1903,” Senate associate historian Betty K. Koed has written, the Senate president pro tem brought down the gavel to end one session of the Senate and then said “the Senate will now come to order.”


“In that moment between sessions,” Koed wrote, “during that split-second of time it took . . . to wield the gavel, President Theodore Roosevelt made 193 recess appointments.”


“There was but one fall of the gavel,” a newspaper reported, “but one stroke, but one sound.” Even senators in the chamber didn’t know there’d been a recess or, as Roosevelt most creatively put it, a “constructive recess.”


The Washington Post also notes that at the time there was considerable controversy over TR’s actions, and the amibiguity remains to this day:

Senators of both parties were furious and launched an investigation into what, under the Constitution, constitutes a recess.


We’re told the answer remains most ambiguous to this day. The more recent consensus is that, to be in recess, the Senate is gone for more than three days. But that’s only based on a 1993 Justice Department analysis in a lawsuit — not a law or Supreme Court ruling.


TR’s appointments were never invalidated, and that is, in effect, a far more powerful historical precedent than any Justice Department Opinion.


Some of our most distinguished public servants initially assumed office through recess appointments. They include Supreme Court Justice Earl Warren, Justices Brennan and Potter Stewart (all of whom were installed through Eisenhower recess appointments).


In the diplomatic arena, Eisenhower appointed Charles W. Yost, as Amabassador to Syria through a recess appointment. Yost would later serve as US Ambassador to the United Nations. While President George H . W. Bush, appointed Laurence Eagleburger Secretary of State in a 1992 recess appointment. In 1995, President Bush similarly used his recess appointment power to name John Bolton U.S. Ambassador to the United Nations.


Moreover, the real and symbolic value of such a bold gesture is high. A central message of the now-popular movie Lincoln is that in turbulent times President’s realize notable achievements both by adhering to a clear vision and by using every power the Constitution bestows upon them.


A great deal has been written about the need for leadership in Washington. President Obama now has a rare chance to demonstrate to Congress and the nation that he intends to be a far stronger leader in pursuit of his goals–using all of the power at his disposal. Few leaders ever have such a chance to reboot the perceptions held by Congress or the people of how they approach their task. This opportunity will not come again. Let’s hope it is not lost.

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Romney’s Ryan Timing: A Taxing Matter? http://itcouldhappenhere.com/blog/romneys-ryan-timing-a-taxing-matter/ http://itcouldhappenhere.com/blog/romneys-ryan-timing-a-taxing-matter/#comments Fri, 17 Aug 2012 11:40:20 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1071 Ann Romney, presumably acting as a surrogate for Mitt, is now announcing that no additional tax returns will be released to the public before the election.

As friends and foes have dissected the Ryan choice, one question has received little serious attention: Why did Mitt Romney destroy any excitement associated with the convention by announcing his choice of Paul Ryan early? What motivated this decision?

Here’s one explanation: The timing of Ryan’s pick was an effort to deflect increased attention on Romney’s tax payments, or lack thereof, before he becomes the official Republican nominee.

Several weeks ago, I wrote in “My $10,000 Bet” that Romney would not release any additional information on his tax returns before he becomes the official nominee. As a result, no matter what the tax returns include, Republicans will be forced to support Romney. If necessary, they will defend the indefensible.

Over the past few weeks, the stakes related to Romney’s lack of disclosure have heightened tremendously. Senate Majority Leader Harry Reid asserted that Romney has effectively paid no taxes over the past ten years; and leading private equity magnates have been unable to explain with any certainty how Romney could lawfully build his “magical IRA”, to a value of $21 million to $102 million. Finally, Romney has flatly stated that he has paid taxes, with at least a 13% tax rate each year, over the past ten years, while providing no proof of any kind.

With regard to tax disclosures, Romney has recognized that the best defense is a good offense.

First, rather than prove Reid was wrong, Romney responded by questioning the name of Reid’s source at Bain Capital, with the aggressive phrase “It’s time for Harry to put up or shut up.” Let’s be clear about one thing: Romney’s response to Reid was meaningless. It was a question designed to deflect the central issue. The real question is whether Romney did indeed pay taxes.

Unfortunately, the press and pundits fell victim to Romney’s punching defense, rather than maintaining their focus on the real issue. The New York Times said the “cantankerous” Reid “hurl[ed] a taunting, unsubstantiated accusation” , and Mark Halperin wrote in Time magazine that these were “charges so reckless, they recalled Joe McCarthy and the birthers.” How does Halperin know if Reid is right or wrong? The only people that know the truth have done everything possible to avoid addressing it.

At this point, Romney’s double offensive: Build a focus on other issues by naming Ryan, and declare his own version of his tax record could put Democrats and advocates of disclosure on the defensive. He has skillfully maneuvered them into asking for disclosure because they don’t trust him. In effect, he is forcing his opponents to risk calling him a liar.

Moreover, if Romney has in fact paid taxes at a 13% or higher rate, and does release his earlier returns, the means he used to build his “magical IRA” and overall wealth however questionable, will be drowned out by the chorus of Republicans repeatedly saying “He told the truth… His tax rate was above 13%…Harry Reid never had a valid source.”

Nonetheless, the Republican party and the American people do have a right to know whether the potential Republican party nominee is, in fact, a liar, or has engaged in questionable financial dealings. Romney’s unverified statements about his taxes, his seemingly unexplainable accumulation of wealth in his IRA, the continuing suspicion that he is hiding something, and the placement of large portions of his wealth in notorious tax havens outside the jurisdiction of the United States (hardly a patriotic act) all create questions about the candidate’s ethics that transcend the minimum disclosure required by law.

How can Americans possibly elect a President who has not dispelled the lingering suspicion that he may be a liar, may be hiding some highly questionable financial activities or may even be a crook?

Here are four lessons from U.S. history and Romney’s personal history that show why Romney must release his tax returns.

First, it’s widely known that Mitt’s father, George Romney, released 12 years of tax returns prior to his Presidential bid. What is not widely repeated is his rationale. To write a biography of George Romney (Mitt’s Dad) published in 1967, George Harris, a senior editor for Look magazine, took a five month leave of absence, When the biography, Romney’s Way: A Man and an Idea, was released, Harris wrote an article on his interactions with George Romney for Look magazine, dated December 12, 1967.

2012-08-16-Look.jpg

In the article, Harris writes:

“He balked when I badgered him for a copy of his latest Form 1040, the Federal Individual Income Tax Return. Release of the document, while it might serve a political purpose, would not prove very much, he argued. One year could be a fluke, perhaps done for show, and what mattered in personal finance was how a man conducted himself over the long haul.

Stumped by this argument, I was not prepared for the move that it eventually led him to make: He ordered up all the Form 1040’s that he and Mrs. Romney had filed over the past twelve years–including those profitable ones when he saved American Motors Corporation from bankruptcy and became a millionaire on the company’s stock options.”

In the published biography, Harris also writes that in examining the tax returns:

“Auditors notice two unusual facts in these returns. First, the Romney’s have never made much use of tax loopholes, such as depletion allowances, that are taken for granted by most people who reach their bracket. Second, over the 12-year period, they have donated an average of 19 percent of each year’s adjusted gross income to their church.”

In the August 9th issue of Business Week, Romney asserts that he will be a successful president, because he is a successful executive who learned about leadership from his father. He says, in part,

“Well, I had the privilege of growing up in a home with a Dad that was a leader…So I learned something about leadership from a man who was an extraordinary leader.”

Unfortunately, it’s clear that Mitt missed one central leadership lesson from his Dad: The need to build the trust of his constituents. As Mitt’s Dad noted, tax returns over a short period can be manipulated. By failing to provide verification of any kind, Mitt is failing to create trust among the electorate that he will ultimately need to govern, if he is elected.

Dad also believed that a man’s past financial history, and what it showed about his character, were important indicators of how he would perform as President. Here, the American people have no idea how Mitt stacks up. However, Mitt’s extensive use of tax shelters and off-shore tax havens, in direct contrast to the way his father, George Romney, conducted his affairs, is not a positive sign.

Second, Romney has repeatedly expressed his admiration for Teddy Roosevelt, saying in one interview, “I love Teddy Roosevelt. I read everything I can get my hands on about Teddy Roosevelt.” Romney must have glossed over the many histories that discuss TR’s belief that leadership without a commitment to moral purpose was meaningless and, in fact, dangerous. In one well known statement in 1901 Theodore Roosevelt declared:

“If courage and strength and intellect are unaccompanied by the moral purpose, the moral sense, they become merely forms of expression for unscrupulous force and unscrupulous cunning. If the strong man has not in him the lift toward lofty things his strength makes him only a curse to himself and to his neighbor. All this is true in private life, and it is no less true in public life.”

There is no doubt that Theodore Roosevelt would assert that merely adhering to the requirements of the law, while failing to serve as a moral example, is well below the essential activities for a positive public leader. Indeed, a good test of whether someone has acted as a moral example is this: Does the nation benefit if every man, woman and child follows the leader’s example. Hence, we must assume that as President Romney would, echoing Theodore Roosevelt’s most famous phrase, be “delighted!” if every American placed their funds in the Cayman Islands and Switzerland.

Leadership, as recognized by Theodore Roosevelt, is not satisfying the minimum required by law. It is going above and beyond the requirements to provide a worthy example to others and to benefit the community. George Romney recognized the need for such moral vision in our leaders, Mitt Romney does not.

Third, it is doubtful, but not impossible, that Mitt Romney’s tax returns contain a campaign-ending, untenable secret. We all remember that President Nixon famously declared “I am not a crook.” Until I viewed the clip below, I had forgotten that as part of this statement Nixon also said, “I welcome this kind of examination, because people have got to know whether or not their President is a crook.” Yes Mitt, Americans “have got to know” that the Republican Presidential nominee, and possible next President, has complied with the laws of the land.

Finally, former president Reagan, perhaps the most admired icon of today’s Republicans, may have made the most compelling argument for disclosure. In matters of importance, he proclaimed “trust but verify.”

Mitt, it’s time for you to put up or shut up.

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The Romney Stall: My $10,000 Bet http://itcouldhappenhere.com/blog/the-romney-stall-my-10000-bet/ http://itcouldhappenhere.com/blog/the-romney-stall-my-10000-bet/#comments Sun, 22 Jul 2012 18:39:46 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1066 Here’s a $10,000 bet: Mitt Romney will stall and stall before opening his tax returns. His strategy is to open the returns after he is officially nominated at the Republican National Convention in August.

Earlier in my career, I negotiated large, complex contracts. The first rule of every negotiator is to have a strategy. One effective strategy is to put off addressing the most difficult issues until the end of all other discussions. Then, after all of the deal participants have spent untold hours on other details, are tired, and can envision a successful outcome, it’s far easier to tackle the hardest issues. At this point, everyone wants to be done so badly that inevitably some compromise is reached.

Mitt Romney is now pursuing precisely this type of negotiating strategy with the Republican Party. Unfortunately, the Republican Party is either unable or unwilling to recognize what’s happening.

There seems to be little doubt that Romney is hiding something. Indeed, even a critical piece of his 2010 returns has still not been opened to public view. The only questions is what Romney is hiding. Speculation has ranged from questionable practices related to his “magical IRA” with the seemingly impossible value between $21 million and $102 million, to the creation of a “blocker corporation” which would have lawfully enabled tax avoidance (effectively invalidating Romney’s claim that his foreign holding had no impact on his U.S. taxes), to the possibility that he paid no federal taxes in 2009 because of large capital losses (a legal but politically deadly possibility).

In effect, there are now two potential realities. The first is that Romney’s off-shore activities don’t reveal any outright illegality but show a host of questionable or politically unpalatable practices. My money’s on this one.

In this case, Romney’s strategy is to force Republicans, willingly or not, to line up and uniformly defend whatever his tax returns ultimately demonstrate. Indeed, once Romney is the nominee the Republican Party potentially will face a Hobbesian choice: Either vigorously defend practices which would otherwise be indefensible (and characterize them as good and virtuous) or somehow remove Romney from the ticket, which would almost certainly hand the election to Obama. Once Romney is the official nominee, it would be a disaster for the Republicans if he were forced off the ticket. Romney is calculating that Republicans will join ranks and vigorously defend whatever indefensible behavior he is now hiding.

The tactical (but destructive),  potential brilliance of this strategy is already apparent. An article in The Hill recently noted that Republican Speaker of the House John Boehner “jumped to the podium” at a news conference to say:

“Listen, listen, Americans are asking, where are the jobs? They’re not asking where in the hell the tax returns are.” he said. “This is another sideshow intended to draw the American people’s attention away from the real issue, and the real issue is that the president’s economic policies have failed. They’ve actually made things worse. And as a result, he can’t run on his record. He’s got to run on something else. And so, whether it’s the tax returns, whether it’s Bain Capital, you’ll see every distraction known to man because the president can’t run on his record.”

Does anyone believe Speaker Boehner would take this position is he were a Democrat?

The second possibility is even more troubling. One doubtful, but possible, explanation is that Romney is part of the super-confidential IRS amnesty program for tax evaders with Swiss bank accounts who came forward voluntarily to pay limited penalties. This is only plausible if, as has also been reported, Romney never intended to release his returns. Otherwise the American people would hear the faint echoes of Richard Nixon’s famous statement, “I am not a crook.”

In either case, Romney’s lack of transparency is a betrayal to America and to the two-party system. The American system depends on trust. Our success as a nation requires that we trust our leaders, our institutions and one another. Romney’s behavior is further destroying this trust and corroding our democracy.

It is a truism in American politics that Presidential candidates effectively give up all rights to their privacy. The American people have come to expect that otherwise personal records, including health and finances, will be available to them as they decide on who should be the leader of the free world. Romney’s finances are one indicator of his character and how he regards his responsibilities to the nation. I strongly suspect that the vast majority of voters who supported Romney in the primaries assumed that he would demonstrate he was worthy of their trust with an appropriate opening of his records. Now, he is betraying this faith.

At this moment, we need leaders who are working to rebuild the vital trust we have lost over the past decade. Yes, it’s the economy stupid. But, more jobs and any economic recovery will inevitably require compromises. In the absence of trust, these will never be achieved, either in the court of public opinion or in our system of governance.

Historically, Americans have been characterized by their unbounded optimism, which was seen as a central aspect of our success as a nation. Now, we face a growing cynicism and mistrust throughout the society. By failing to open his returns now, Romney adds to the cynical and mistrustful character of the nation. These are the opposite of what made America a great nation, or will restore our economic and societal prosperity.

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What A Bank Is Supposed To Do? http://itcouldhappenhere.com/blog/bank/ http://itcouldhappenhere.com/blog/bank/#comments Wed, 27 Jun 2012 17:10:14 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1056 Banks in a capitalist society are meant to create wealth and decrease risk. JPMorgan and its kind do the opposite.

As reports of JPMorgan Chase’s potential losses on the trading debacle reach $9 billion, it’s critical that our nation understand what activities do, and do not, represent acceptable behavior for a bank in our capitalist economy.

In his testimony before a congressional panel on the recent Swiss trading debacle, Jamie Dimon, CEO of JPMorgan Chase, said, “We’re doing what a bank is supposed to do.”

Was Dimon correct? In a capitalist economy, was Chase doing “what a bank is supposed to do”?

The answer is assuredly no. A bank is not supposed to do what JPMorgan Chase and its fellow too-big-to-fail compatriots do every day. They are practicing something other than actual capitalism. As this column has consistently stated, capitalism is not a vague idea. It is an economic system with  well-defined principles designed to create wealth for society. These principles have powered the creation of wealth in America since the nation’s founding and empowered our country with an extraordinary resilience.

But importantly, wealth does not mean profits. Wealth is anything that can be experienced or physically used. Profits are an accounting proxy for the wealth that an entity generates. Like most proxies, the idea of profits as a measure of the wealth created for society may often be a good indicator, but as I have written previously, this proxy has failed spectacularly in the financial sector. The profits generated by today’s financial institutions bear little resemblance to the (lack of) wealth they have created for our society.

Capitalism also means there is no such thing as a “free market.” All markets require rules in order to operate fairly. The word “regulation” is really just another term for the rules that govern how participants in a market must behave. Indeed, one modern example of a free market economy may have been the period of economic chaos in Russia that followed the collapse of the Soviet Union, when the absence of rules led in part to devastating results.

Now let’s turn to the purpose of banks in a capitalist economy. Finance is an intermediary good: You cannot eat it, experience it, or physically use it. The purpose of finance is to support other activities in the economy. Banks are meant to allocate capital (funds) to the best possible use. In a capitalist economy, this means allocating money to the people or entities that will create the greatest wealth for the overall society. At the same time, risk management is supposedly a primary skill for bankers. When capital is allocated well and available to wealth creating entities, societies flourish. When capital is poorly allocated, economies can collapse.

Speaking broadly, banks allocate capital in two ways: through loans and by facilitating investments. Indeed, as we read breathless news reports on the first-day performance of IPOs, it’s easy to forget that the central purpose of an initial public offering (IPO) is to channel investment money into an enterprise that will hopefully create wealth for our entire society.

In light of today’s overly complex, overly concentrated, and overly influential financial sector, the above description may seem far too simplistic. But it’s not. In Judaism, there is a well-known story of the famous Rabbi Hillel describing the essence of Judaism in a simple statement, and then saying “the rest is commentary.” The same holds true in today’s financial sector. All of finance is meant to allocate capital to the best use, the rest is commentary.

Since capitalism is a system designed to create wealth for society, gambling is antithetical not for moral reasons but because no wealth is created. Gambling is a zero-sum game. In a heads I win, tails you lose transaction, it’s impossible to create wealth.

Now, let’s return to Jamie Dimon’s statement before Congress and reframe it. Was Chase “doing what banks are supposed to do”?

First, as numerous commentators have pointed out, Chase was trading to increase its profits. This type of trading is simply gambling by another name. The outcome has no impact on the larger wealth of our society. It had nothing to do with the purpose of banks in the economy. At the same time, many of the so-called brilliant financial innovations of the recent era are, in themselves, nothing more than hidden forms ofgambling.

Second, Chase was increasing rather than decreasing the risk associated with its banking functions. It has become blindingly obvious that in trading and creating complex financial instruments (also called weapons of mass destruction) our Masters of the Universe never fully understand the risks they are creating for their own institutions or our larger society.

Mr. Dimon’s idea of what banks are supposed to do does not exist within the principles that makes a capitalist economy function.

I do, however, have one question for him. I strongly suspect he would argue that the purpose of management decisions is to increase shareholder value. In 2011, the value of JPMorgan Chase’s stock price decreased by 20 percent, yet he was paid $23 million. Is this also what a bank is supposed to do?

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The Coming Train Wreck http://itcouldhappenhere.com/blog/the-coming-train-wreck/ http://itcouldhappenhere.com/blog/the-coming-train-wreck/#comments Mon, 18 Jun 2012 01:49:26 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1050 The U.S. housing market and any economic recovery are confronting a brick wall, and no one is discussing it. Like a speeding train, the housing market and our economy are heading over a cliff with no bridge. Yet, no one in Washington wants to discuss this very real and approaching danger.

Recently, Salon ran an article on the conflicting, confusing, and ineffective nature of housing policy to date. The article traced the conflicting narratives and debate associated with principal reduction and the Obama Administration’s efforts in this arena.

Andrew Leonard, the author of the article, interviewed me as he was trying to sort out the different issues, and the article correctly states, that I believe there is a “night-mare scenario” in which Congress fails to extend essential legislation before it expires at the end of this year. If Congress does not act, we will almost inevitably see a further collapse in the housing market, with a ripple effect that has the potential to destroy vital consumer confidence, stop any economic recovery, or even cause an economic catastrophe.

There’s even a nightmare scenario in which the entire fight over principal reduction becomes, in Judson’s words, “irrelevant.”

Here’s why:

That’s because, says Judson, tax law historically treats principal reduction as income to the homeowner who gets it. In other words, if you have a $300,000 mortgage on a house that is now only worth $200,000, and your bank gives you a $100,000 break to bring the mortgage and the home value in line with each other, the IRS will consider that $100,000 break taxable income.

Congress recognized this obvious insanity in 2007 and passed a provision that gave homeowners a waiver from that liability, but the waiver will expire on Jan. 1. Not only would the change in tax law mean that getting a principal reduction would make no sense for a beleaguered homeowner, but it would also destroy the market for “short sales” — in which banks allow homeowners to get out of their mortgage by selling their property for less than the mortgage is worth. Judson believes some 30 percent of home sales are currently short sales. Knock the legs out of that market, and you’re asking for serious trouble.

“If we hit a train-wreck on Jan. 1,” says Judson, “it will take the housing market and any economic recovery down with it.”

At present there seems to be almost no discussion of extending the income tax exclusion, either emanating from the Executive Branch of from Congress.

Let’s look the current housing market. In January of 2012, short sales comprised 24% of all home sales, as compared to 20% for bank foreclosure sales. Moreover, there’s a seemingly uniform belief that the number of short sales as a percentage of total home sales has been rising since January, and will continue to rise. So, any housing recovery or price stabilization we are witnessing reflects, in large measure, the rise of short sales. My best estimate is that right now short sales do, in fact, represent about 30% of all home sales.

How many of the recent short sales would have taken take place if the homeowner selling were then forced to pay income tax on the debt forgiven? To my knowledge, no one has analyzed the size of the tax debts that would be incurred. But, here’s my hypothesis: In this era of high unemployment, little if any wage growth, and a reduction in the median American family’s net worth to 1992 levels, the answer is not a lot.

Reportedly, Republicans believe that extending the tax exclusion will cost the government $2.7 billion, and oppose it, in large part, based on this estimated cost. This makes no sense.
First, no one has ever released the source for this estimate. It is almost certainly based on an assumption that short sales continue after the exemption is removed, and the government collects the income tax. As discussed below, this reasoning is nothing short of ridiculous.

Second, our nation has spent hundreds of billions of dollars to prevent a collapse of the economy. The idea that we will put at risk the health of the entire housing market, and its spill-over effects on consumer confidence and the economic recovery, to save $2.7 billion is ludicrous.

Does any rational person believe that homeowners who need principal reduction in order to maintain their mortgages will be able to afford the income tax on an additional $100,000 (if that’s the amount forgiven)? Instead, it seems likely these homeowners will do everything possible to tough it out, and start to refuse principal reductions offered by the government or the banks. Suffering American homeowners will be in the impossible situation of refusing assistance because of the short term cost (i.e. the income tax imposed) on this assistance: The one situation every American wants to avoid is a large, unpaid bill from the IRS.

Any housing recovery is almost unquestionably dependent on the continued growth of short sales. If Congress fails to act, short sales will almost certainly return to an anemic level. We are playing fire, and the chances of serious burns are not slim.

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Let’s Risk Destroying The Housing Market and Any Economic Recovery! http://itcouldhappenhere.com/blog/lets-risk/ http://itcouldhappenhere.com/blog/lets-risk/#comments Sun, 06 May 2012 20:29:18 +0000 Bruce Judson http://itcouldhappenhere.com/blog/lets-risk/ The extraordinary risk to the housing market and the economy no one seems to be discussing.

The economic crisis began with the housing crisis, and it will only end when the housing crisis also ends. Unfortunately, the evidence of the past five years suggests that the Obama administration and Congress have never actually understood this connection. Despite massive numbers of foreclosures, the loss of almost $7 trillion in housing wealth (over one-half the nation’s home equity), and even unprecedented pleas from the Chairman of the Federal Reserve, there has been a shocking paucity of innovation or even policy activity in the housing arena.

Now there is a a very real chance that Congress will destroy the limited policies the Obama administration does have in place, prevent additional efforts, and further widen the gap between the haves and have-nots in America. Moreover, the net effect of this congressional failure could be to further undermine the weak housing market and risk sending the nation into another economic tailspin.

The administration’s signature housing policy effort is now aimed at mortgage principal reductions. This effort is at the core of the multi-state robo-mortgage settlement and central to the administration’s criticism of Edward DeMarco, the acting director of the Federal Housing Finance Agency. From the perspective of many analysts, myself included, the administration is finally on the right track, but its efforts are far too minimal to make a meaningful difference. Indeed, the nation’s total negative equity (the amount of mortgage debt owed which exceeds the value of the underlying properties) is presently in the range of $700 billion, and it’s likely to increase.

Nonetheless, the administration’s principal reduction efforts are a step in the right direction. These efforts open the door for the far larger, far more creative efforts that will ultimately be needed to prevent millions of upcoming foreclosures and possibly massive walk-aways from the estimated 23 percent (and increasing) of all mortgage holders — 11 million families — who are underwater.

Here’s the issue: As a general rule, any debt forgiveness is income. This means that if a home buyer borrows to buy a house and the bank forgives a portion of the loan, whether in a short sale, through debt reduction (i.e. the settlement), or even foreclosure in states that allow banks to officially choose not to seek recourse, a taxable event has occurred. The income earned is the difference between the original mortgage borrowed and the amount ultimately repaid to the bank.

For example: A family borrows $300,000 for a mortgage. The home declines in value and the bank agrees to a short sale (where the sale price is for less than the amount of the homeowner’s mortgage debt) and receives a total pay-off of $200,000. The $100,000 difference between the amount borrowed and the amount ultimately paid back is the amount of the loan the bank has forgiven. This $100,000 is a type of principal reduction and generally subject to ordinary income taxes.

However, at the start of the housing crisis in 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act of 2007, which exempts precisely this phantom income from federal taxation. The term of the law was extended in 2008. But the current law expires at the end of 2012, and it is by no means clear that it will be extended. Moreover, the seeming lack of public discussion about the need to extend it is shocking.

(There are a complex array of qualifying circumstances and exemptions surrounding this tax issue, including the laws of the individual state involved, the solvency of the homeowner, whether the homeowner is in bankruptcy, whether the sale involves a primary residence, refinancing associated with the property, and a variety of other factors related to qualifying for the federal exemption. In particular, short sales in nonrecourse states (which include California) are not considered debt forgiven and therefore, if no other income-generating activities apply, do not trigger federal taxes. But this post does not address the many nuances involved in these issues.)

It’s virtually impossible to imagine that struggling families who are selling underwater homes at a large loss (and have already lost a large chunk of their life savings as the value of their home equity, including their down-payment, was vaporized in the housing crisis) will go forward with short sales. The vast majority of homeowners will not be able to afford the resulting tax debt. So one consequence of a failure to extend this law is likely to be an immediate end to the vast majority of short sales, which have been increasing rapidly. Short sales constituted an estimated 24 percent of all January 2012 home sales and surpassed the estimated 20 percent of all January sales comprised of foreclosed homes.

For the same reasons, all efforts at principal reduction will be stopped cold at the end of this year. Homeowners who are struggling to meet their monthly obligations are unlikely to be able to accept sizeable principle reductions that will create large income tax obligations that they can’t afford. This means Obama’s debt principal reduction initiative will never get off the ground.

Congressional opponents of renewing this legislation estimate that the cost of extending the exemption at $2.7 Billion, a large enough cost to lead them to oppose the measure. Members of Congress may also oppose extending the exemption as an unfair benefit to individuals whom they deem irresponsible, which is subsidized by taxpayers who did the right thing and paid off their mortgages. Finally, in this election year, it’s easy to imagine that legislation of all kinds could grow hostage to partisan gridlock.

The source of this cost Congressional cost estimate is unknown. But, it is almost certainly wrong.  It appears to assume that without this exemption short sales will continue to dominate the fragile housing market, thereby generating new income tax revenues. In fact, the best conclusion is that, if the exemption disappears, so will short sales and any accompanying tax revenues. The real cost of failing to extend this exemption is the unacceptable risks it poses to any housing recovery and the economy at large. The idea that tax revenues will be lost is a fiction.

Moreover, arguments related to individual responsibility are disingenuous. Over the past several years financial executives have avoided accountability for their actions. Indeed, there have been no substantive congressional hearings on massive law-breaking by financial executives, such as the congressionally sponsored Pecora Hearings in the era of the New Deal.

I would suggest that these disingenuous arguments by some members of congress are a further indicator of the consequences of extreme inequality afflicting the nation. They demonstrate an unacceptable double-standard: One set of laws and permissive irresponsibility for those at the top of the society, and one set of rules for everyone else. They also vividly demonstrate a natural consequence of extreme inequality: Societies grow harsher. As inequality increases, those at the top lose empathy for the less fortunate, including the formerly middle class. As a result, the elites lose their view of the nation as one community, and rationalize actions of all types that they would find abhorrent if the shoe were on the other foot.

Congressional opponents of renewing this legislation are assuming a lack of potentially severe consequences. It’s impossible to predict what might happen, but the downside risks are unquestionably high. It raises the real risk of directly leading housing prices to decline further or even plummet for a variety of reasons. Efforts at principal reduction could come to a stop as the public loses confidence in a housing recovery, the end of short sales could have a strong negative impact on the housing market, or underwater homeowners fearing tax consequences could decide to walk away from their homes, leading to a massive increase in the inventory of newly empty homes that banks must ultimately resell.

None of this may happen, but the risks are real and unacceptable. A substantial drop in housing prices will almost certainly harm or destroy the already tepid pace of our economic recovery. Congress and the Obama administration are playing with fire. Sometimes those who do so remain unscathed, but sometimes they get burned.

Congressional inaction also fails the pro-capitalism test. As an economic system, capitalism is intended to build the overall wealth of a society. To properly function, capitalism requires an equal playing field, absolute accountability for business decisions, and rules ensuring that markets function fairly. As I have repeatedly argued, the many failures of lawmakers and administration officials to hold the financial services sector to a capitalist model has created a financial sector that is anti-capitalist and wealth-destroying. The current predicament of homeowners who might rely on this lifeline is a direct result of this failure. To now penalize the weakest link in the chain is a further demonstration that we have created an economic system that is not fair capitalism, where everyone lives up to their responsibilities and is accountable for their actions.

Capitalism only works when the citizenry believes it leads to fair outcomes. Our nation has already reached dangerous levels of anger. The lack of trust in our institutions is pervasive, and Americans who have always been regarded as optimists have turned cynical and lost hope. By taxing struggling families on phantom income, Congress will reinforce the belief that our economy is blatantly unfair and further wear away the remaining thread of our painfully frayed social fabric.

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A Seven Day Plan to Finally Hold Wall Street Accountable http://itcouldhappenhere.com/blog/seven-day-plan/ http://itcouldhappenhere.com/blog/seven-day-plan/#comments Mon, 19 Mar 2012 20:52:43 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1036 New evidence points to illegal behavior. Prosecution is the only way to keep that behavior from continuing.

It’s now a near certainty that Wall Street executives committed felonies.

The recently released audits of robo-mortgage activities by the Office of the Inspector General of the Department of Housing and Urban Development (HUD) details shocking behavior at the five banks constituting the Federal Housing Administration’s largest mortgage servicers. At Wells Fargo, management quashed a midlevel manager’s study of the foreclosure process as negative results began to emerge, and it gave an individual whose last job had been in a pizza restaurant the title of “vice-president of loan documentation” to facilitate robo-mortgage signing. Bank of America evaluated employees on the volume of foreclosure affidavits produced. JP Morgan Chase gave individuals titles such as “vice-president of Chase Home” where “the titles were given by Chase for the sole purpose of allowing individuals to sign documents and came with no other duties or authority.” Citigroup and Ally similarly engaged in seemingly illegal practices.

Under federal law, the knowing filing of a false affidavit with the court is a felony offense of perjury, punishable by a prison term of up to five years. An individualviolates laws against perjury whether he or she personally appears in court and swears to a false statement or provides the court with a false affidavit. Individual states have their own perjury laws, which were undoubtedly violated as well. The HUD report also suggests that individual banks may be guilty of obstruction of justiceand the criminal violation of the False Claims Act for filing insurance claims without following HUD requirements.

Since the start of the financial crisis, federal and state officials have been struggling to change Wall Street behavior. To date, every effort has failed miserably, and theweak enforcement provisions of the robo-mortgage settlement are unlikely to meaningfully change this dynamic. Government officials have also relied, with a very few exceptions, entirely on civil enforcement when criminal laws appear to have been egregiously violated.

The greatest moral hazard now confronting the nation is what appears to be increasingly brazen criminal activity by financial industry executives. With each decision not to prosecute, Wall Street executives justifiably conclude that they are immune to the rules. As a result, it appears that Wall Street criminal activity is increasing in frequency and severity, as opposed to the reverse. The activities surrounding the collapse of MF Global are one example.

So what can be done about it? We can change the behavior in the financial service industry for a full generation in just seven days. This plan may seem to be tongue and cheek, but it hearkens back to a similar action in the era of the Great Depression. In the final months of Herbert Hoover’s presidency, the Senate Banking Committee began an investigation into the causes of the Great Crash of 1929, and a young prosecutor named Ferdinand Pecora was appointed as Chief Counsel. Subsequently, the Roosevelt administration conveyed to Pecora that “the prosecution of an outstanding violator of the banking law would be the most salutary action that could be taken at this time. The feeling is that if the people become convinced that the big violators are to be punished, it will be helpful in restoring confidence.” Ultimately, this investigation, which came to be known as the Pecora Commission, led to the indictment of one of America’s most prominent financiers; demonstrated widespread self-dealing in the financial sector; and, as noted by historian Alan Brinkley, generated “broad popular support” for Roosevelt’s reform agenda, including the creation of the SEC and the Glass-Steagall Act.

Buy a copy of The Unfinished Revolution: Voices from the Global Fight for Women’s Rights, featuring a chapter by Roosevelt Institute Senior Fellow Ellen Chesler.

My seven day plan is based on a simple premise: When criminal laws are egregiously violated, the guilty parties should face appropriate punishment. Here’s the plan:

Day One: Read the HUD Inspector General’s reports and the public records of past mortgage foreclosure cases from across the nation.

Day Two: Meet with the team at the Office of the Inspector General at HUD that prepared the audits. Obtain the names of all the bank officials, lawyers, and notaries whose behavior, as cited in the audit reports or otherwise known to the investigators, represent clear and unquestionable criminal violations. Add to this list other individuals who have similarly demonstrated or testified to behavior unquestionably constituting criminal acts, as indicated by the public records of the mortgage foreclosure cases reviewed in day one.

Day Three: Indict all of the individuals on the list compiled on day two.

Day Four: Indict banks and financial institutions on criminal charges where criminal behavior by employees (as demonstrated by day three indictments) appears to be endemic. The Justice Department guidelines for prosecuting firms include: (1) the pervasiveness of such activity, (2) the compliance procedures in place, (3) attempts by the corporation to end bad behavior, and (4) cooperation with federal investigators. In 2008, the Justice Department adopted a policy of accepting “deferred prosecutions,” involving agreements to change corporate behavior without damaging innocent third parties through prosecution.

Corporations receive the benefits of “legal persons,” as demonstrated by Citizens United. But they must also bear the responsibilities of these privileges. A reading of the HUD reports, and other public records, suggests several banks should clearly be prosecuted.

Day 5: Discuss plea bargains with indicted lower-level officials in return for cooperating in investigations of higher-level officials.

Day 6: Consider plea bargains with indicted banks, which require the removal of all remaining officers and directors who were serving when egregious criminal activity occurred, as well as senior officials who were in a position to exercise appropriate supervisory responsibility but chose to look the other way.

Day 7: Indict any senior Wall Street officials implicated by new cooperative testimony resulting from activities on day five. Adopt and announce a policy that future criminal violations will be prosecuted in a similar fashion.

What is particularly disturbing is that a look at the evidence already in the public domain (much less what investigators already know) shows that none of the actions discussed above are entirely absurd. The purpose of prosecution not simply punishment. It acts to deter further illegal activity and to restore public confidence in our system of governance. The nation desperately needs both of these benefits today.

Moreover, these ongoing, almost certainly criminal activities are ultimately dangerous threats to our economy, the success of capitalism, and our democracy. In his column New York Times column on the collapse of MF Global, Joe Nocera noted that “customers need to be able to trust” the laws protecting their money. “Otherwise, the markets can’t function.”

Today, as in the era of FDR, we must send a message to the financial community that illegal behavior will not be tolerated. By prosecuting blatant felonies now, we will deter future misbehavior and begin the process of recreating a fair society where equal justice prevails.

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Why Inequality Matters: The Housing Crisis, The Justice System & Capitalism http://itcouldhappenhere.com/blog/inequality-and-capitalism/ http://itcouldhappenhere.com/blog/inequality-and-capitalism/#comments Mon, 20 Feb 2012 20:53:16 +0000 Bruce Judson http://itcouldhappenhere.com/blog/why-inequality-matters-the-housing-crisis-the-justice-system-capitalism/

Extreme economic inequality is among the most destructive forces in a society. As inequality grows, it undermines the effective functioning of the economy, the basic tenets of capitalism, and the foundations of democracy.

Unfortunately, the housing crisis and now the housing settlement increasingly look like an example of how this mechanism works.

One of the central characteristics of highly unequal societies is that two sets of laws develop: One set for the rich and powerful and one set for everyone else. The more unequal societies become, the more easily they accept the unacceptable, and with each unrebuked violation, the powerful actors at the top of the society gain an ever greater sense of entitlement and an ever greater sense that the laws that govern everyone else don’t apply to them. As a result, their behavior becomes increasingly egregious.

In contrast, sustainable capitalism requires that all participants in a contract or bargain believe their interests will be enforced equally by the courts: Capitalism requires that Lady Justice wear a blindfold. When powerful players are permitted to alter established rules at will, capitalism ultimately collapses. Contracts and the idea of a fair bargain become meaningless as less powerful parties to an agreement know their rights will not be enforced. Over time, citizens lose faith in government and their own ability to thrive in what becomes a corrupt economy. This uncertainty leads the small businesses, which are so often cited as important to our economy, to shy away from new activities that might put them at the risk of unequal treatment.

I would suggest that the robo-mortgage scandal is a strong indicator that this type of unequal justice is now becoming ever more commonplace in America. Past bank abuses are typically discussed without a sense of outrage. They have, in effect, become a recognized practice of deception with no consequences. Here are three prominent examples from the past few years:

First, the robo-mortgage scandal was discovered. As powerful members of society, the banks effectively decided what laws they wanted to follow and disregarded others. The banks claimed that their violations were technical and harmed no one. Nonetheless, the activities of the banks constituted massive fraud, perjury, and conspiracy. Bank officials have testified in court that they filed as many as10,000 false affidavits a month. These are effectively undeniable admissions of law-breaking on a massive scale.

It’s a federal crime, punishable by up of five years of imprisonment, to knowingly file a false affidavit with the court. From the perspective of the law, you are guilty of the same perjury, when you falsely testify in court or when you submit a false affidavit. In most states, filing false affidavits with the court similarly constitutes a felony offense of perjury.

If an individual citizen perpetrated this kind of massive perjury, he or she would be prosecuted. For illegal activities to take place on this type of massive scale, other serious crimes, such as conspiracy, are almost certainly committed as well.

Last week an audit of San Francisco mortgage practices, the first systematic audit in the nation, revealed that an astounding 82 percent of the cases analyzed involved suspicious activity by the foreclosing institution and concluded that a large portion of these activities probably involved felony violations of California perjury laws.

Second, when Martha Coakley, the attorney general of Massachusetts filed a civil suit related to the robo-mortgage scandal against several financial institutions, she was demonized by the financial services industry and appropriately recognized for her bravery by housing advocates seeking to end abusive bank practices.

What is noteworthy, however, is that Coakley filed a civil suit. This was a lenient effort as she undoubtedly had the ability to build a compelling criminal case against the banks (as institutions) and the bank officers who knowingly created the robo-mortgage scheme.

Third, the national housing settlement, involving the federal and state governments, was announced almost two weeks ago. A central concern associated with the settlement is how it will be enforced. The banks have a long and well-documented history, of agreeing to settlements that will change their behavior and then failing to live up to these binding agreements. Moreover, penalties for failure to comply with these settlements are rarely, if ever, assessed.

In her New York Times feature story, The Deal is Done, but Hold the Applause, Gretchen Morgenson wrote about this behavior, and how it relates to the current settlement:

“But perhaps the largest question looming over this settlement is how it will be policed. Recent history is littered with agreements that required banks to take specific steps to make amends. All too often, the banks have skated away from their promises.”

Morgenson then recounts a series of instances where the banks failed to comply with past settlements, including this quote from a former judge involved in these processes and her conclusion:

“‘It’s astounding that in such a huge percentage of cases the lenders are not complying,’; said Philip A. Olsen, a former Nevada Supreme Court settlement conference judge.”The banks have learned that they can thumb their noses at the program and it won’t cost them anything.”

So you have to wonder whether banks will thumb their noses at last week’s settlement, too. That makes policing compliance crucial.”

The full details of the settlement have not been released, but unfortunately, the most recent disclosures suggest that this enforcement power and large penalties per violation are wishful thinking. An executive summary of the provisions of the settlement can be found here. It states, among other things: “If banks fail to remedy violations, they are subject to civil penalties of up to $5 million from the court.”(emphasis added)

While the full details may indicate otherwise, the process as described here seems to be a far cry from substantial penalties of $1 million to $5 million for each failure of compliance that some media reports appeared to suggest.

Why does the monitor need to provide the banks with a chance to remedy violations of the settlement? The banks certainly know what they are supposed to be doing. It’s one indication that the banks will be able to pursue the changes requires by the without a sense of urgency.

With no set penalty formula the same banks which have argued that over 10,000 knowing violations of the law harmed no one, will undoubtedly argue–perhaps for years–that any violations of the settlement are inevitable consequences of glitches in operating a new system, have no practical impact, don’t merit fines of any kind.

In addition, have the banks agreed that they will not contest the monitor’s request of penalties to the court? If not, then, as I have previously noted a court fight over each penalty can—and most probably will—ensue, with the possibility that the entire monitoring process is a charade.

I hope that I am wrong, but the above analysis certainly suggests that, in Morgenson’s words, banks will have the opportunity to “thumb their noses at [the] settlement” without incurring serious penalties.

If the enforcement provisions of the settlement prove to be meaningless, Americans will rightfully believe they have been misled by public officials to believe the settlement included stiff penalties to ensure violations did not occur.

The stakes here are enormous. They extend beyond the housing market to the nature of American society itself. The banks’ blatant malfeasance with regard to the robo-mortgage scandal and other foreclosure-related activities have been a clear example of unequal enforcement of the laws. Now, the settlement may serve as another example that equal justice through equal enforcement of the laws, which is necessary for sustainable capitalism, no longer prevails in America.

Yale’s Robert Dahl, one of the preeminent political scientists of our era, wrote in 2006 in On Political Equality (Yale University Press) of the risks of rising economic inequality, which is inevitably accompanied by political power which also concentrates at the top of the society:

“The unequal accumulation of political resources points to an ominous possibility: political inequalities may be ratcheted up, so to speak, to a level from which they cannot be ratcheted down. The cumulative advantages in power, influence, and authority of the more privileged strata may become so great that .. a majority of ordinary citizens…are simply unable…to overcome the forces of inequality arrayed against them.”

I fervently hope we are not living out the ominous possibility Professor Dahl raises.

President Obama has declared income inequality to be “the defining issue of our time.” I agree, but I am terrified that the most recent news related to the housing settlement is not the definition the president intends.

An earlier version of this article appeared in the Restoring Capitalism series of the New Deal 2.0 blog, a project of the Roosevelt Institute.

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The Mortgage Settlement’s Missing Piece: Will Banks Now Follow The Law? http://itcouldhappenhere.com/blog/settlement-3/ http://itcouldhappenhere.com/blog/settlement-3/#comments Fri, 10 Feb 2012 19:49:50 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1022

The country’s banks agreed to change their behavior as part of the robo-mortgage settlement announced earlier this week. The announcement, however, leaves open a central question: Does the settlement include new, pre-defined penalties for banks that fail to uphold their new promises? Since a change in bank behavior is a vital piece of the settlement, the absence of an answer is highly disconcerting.

When the deal was announced, the Associated Press reported reported:

“The conditions will be overseen by Joseph A Smith Jr., North Carolina’s banking commissioner. Lenders that violate the deal could face $1 million penalties per violation and up to $5 million for repeat violators.”

The initial impression on reading this report is that there are real teeth to it. It sounds like the banks are agreeing to pay $1 million dollars each time they fail to perform as promised.

However, the actual press release from the Department of Justice announcing the deal reads (emphasis added):

“Compliance with the agreement will be overseen by an independent monitor, Joseph A. Smith Jr. Smith has served as the North Carolina Commissioner of Banks since 2002… The monitor will oversee implementation of the servicing standards required by the agreement; impose penalties of up to $1 million per violation (or up to $5 million for certain repeat violations); and publish regular public reports that identify any quarter in which a servicer fell short of the standards imposed in the settlement.”

There are two open questions. First, what does “up to” mean? Does the independent monitor have discretion over the size of each penalty? This could effectively make the million dollar figures announced by the Justice Department meaningless. Banks have argued that the tens of thousands of robo-mortgage signatures and well-documented servicing errors were all technical violations that harmed no one. Undoubtedly, they will argue that any single violation was a meaningless error.

This provision would have real meaning if we applied the same standard our nation has applied in other areas: a zero tolerance rule. What would happen if each bank knew that any violation would result in a minimum fine of $1 million? I suspect bank behavior would change significantly.

Second, can banks contest these fines? Have the banks agreed that they will pay any fines assessed by the independent monitor? If not, then once again the provisions have the potential to be meaningless. The monitor will assess fines for violations and the banks will challenge the fines through whatever venues, the courts or otherwise, have been established by the settlement. The judgment and ability of the independent monitor to set fines will have been eviscerated.

Efforts to determine answers to these and related questions have seemingly been rebuffed. The Huffington Post reported on its efforts to understand the details of the enforcement provisions of the settlement:

“North Carolina banking commissioner Joseph Smith will serve as the national monitor of the deal, working from Raleigh…

The announcement on Thursday did not include any new information on bank penalties. A call to Smith’s office was not immediately returned. A HUD spokesman did not immediately return an e-mailed request for comment.”

There appears to be near universal agreement that this settlement will do little for homeowners who have been the victims of past bad bank behavior. But there may be real value in the deal if it successfully changes bank behavior going forward. The New York Times quoted Roy Cooper, the attorney general of North Carolina as saying, “This agreement is more important for the foreclosures we’re hoping to prevent” (emphasis added).

At the same time, The New York Times wrote, “Advocates for homeowners facing foreclosure expressed cautious optimism,” but indicated that these same advocates believe rigorous enforcement is essential for the program to work:

“We’re hopeful,” said Joseph Sant, a lawyer at Staten Island Legal Services’ homeowner defense project. “But we had a lot of programs that are good on paper. What will make the difference is that it’s vigorously enforced.”

The stakes here are enormous. They extend beyond the housing market to the nature of American society itself. The banks’ blatant malfeasance with regard to the robo-mortgage scandal and other foreclosure-related activities has been a clear example of unequal justice. The banks have knowingly and repeatedly violated laws (such as providing tens of thousands of false affidavits to the courts) that would have landed an ordinary citizen in jail.

At the same time, successful capitalism itself depends on the enforcement of rules and contracts in a fair bargain that all participants believe will be enforced by the courts. When powerful players are permitted to alter established rules at will, capitalism ultimately collapses. Contracts and the idea of a fair bargain become meaningless as less powerful parties to an agreement know their rights will not be enforced. Over time, citizens lose faith in government and their own ability to thrive in what becomes a corrupt economy.

If the settlement enforcement provisions turn out to lack substance, these forces will be reinforced rather than counteracted. We must wait for the details. Like homeowner defense advocates, I am cautiously optimistic — but terrified that ultimately I will be disappointed.

This article originally appeared on the New Deal 2.0 blog a project of The Rossevelt Institute.

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Is the Robo-Mortgage Scandal the Back-End of Tax Evasion & Fraud? http://itcouldhappenhere.com/blog/robo-mortgage/ http://itcouldhappenhere.com/blog/robo-mortgage/#comments Sun, 05 Feb 2012 03:25:13 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=1017 On Thursday (Feb. 2), I wrote an article titled The Proposed Robo-Mortgage Settlement Might Give Banks A Free Pass. At the time the deadline for states Attorney’s General to sign on to the settlement was February 3. It has now been pushed back to February 6.

In the article, I wrote that while the banks have insisted for the past several years that the robo-mortgage violations represented minor technical issues, which harmed no one. Recently, a far more grave explanation has emerged: The possibility that the scandal was the back-end of activities that appear to represent tax evasion, the failure to comply with basic rules in securitizing mortgages, and massive fraud on the purchasers of the securitized mortgage bonds.

Now, I have received numerous requests to clarify this extraordinary alternative explanation.

It’s complex, but here goes: First, as Yves Smith at Naked Capitalism explains, it appears the specific mortgages which were the assets comprising the securitized bonds were never actually transferred to the bonds, within the required time period (90 days under New York law).

By way of background: remember that the big concern about the release was that it would go beyond robosigning and waive other types of liability. The ones observers were most concerned about were what we called chain of title issues, namely that the parties that had put mortgage securitizations together had failed on a widespread basis to take the steps stipulated in their own contracts to transfer the notes (and in lien theory states, to assign the lien) properly.

The securitization agreements were rigid, requiring that the transfers through multiple parties be completed by a date certain, typically 90 days after the closing of the trust. Most deals elected New York law as the governing law for the trusts, and New York law allows them to operate only as stipulated. Since the notes were supposed to be transferred in by a particular date, trying to move them in later is a “void act” having no legal effect. That makes attempts to make transfers legally at this juncture a non-starter.

Having realized somewhat late in the game that their failure to do what they promised could interfere with trusts’ ability to foreclose and create tons of liability, servicers and their various agents have relied on not just robosiging, but widespread document fabrication and forgeries to fix their transfer problem when judges have taken notice. Anyone who has been on this beat knows of numerous cases where foreclosure documents are challenged, say for being too late, not having the right transfers, etc, that new versions of supposedly original documents that tell the right story miraculously show up in court.

Second, Ellen Brown, the President of The Public Banking Institute, explains the implications of this failure to abide by the 90 day deadline:

Since 1986, mortgage-backed securities have been issued to investors through SPVs [Special Purpose Vehicles] called REMICs (Real Estate Mortgage Investment Conduits). REMICs are designed as tax shelters; but to qualify for that status, they must be “static.” Mortgages can’t be transferred in and out once the closing date has occurred. The REMIC Pooling and Servicing Agreement typically states that any transfer significantly after the closing date is invalid. Yet the newly robo-signed documents, which are required to begin foreclosure proceedings, are almost always executed long after the trust’s closing date.

Third, as Brown also notes, the liabilities associated with a failure to transfer the documents on time came to head when:

Fannie Mae sent out a memo telling servicers that in order to be reimbursed under HAMP–a government loan modification program designed to help at-risk homeowners meet their mortgage payments–the servicers would have to produce the paperwork showing the loan had been assigned to the trust.

Brown believes that, as a result,

The hasty solution was a rash of assignments signed by an army of “robosigners,” to be filed in the public records…

This explains why, as noted by Brown above, “the newly filed robo-signed documents” are “almost always executed long after the trusts closing date.”

All of this is undoubtedly highly complex. And, I am not in a position to investigate whether it is true. However, the implications of these assertions are grave. If the mortgages were knowingly assigned to the REMICS after the closing date, then the tax benefits of the REMICS appear to be invalid. If so, these transfers (as I understand the law) represent tax evasion by the banks. As part of an ongoing scheme, they also constitute, in all likelihood, conspiracy and fraud on the bond purchasers.

With regard to the bond purchasers, as Yves Smith notes above, the failure to adequately establish the trusts created “tons of liability” for the banks to these purchasers; since the banks then effectively misrepresented the nature of the bonds they were selling.

At the moment, the important question here is not whether these allegations are true. What’s important is that their appears to be enough evidence to warrant at least a minimal investigation of these astounding assertions: The possibility that for years the banks have been knowingly misleading the public and the government on the extent to which robo-mortgage scandal activities were merely technical violations versus the back-end of potentially serious criminal activities and an attempt to evade enormous liabilities.

If we are a nation where justice is blind, should we not investigate this possibility before we give the offending financial institutions another free pass?

The essence of an effective capitalist system is rules and accountability. For markets, and our larger economy to work, important players cannot be permitted to make up their own rules. In all likelihood, a settlement next week means these serious questions will never be answered.

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