Jennifer S. Taub - Other peoples houses : how decades of bailouts, captive regulators, and toxic bankers made home mortgages a thrilling business

OTHER PEOPLES HOUSES

How Decades of Bailouts, Captive Regulators, and Toxic Bankers Made Home Mortgages a Thrilling Business

JENNIFER TAUB

Published with assistance from the foundation established in memory of James Wesley Cooper of the Class of 1865, Yale College.

Copyright 2014 by Jennifer Taub.
All rights reserved.

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Library of Congress Cataloging-in-Publication Data
Taub, Jennifer.

Other peoples houses : how decades of bailouts, captive regulators, and toxic bankers made home mortgages a thrilling business / Jennifer Taub.
pages cm
Includes bibliographical references and index.

ISBN 978-0-300-16898-3 (cloth : alk. paper) 1. Savings and Loan Bailout, 19891995. 2. Savings and loan association failuresEconomic aspectsUnited States. 3. Mortgage loansUnited States. 4. Banks and bankingUnited StatesHistory. 5. Financial crisesUnited StatesHistory. I. Title.
HG2151.T38 2014
332.720973dc23 2013044531

A catalogue record for this book is available from the British Library.

This paper meets the requirements of ANSI/NISO Z39.48-1992

(Permanence of Paper).

10 9 8 7 6 5 4 3 2 1

For Michael

The goose that lays golden eggs has been considered a most valuable possession. But even more profitable is the privilege of taking the golden eggs laid by somebody elses goose. The investment bankers and their associates now enjoy that privilege. They control the people through the peoples own money.

LOUIS D. BRANDEIS, Other Peoples Money and How the Bankers Use It (1914)

OTHER PEOPLES HOUSES

Katherine Copeland swept out the living quarters of her familys 1,280-acre wheat and cotton farm in Chattanooga, Oklahoma. Believing a foreclosure was imminent, she apparently wanted to get things in order. She gathered refuse from drawers and cabinets, making a pile outside. When this work was completed, Katherine set the pile on fire. Then she climbed onto the burning heap and asphyxiated in the smoke. Her husband, Eugene, found her body there later that day. In the note she left on the dinner table, Katherine blamed herself for the expected loss of the land that her family had farmed since 1910 and that she had hoped to pass on to her children.

Copelands suicide gained national attention that summer of 1986 because it was not an isolated incident. Her desperate act echoed the suffering of many during the farm crisis. Due to a 1970s agricultural export boom, crop prices and thus farm incomes shot up, so farmers, encouraged by the government and private lenders, borrowed money to expand operations. Farmland prices rose. Lenders loosened underwriting standards, extending loans excessively, with the exuberant forecast that commodity prices and thus income and land values would keep rising. The banks calculated that if borrowers defaulted, the land would be good collateral to seize and sell.

The U.S. Congress responded in November 1986 with an amendment to the Bankruptcy Code that empowered courts to help families save their farms. They could emerge from bankruptcy with a fresh start, able to continue both commercial and family life with manageable debt. Among other things, this legislation permitted a farm debtor to reduce the outstanding principal on the farm home mortgage, as well as to get a new term length and possibly a lower interest rate. The new law gave farmers bargaining power to negotiate modifications even without bankruptcy, as their lenders were aware of the relief the court would provide if they failed to bargain. Similarly, for a time, some courts also permitted nonfarm homeowners to use another provision of the Bankruptcy Code to modify underwater mortgages for principal residences. However, in 1993, the United States Supreme Court abolished that practice.

Homeowners in America are once again weighed down by mortgage debt. Like many farm families in the 1970s, homeowners were encouraged by lenders to take on more debt as property values rose. New types of mortgages with low teaser rates and low initial monthly

During the seven-year housing boom that began in 2000, home prices roughly doubled and mortgage debt increased by 80 percent. Then, in 2006, the housing bubble burst; home prices stopped rising and retreated. Mortgage defaults mushroomed. Banks that borrowed heavily to purchase toxic mortgage-linked securities for their portfolios began to collapse as did the firms that insured these instruments. The financial sector was swiftly bailed out after the chaotic Lehman Brothers bankruptcy, for fear that the collapse of other too big to fail firms would create cascading losses. Ordinary homeowners have not been as fortunate. Between 2006 and 2013, about five million homes were lost to foreclosure with millions more still in process. In 2013, nearly ten million homes remained underwaterapproximately one-fifth of all mortgaged properties. The collective negative equity for U.S. homes still holds back our economic recovery. Thanks to the Fed holding interest rates exceptionally low and expanding the money supply, the stock market rebounded from its postcrisis trough. However, unemployment remains high and home prices low. For the broad middle class that depends on wages for survival and whose wealth is linked mainly to housing, the crisis continues.

Like Katherine Copeland, many Americans internalize shame and blame. Yet this reflex ignores the more-complex machinations and

The same skyrocketing interest rates that crushed farmers in the early 1980s sank many savings and loans (S&Ls). These once-staid institutions historically channeled customer savings accounts into home loans. After interest rates spiked, they lost money paying out double-digit interest to savers while collecting, on average, single digits from the fixed-rate, long-term mortgages in their portfolios. Hundreds of S&Ls were deeply insolvent on a market-value basis. Instead of orchestrating an immediate rescue, the government decided that deregulation could help the troubled firms grow out of their problems. Responding to industry lobbying, beginning around 1980, Congress enacted liberalizing laws and the S&L federal regulator relaxed its rules. This allowed S&Ls to bring in billions of dollars in wholesale funding, which, unlike retail deposits, enabled them to grow very rapidly, but also made them more vulnerable to runs. They were freed to move beyond their home mortgage expertise to make and purchase high-yielding, risky real estate development loans and to invest in new assets, including junk bonds. States further loosened up on the S&Ls they chartered, which, like the federal thrifts, also were protected by federal deposit insurance.

The S&Ls did not grow out of their problems, but instead attracted many high-flying executives who quickly piled on more losses, acted recklessly, or engaged in fraud, putting the deposit insurance fund and taxpayers at greater risk. Some vigilant officials spotted the impending catastrophe and attempted to restore sensible safety and soundness regulations, however, the reformers were greatly outnumbered and subjected to extreme pressure from industry-friendly government insiders. By 1989, hundreds of S&Ls were shut down and hundreds were rescued from failure by the government. The