Image via WikipediaBy pocket-vetoing the bill that sailed through Congress to expedite mortgage foreclosures, President Obama may have begun a chain reaction that will blow up Treasury Secretary Tim Geithner's confidence game with the banks. Let me explain.
In early 2009, Obama and his top economic aides faced a fateful choice: either do an honest accounting of the nation's big insolvent banks, like Citigroup; or keep propping them up and collude with the banks in camouflaging just how bad things were -- and still are.
They opted for camouflage. Geithner and the Federal Reserve devised a "stress test" exercise that avoided an honest accounting of the junk on the banks' balance sheets; instead they used economic models based on very rosy assumptions about how bad the recession would be. Citi and the others were pronounced basically healthy.
This move avoided the kind of reckoning that would break up (and clean up) the big banks. Instead, the camouflage policy allowed the big banks to very slowly rebuild their balance sheets with speculative profit centers, relying first on TARP money and then on zero interest rate advances from the Federal Reserve.
But there was a huge downside for the economy. The banks reverted to the same kind of speculative plays that crashed the system; they also continued gouging consumers. And thanks to the Federal Reserve, the banks could make very easy money borrowing from the Fed at almost zero interest rates and investing the money in government guaranteed Treasury securities.
By 2010, the banks were again making large profits and paying huge bonuses -- as if the financial collapse had never occurred. What they did not, however, do was make very many loans to small and medium sized businesses or hard pressed consumers.
Meanwhile, regional and community banks, which do make loans to business, have been hard hit by the collapse in commercial real estate prices, and have tightened terms for ordinary business borrowers. So all but the largest businesses, which can access the bond market directly, are starved for credit.
Thanks to Geithner's permissive accounting standards, the big banks have also been allowed to carry on their books at full value securities based on underwater mortgage loans -- securities that are really worth between 30 and 70 cents on the dollar. If the banks had to honestly account for their depressed market value, the banks' balance sheets would look even worse.
This is an exact repetition of what befell Japan in the 1990s -- a lost decade of economic growth caused by a financial collapse and the collusion of the government with the banks to pretend that all was rosy. Indeed, the US economy today is in far worse shape than Japan was, because all during that period Japan continued to be a major export power while the US today runs a huge trade deficit.
But Obama's veto of the foreclosure-streamlining bill calls the question on Geithner. We are now learning that a lot of the securities were not properly documented, which makes them worth even less.
If the foreclosure machinery is suddenly gummed up because the President has ruled out a quick fix that favors bankers, the banks may be forced to recognize what the junk on their balance sheets is really worth (not much). And the whole game of pretending that all is fine with the banks is in jeopardy.
The fact is that a vast number of mortgages that we turned into mortgage backed securities are legally flawed. This calls into further question the value of massive portfolios held by banks -- and forces some kind of reckoning.
For aficionados who want more detail, Mike Konczal has provided a very useful idiots' guide to the next great unraveling.
Obama's veto also pulls the rug out from under the pretense that the Administration's mortgage relief program is working. For nearly two years, the Treasury and the Department of Housing and Urban Development have sponsored a mortgage modification program known as HAMP (Home Affordable Modification Program).
This program is voluntary to the banks, who get a few thousand dollars in incentive payments from the government in exchange for reducing monthly payments. But the relief is usually shallow and something like half of borrowers who do get modifications go back into default. Fewer than 500,000 have gotten modifications out of several million at risk of foreclosure.
Most of the underwater homeowners, now almost one in three, are not speculators or people who took out sub-prime loans. They are simply ordinary Americans whose houses are suddenly worth less than the mortgages on them, because of the general collapse in housing prices.
The lame HAMP program, the joint creation of Treasury and HUD, is another part of Geithner's grand design to disguise just how bad things are at the big banks and prevent an honest accounting or a serious reckoning.
Meanwhile, housing prices are declining again, despite record low mortgage interest rates (available only to blue chip borrowers), which creates another serious drag on the economy. And the housing market won't return to normal until the mortgage mess is resolved.
But the belated recognition that millions of mortgages are inadequately documented could be a blessing in disguise. It could force the administration to come up with stronger medicine both to clean up the banks and to help distressed homeowners.
The Dodd-Frank Act (PDF) gives the Treasury the tools to do an honest accounting of the big banks, and shut down or break up zombie banks that are insolvent -- so that successor banks can get on with the business of lending. With a serious strategy for both the banks and the mortgage mess, we could remove two of the main drags on the economy.
White House political chief David Axelrod, speaking on CBS's Face the Nation Sunday, tried to back-pedal from the significance of Obama's action. (Heaven forbid that three weeks before a crucial election Obama should sound like he is siding with consumers against bankers.) Meanwhile, the indispensable Rep. Alan Grayson of Florida called for a national moratorium on foreclosures.
Of the three prime architects of Obama's inadequate economic program, two have now moved on -- economic policy czar Larry Summers and budget chief Peter Orszag. It's time to for Geithner to join them, so that Obama can get real about the banking and mortgage crisis.
The president's veto of the foreclosure bill shows that his Obama's own instincts are better than his advisors'. It's a start. But if Obama temporizes now, he faces a slow unraveling of the flimsy financial house that Geithner built, and an even weaker economy.
In early 2009, Obama and his top economic aides faced a fateful choice: either do an honest accounting of the nation's big insolvent banks, like Citigroup; or keep propping them up and collude with the banks in camouflaging just how bad things were -- and still are.
They opted for camouflage. Geithner and the Federal Reserve devised a "stress test" exercise that avoided an honest accounting of the junk on the banks' balance sheets; instead they used economic models based on very rosy assumptions about how bad the recession would be. Citi and the others were pronounced basically healthy.
This move avoided the kind of reckoning that would break up (and clean up) the big banks. Instead, the camouflage policy allowed the big banks to very slowly rebuild their balance sheets with speculative profit centers, relying first on TARP money and then on zero interest rate advances from the Federal Reserve.
But there was a huge downside for the economy. The banks reverted to the same kind of speculative plays that crashed the system; they also continued gouging consumers. And thanks to the Federal Reserve, the banks could make very easy money borrowing from the Fed at almost zero interest rates and investing the money in government guaranteed Treasury securities.
By 2010, the banks were again making large profits and paying huge bonuses -- as if the financial collapse had never occurred. What they did not, however, do was make very many loans to small and medium sized businesses or hard pressed consumers.
Meanwhile, regional and community banks, which do make loans to business, have been hard hit by the collapse in commercial real estate prices, and have tightened terms for ordinary business borrowers. So all but the largest businesses, which can access the bond market directly, are starved for credit.
Thanks to Geithner's permissive accounting standards, the big banks have also been allowed to carry on their books at full value securities based on underwater mortgage loans -- securities that are really worth between 30 and 70 cents on the dollar. If the banks had to honestly account for their depressed market value, the banks' balance sheets would look even worse.
This is an exact repetition of what befell Japan in the 1990s -- a lost decade of economic growth caused by a financial collapse and the collusion of the government with the banks to pretend that all was rosy. Indeed, the US economy today is in far worse shape than Japan was, because all during that period Japan continued to be a major export power while the US today runs a huge trade deficit.
But Obama's veto of the foreclosure-streamlining bill calls the question on Geithner. We are now learning that a lot of the securities were not properly documented, which makes them worth even less.
If the foreclosure machinery is suddenly gummed up because the President has ruled out a quick fix that favors bankers, the banks may be forced to recognize what the junk on their balance sheets is really worth (not much). And the whole game of pretending that all is fine with the banks is in jeopardy.
The fact is that a vast number of mortgages that we turned into mortgage backed securities are legally flawed. This calls into further question the value of massive portfolios held by banks -- and forces some kind of reckoning.
For aficionados who want more detail, Mike Konczal has provided a very useful idiots' guide to the next great unraveling.
Obama's veto also pulls the rug out from under the pretense that the Administration's mortgage relief program is working. For nearly two years, the Treasury and the Department of Housing and Urban Development have sponsored a mortgage modification program known as HAMP (Home Affordable Modification Program).
This program is voluntary to the banks, who get a few thousand dollars in incentive payments from the government in exchange for reducing monthly payments. But the relief is usually shallow and something like half of borrowers who do get modifications go back into default. Fewer than 500,000 have gotten modifications out of several million at risk of foreclosure.
Most of the underwater homeowners, now almost one in three, are not speculators or people who took out sub-prime loans. They are simply ordinary Americans whose houses are suddenly worth less than the mortgages on them, because of the general collapse in housing prices.
The lame HAMP program, the joint creation of Treasury and HUD, is another part of Geithner's grand design to disguise just how bad things are at the big banks and prevent an honest accounting or a serious reckoning.
Meanwhile, housing prices are declining again, despite record low mortgage interest rates (available only to blue chip borrowers), which creates another serious drag on the economy. And the housing market won't return to normal until the mortgage mess is resolved.
But the belated recognition that millions of mortgages are inadequately documented could be a blessing in disguise. It could force the administration to come up with stronger medicine both to clean up the banks and to help distressed homeowners.
The Dodd-Frank Act (PDF) gives the Treasury the tools to do an honest accounting of the big banks, and shut down or break up zombie banks that are insolvent -- so that successor banks can get on with the business of lending. With a serious strategy for both the banks and the mortgage mess, we could remove two of the main drags on the economy.
White House political chief David Axelrod, speaking on CBS's Face the Nation Sunday, tried to back-pedal from the significance of Obama's action. (Heaven forbid that three weeks before a crucial election Obama should sound like he is siding with consumers against bankers.) Meanwhile, the indispensable Rep. Alan Grayson of Florida called for a national moratorium on foreclosures.
Of the three prime architects of Obama's inadequate economic program, two have now moved on -- economic policy czar Larry Summers and budget chief Peter Orszag. It's time to for Geithner to join them, so that Obama can get real about the banking and mortgage crisis.
The president's veto of the foreclosure bill shows that his Obama's own instincts are better than his advisors'. It's a start. But if Obama temporizes now, he faces a slow unraveling of the flimsy financial house that Geithner built, and an even weaker economy.
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