Financial industry lobbyists are becoming increasingly concerned about proposals pending in Congress that would amend the bankruptcy law to provide relief for subprime borrowers at risk of losing their homes.
In the House, efforts to increase Republican support for a measure sponsored by Rep. Brad Miller (NC) paid off in a 17-15 vote to report the bill favorably out of the Judiciary Committee. Miller’s bill still allows bankruptcy judges to adjust the terms of mortgages on a primary residence and “cram down” the mortgage amount if the property’s value has declined. But the compromise, targeting objections from Rep. Steve Chabot (R-OH), narrows the pool of borrowers eligible for this relief to holders of subprime or “non-traditional” loans (as defined by the regulatory guidance on subprime mortgages) obtained between Jan. 1, 2000 and the enactment date of the legislation. Eligible borrowers would also have to meet the means test the bankruptcy reform law establishes for debtors seeking to eliminate their debts through a Chapter 7 bankruptcy filing. The revised measure also now contains a seven-year sunset provision – another concession sought by Chabot.
The National Association of Federal Credit Unions (NAFCU), which claimed credit for helping to broker the compromise with Chabot, hailed the progress on the bankruptcy legislation and the balance it strikes between the needs of lenders and borrowers. “We are delighted to have come to this compromise, which affords consumers welcome relief from possible foreclosure, but still protects the majority of credit union loans,” NAFCU President Fred Becker said in a press statement. “At a time like this,” he added, “the last thing we want to do is make credit harder to come by when people need it most.”
Somewhat less enthusiastic about the compromise, the Credit Union National Association (CUNA) says further modifications are needed to clarify that the bankruptcy protections do not apply to borrowers with interest-only prime loans. Absent that clarification, the restrictions “would impact almost 500 credit unions that have made interest-only loans in good faith in response to member requests” in California, where high housing costs required innovative lending tools, CUNA chairman and CEO Dan Mica warned in a letter to members of the House Judiciary Committee. “These are not subprime loans,” he insisted, “but rather loans which were rigorously underwritten with full and clear disclosures.”
While CUNA’s concern seems to be limited to one provision of the proposed bankruptcy legislation, bank and mortgage industry trade groups oppose its underlying premise: That bankruptcy judges should be allowed to restructure some residential mortgages. “That will impose added risk and uncertainty on an already volatile market,” according to the American Bankers Association (ABA). Even with the compromises approved by the House Judiciary Committee, the legislation “still gives bankruptcy judges, with no expertise in mortgage lending, the ability to re-determine the size, value, and length of the loan,” the ABA complained in a press statement. “This will introduce more risk for the lender by creating uncertainty about when and if a loan will be repaid,” the association warned.
The Wall Street “super fund,” which had already been dubbed “the incredible shrinking superfund,” has disappeared entirely. Intended to help defrost credit markets frozen by concerns about the subprime crisis, the superfund consisted of a giant “master liquidity vessel” that was supposed to purchase securities that the structured investment vehicles holding subprime-backed and other debt securities haven’t been able to sell. Of course, the reason the SIVs are having trouble unloading those securities is because investors don’t want the subprime loans they contain, and it turned out, the financial institutions that were supposed to invest in the liquidity fund didn’t particularly want that toxic waste, either. When the initial response proved lukewarm, at best, J.P. Morgan Chase, Citigroup, and Bank of America, the plan’s lead sponsors, reduced their announced funding goal from $80 million to $50 million (hence the “incredible shrinking fund” description). But shortly before the Christmas holiday, the three banking giants gave up on the fund entirely, concluding that “it was not needed at this time.”
Although credit markets remain jittery, they have been calmed considerably by an infusion of capital from foreign investors into companies, such as Merrill Lynch, that have suffered massive subprime losses. Additionally, several banks that had off-loaded subprime investments into SIVs (Citigroup notably among them) have moved those under-water assets back onto their balance sheets, simultaneously bruising investors (who must absorb the resulting losses) and calming markets concerned that financial institutions weren’t acknowledging the extent of the subprime problem or dealing effectively with their exposure to it.
Still, the collapse of the superfund plan was something of an embarrassment for Treasury Secretary Henry Paulson, who had strongly encouraged the lead banks to undertake the bail-out effort, while emphasizing that the initiative was voluntary and market-driven. Putting the best face on the issue, a Treasury spokesman said the department “welcomes market-based solutions to facilitate liquidity and orderliness” in the debt markets.
A place for fraud
When you’re listing the causes of the subprime mortgage crisis, save a prominent place for fraud. The Federal Bureau of Investigation (FBI) reports 1,210 active fraud cases for this year compared with 436 in 2003; 28 percent of the agency’s white-collar agents and analysts are now assigned to investigating and prosecuting mortgage fraud cases, up from 7 percent in 2003, according to a recent Wall Street Journal report. That article cited a report by the Prieston Group predicting that mortgage losses resulting from fraud could reach $4.5 billion in 2007 – a 100 percent increase over the 2006 total. The reason for the increase, the company’s chairman, Arthur Prieston, told the Journal: “We’ve created a culture where a great many people know how to take advantage of the system.”
No Free Lunch
A year-long study by federal and state securities regulators has confirmed once again what we all know to be true: “There is no free lunch.” And the free lunches investment companies offer seniors are not only anything but free – they can also be hazardous to the financial health of the participants. The study found that the seminars, promising an educational program along with the free lunch or dinner, actually involved high-pressure sales pitches, and “misleading” -- sometimes “fraudulent”—claims for “inappropriate” financial products.
Christopher Cox, chairman of the Securities and Exchange Commission, termed the study’s results “a wake-up call for securities regulators, the financial services industry, and especially older investors. The SEC and our fellow regulators intend to put a stop to this,” Cox said in a press statement. “We will step in whenever false claims are being made. We will sanction crooks who try to feast on the life savings of older investors.”
The SEC conducted the study in conjunction with the Financial Industry Regulatory Authority and securities regulators in seven states with large retiree populations: Alabama, Arizona, California, Florida, North Carolina, South Carolina and Texas. Researchers examined 110 securities firms and branch offices that sponsor sales seminars and off free lunches or dinners to attract attendees. Among the key findings:
- All of the “seminars” were actually sales presentations and despite representations that “nothing would be sold,” the goal of the programs was to sell investment products at the event or in follow-up contacts with attendees.
- Examiners found “exaggerated” or “misleading” advertising claims at half the seminars, and “weak supervisory practices” at 59 percent of the companies sponsoring the programs.
- Nearly 25 percent of the seniors attending the programs received unsuitable recommendations for investment products.
- Examiners found evidence of fraud at 13 percent (14) of the seminars in the study, including “serious misrepresentations of risk and return,” the possible sale of “fictitious” investments,” and the possible liquidation of accounts “without the customer’s knowledge or consent.”
This study is part of a larger campaign the SEC and other regulators have launched to combat fraudulent and abusive practices targeting seniors. The SEC has initiated more than 40 enforcement cases in the past two years, the most recent of them resulting in $250,000 penalties (each) for two brokerage firms and a $50,000 fine against an executive for failing to properly supervise a broker who allegedly defrauded more than 100 elderly clients.
FINRA, formerly the National Association of Securities Dealers has conducted well-publicized inspection “sweeps,” targeting products and programs of dubious value for seniors, including pitches encouraging them to retire early and cash out their retirement accounts, and promotions encouraging seniors to use so-called “senior financial investment specialists,” a designation that, regulators say, has no meaning.
The “free lunch” report recommends among other measures, that financial services firms review their supervisory practices, supervise sales seminars more closely and “redouble their efforts to ensure that the investment recommendations they make to seniors are suitable [for them].”
Let's Hear It For Recessions!
This may be stretching the effort to “look on the bright side,” but an article published by Dow Jones Newswire has identified 17 reasons we should be thankful for the recession that most economists now say is either imminent or has already arrived.
The top 10 on the Dow Jones list:
- A recession will “purge the excesses” of the housing boom.
- It will provide a “wake-up call,” reversing the dollar’s decline and “[reviving] our global credibility.
- It will force financial institutions to acknowledge and write off their losses.
- It will force the U.S. government (and consumers) to rediscover the joys of budgeting and the need to live within their means.
- A downturn will puncture the “over-confidence” of investors. “Downturns bruise egos but encourage rational long-term strategies,” the article suggests.
- A recession will “shake up” the rating agencies, exposing and eliminating the “massive” conflicts of interest that led them to favor the corporations that paid for their ratings at the expense of investors who depended n them.
- A downturn will trigger an “internal recession” in China, demonstrating that the U.S. “will not go into debt forever to finance China’s domestic growth and military war machine.”
- It will expose the true cost of our dependence on oil, forcing the energy and auto industries “to get serious about emissions standards” and about alternative energy sources.
- It will demonstrate the risks of “moral hazard,” discouraging the Federal Reserve from reducing interest rates “to bail out speculators.”
- It will encourage a renewed and necessary emphasis on regulation. “Lobbyists have replaced regulators,” the article says, but the resulting “extreme theories of unrestrained free trade and zero regulation must don’t work.”
It’s time to “get real,” the article’s authors insist, and a recession, they say, will produce precisely the painful but necessary reality check we need.