Kevin Drum

The Foreclosure Mess

| Thu Oct. 14, 2010 10:35 AM EDT

I haven't been blogging about the foreclosure debacle in detail, so here's a quickie catch-up on what it could all mean:

Beyond sloppy documents, the foreclosure debacle has exposed one of Wall Street's little-known practices: For more than a decade, big lenders sold millions of mortgages around the globe at lightning speed without properly transferring the physical documents that prove who legally owned the loans.

Now, some of the pension systems, hedge funds and other investors that took big losses on the loans are seeking to use this flaw to force banks to compensate them or even invalidate the mortgage trades themselves. Their collective actions, if successful, could blow a hole through the balance sheets of big banks and raise fundamental questions about the financial system, financial analysts and a lawmaker said.

....Local laws in most states dictate that each time a mortgage changes hands, the transaction needs to be recorded in courts or county offices. But the speed with which the loans were being generated during the housing boom and then pooled together and passed around Wall Street meant that big financial firms took shortcuts, consumer lawyers said.

Italics mine. I was at dinner last night with a longtime reader, and we naturally ended up talking a bit about the economy. My biggest worry, I said, continues to be an "event." Maybe China crashes. Or Iran decides to embargo oil for some reason. Or Ireland collapses, sending the Euro into a tailspin. Or maybe something like this foreclosure mess, which blows a hole in bank balance sheets yet again and turns into a replay of September 2008. I don't know how likely this is, but the fact that Geithner & Co. are so obviously eager to keep the foreclosure machinery humming suggests to me that they have similar worries.

Now, maybe I'm just a worrywart. If I start hawking gold on the blog, that'll be a sign that weird economic conspiracies have finally seized hold of my mind and I can be safely ignored. But a "lost decade" of slow growth and stagnant income, bad as it is, isn't the worst thing that could happen to us. My sense is that although banks are much stronger now than they were two years ago, they're still not strong enough. Another meltdown is still possible given the right event to set it off.

UPDATE: Details of the worst case scenario here.

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Eric Cantor on Earmarks

| Wed Oct. 13, 2010 4:19 PM EDT

Eric Cantor explains today why he's obsessed with earmark reform even though it wouldn't have the slightest impact on federal spending:

If we hope to preserve Social Security and Medicare for seniors, younger workers and our children, we must begin the conversation about common-sense ways to reform both programs.

These are big things — and there is little question that turning trillion-dollar deficits into surpluses, while starting to pay down our national debt, is an enormous mountain to climb. Yet the long climb to fiscal responsibility must begin with a few smaller, but necessary, steps.

Hmmm. I think Cantor has failed to explain his position clearly. Allow me to make a few small edits. Don't worry, I'm a professional:

If we hope to preserve Social Security and Medicare for seniors, younger workers and our children, we must begin the conversation about common-sense ways to reform both programs.

These are big things — but proposing cuts to these program would be an electoral disaster. If Republicans proposed real federal spending reductions we'd get our hats handed to us in November. So we're not going to do it. We're just not. And we're not going to do anything serious about cutting spending after the election either. Instead we're going to distract the rubes with some chatter about a problem that even I admit is trifling. They'll eat it up. I might be pandering here, but that's sure better than the alternative.

All fixed. Any questions?

Lunch at the White House

| Wed Oct. 13, 2010 3:35 PM EDT

 I just saw this picture on the New York Times front page:

Seriously? Obama and Biden eat lunch with each other at opposite ends of a long table? I've seen that used as a joke in movies, but never in real life. Is there some kind of weird White House etiquette that prevents them from sitting right next to each other?

Trouble in Bankster Land

| Wed Oct. 13, 2010 1:29 PM EDT

Felix Salmon has a fascinating post today on the ever expanding mortgage foreclosure scandal. His take goes beyond the foreclosure problems themselves, though. The background is this: back in the glory days, when banks bought up mortgages by the millions to repackage into MBS and CDOs, they'd hire a firm (usually Clayton Holdings) to do a spot check of the quality of the mortgages. Typically, Felix says, the spot check would show that upwards of half the mortgages had underwriting problems, but instead of rejecting the entire pool the bank would just reject the mortgages that had been spot checked and then negotiate a lower price for all the rest of them:

This is where things get positively evil. The investment banks didn’t mind buying up loans they knew were bad, because they considered themselves to be in the moving business rather than the storage business. They weren’t going to hold on to the loans: they were just going to package them up and sell them on to some buy-side sucker.

....Now here’s the scandal: the investors were never informed of the results of Clayton’s test. The investment banks were perfectly happy to ask for a discount on the loans when they found out how badly-underwritten the loan pool was. But they didn’t pass that discount on to investors, who were kept in the dark about that fact.

So in addition to investment banks being at risk because they screwed the pooch on title transfer paperwork, which might mean that bondholders can force them to repurchase the mortgages, they might also be at risk because they knew the mortgages were crappy and failed to disclose that to the bondholders. Result: lots of lawsuits and, potentially, lots more crappy mortgages on the books of our biggest banks. Stay tuned.

Trouble at the Legion Post

| Wed Oct. 13, 2010 1:00 PM EDT

 Adam Weinstein reports that the VFW is facing an insurgency right here at home:

From Hernando County, Florida, to Windsor, Connecticut, plenty of the VFW's 8,000-plus local posts are happy to host tea party meetings for the dozens of GOP vets vying for House and Senate seats next month. But when the group's political action committee released its latest slate of endorsements, none of those hopefuls made the cut. Not Joe Miller, the Sarah Palin-approved ex-soldier who's already dispatched sitting Alaska Sen. Lisa Murkowski for the state's GOP nomination. Not Ilario Pantano, an outspoken conservative former Marine and VFW member running for the House in North Carolina. And not Allen West, the Islam-criticizing Army vet who's challenging an two-term Democratic congressman in a South Florida district. In all, at least 11 GOP tea party candidates (see a list below) with solid military credentials have been passed over by the VFW, even as it's endorsed incumbents like Nancy Pelosi, Harry Reid, Barbara Boxer, and Jesse Jackson Jr.

The tea partiers are not happy about this state of affairs. "Have you seen these guys?" asks critic Jonn Lilyea. "These members of the board of the PAC look like they rode with Pershing. They don't know what's going on." More at the link.

Schools and Poverty

| Wed Oct. 13, 2010 12:40 PM EDT

Matt Yglesias muses on the eternal question among education wonks: should we focus our attention specifically on education reform itself, or is that unlikely to make much difference unless we also address the broader issues of concentrated poverty that are largely behind so many of our educational problems? He kinda sorta defends the latter view:

The rising cost of health care, the shrinking public tolerance for tax hikes on the middle class, and the hyper-empowerment of the rich in the political system are combining to create a situation where it will be impossible to finance K-12 education in the United States. Institutions committed to “education reform” as their mission sort of can’t focus on this nexus by definition and the people who fund such outfits are generally not interested in funding talk about the desirability of higher taxes. Similarly, most American cities are in a position where if they improve their school system and hold housing policies constant, the medium-term impact will be to create a new equilibrium where poor people can’t afford to live in the city, not a new equilibrium where poor people attend the new good schools.

I'm going to get the ed people mad at me again — and I guess I'll add the poverty people too this time — but I continue to think that the biggest problem here is simply that no one has any really compelling answers. Movies like Waiting for Superman (which I haven't seen), along with an endless stream of credulous punditry, keep suggesting that the answers are out there if only we'll fund them and take them seriously. But they aren't. Charter schools are great, but they're no panacea. (Not yet, anyway. Maybe someday after we figure out which ones work.) High-stakes testing might be a necessary evil, but it hasn't proven to have any long-term value yet either. Etc. You can go down the list of every ed reform ever touted, and they either can't scale up, turn out to have ambiguous results when proper studies are done, or simply wash out over time.1

And as Matt suggests, the tolerance of the middle class for raising its own taxes to improve education is pretty low. One reason, I suspect, is that people have largely lost faith that their taxes are being used for anything useful. If they pay more, they won't get better schools, they'll just get higher teacher salaries as the teachers unions hoover up all the dough. That's especially galling for a middle class that no longer believes teachers are underpaid. Here in California, the average teacher makes about $55,000, and that's for a job with good benefits, great job security, a nice pension, and a workyear of 180 days. Like it or not, your average waitress or truck driver just doesn't think that's so terrible.

So is the answer to address concentrated poverty? Sure. Except that, if anything, attempts to address poverty have a worse track record than attempts to improve education. Hell, attempts to address poverty have such a bad track record that even credulous pundits rarely bother writing about it anymore. Nobody really seems to have any compelling answers, and for about 90% of the country it's just too easy to ignore the problem entirely. They won't phrase it quite this way, of course, but basically they're willing to let the cities rot.

I would really, really like someone to tell me I'm wrong. So far, though, no one has. At least, not to my satisfaction. But I'm willing to be schooled if anyone thinks I'm missing the big picture here.

1As near as I can tell, the only real exception is intense and persistent early intervention. It's still no panacea, but done right it really does seem to make a difference.

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The Next Crisis

| Wed Oct. 13, 2010 11:54 AM EDT

This has been on the back burner for a while as we dealt with a financial meltdown and a brutal recession, but Steven Pearlstein reminds us today of what our biggest and most enduring economic problem really is:

The fundamental economic challenge facing the United States is to get what we consume more in line with what we produce after years of living beyond our means. Obviously there are two ways to correct this imbalance — increase production or reduce consumption — and given the magnitude of the adjustment, it's likely we're going to have to do both.

....From a policy standpoint, this appears to put us in a terrible bind: either reduce unemployment by returning to our free-spending ways, or finish the job of reducing consumption by pushing unemployment up even further. For the moment, we've decided to choose neither. There is, of course, a way out of this bind: produce more without consuming more. For all practical purposes, that means grabbing a bigger share of global markets, either by exporting more goods and services, or replacing some of the stuff we import by producing it at home.

This, of course, was behind Barack Obama's (largely empty) promise to double U.S. exports over the next five years. For that to happen, though, the dollar has to fall. Probably a lot. That makes U.S. exports to the rest of the world cheaper and everyone else's exports to us more expensive. Martin Wolf comments:

To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world.

....China objects to the huge US fiscal deficits and unconventional monetary policies. China is also determined to keep inflation down at home and limit the appreciation of its currency. The implication of this policy is clear: adjustments in real exchange rates should occur via falling US domestic prices. China wants to impose a deflationary adjustment on the US, just as Germany is doing to Greece. This is not going to happen. Nor would it be in China’s interest if it did. As a creditor, it would enjoy an increase in the real value of its claims on the US. But US deflation would threaten a world slump.

....The US is going to win this war, one way or the other: it will either inflate the rest of the world or force their nominal exchange rates up against the dollar. Unfortunately, the impact will also be higgledy piggledy, with the less protected economies (such as Brazil or South Africa) forced to adjust and others, protected by exchange controls (such as China), able to manage the adjustment better.

Before the financial collapse of 2008 this was the big topic of conversation among macroeconomists. Virtually none of them predicted the havoc that the housing bubble would wreak, but they did predict the havoc that an ever-expanding trade deficit would wreak. That's been largely in the background for a while as we dealt with the immediate crisis, but it hasn't gone away and after a brief bit of improvement in 2008-09 the trade deficit has been climbing all over again for the past year. The world has relied on U.S. consumers as the engine of global growth for the past two decades, and one way or another that was never going to keep up forever. The only question was whether it it would adjust gradually — producing modest but long-lived pain — or adjust suddenly, producing all the pain at once. That's still the question.

Life on the Street

| Wed Oct. 13, 2010 11:05 AM EDT

And now for some contradictory news about Wall Street earnings:

With the country's major banks due Wednesday to start reporting third-quarter earnings, a new pessimism is taking hold on Wall Street based on the growing belief that the economy will remain weak for some time, limiting the industry's ability to make money....Wall Street analysts who follow their own industry have recently slashed earnings estimates for a number of big players. Several firms have quietly fired staff, and many more layoffs are expected by early next year. There are even predictions of a severe drop in Wall Street's notoriously generous compensation.

"We're going to see a larger increase in unemployment in the financial services than anyone had expected," said Steven Eckhaus, a lawyer who advises banks on employment matters.

So are Wall Street traders breaking out the champagne buckets (yesterday's news) or preparing to sell their backup vacation homes (today's news)? Hard to say. But this report does suggest one reason that it's going to be hard to tell if financial reform is working. I've suggested before that overall industry profitability is a key metric to watch because a safer industry is inherently a less profitable industry. However, the opposite isn't mathematically equivalent: a less profitable industry might be a safer industry but it might not be. It might be less profitable just because the economy is sucking.

So: if industry profits stay high, that's definitely a bad sign. But if industry profits fall, it's an ambiguous sign. Wait and see.

Drowning in Ethanol

| Wed Oct. 13, 2010 12:53 AM EDT

Somebody just shoot me now:

The Environmental Protection Agency is expected to announce Wednesday that it has approved motor fuel with higher blends of ethanol for use in newer vehicles....The agency will grant a waiver to existing rules to allow the use of E15 — made with 15 percent ethanol and 85 percent gasoline — in cars made in model year 2007 or more recently.

....Big agriculture companies and ethanol distilleries have been pressing for an increase in the limit on ethanol in motor fuel because the nation's overall ethanol production is approaching 10 percent of motor fuel use, a point commonly known as the "blend wall" by people in the industry.

Just what we need. More land-use destroying, corn price increasing, environmentally idiotic ethanol. All taxpayer-subsidized, of course. I guess the Iowa caucuses must be coming up any year now.

How They Win

| Tue Oct. 12, 2010 4:27 PM EDT

Via Jon Chait, a new study shows that the good looking guys really do get all the hot chicks votes. Three researchers did a study to find out if attractive political candidates were more likely to win elections, and in order to eliminate a source of bias they asked Americans and Indians to rate the attractiveness of candidates for Mexican and Brazilian offices:

Despite cultural, ethnic, and racial differences, Americans and Indians agree about which candidates are superficially appealing (correlations ranging from .70 to .87).  Moreover, these superficial judgments appear to have a profound influence on Mexican and Brazilian voters, as the American and Indian judgments predict actual election returns with surprising accuracy. These effects, the results also suggest, may depend on the rules of the electoral game, with institutions exacerbating or mitigating the effects of appearance.

Since, unlike Chait, I'm a serious blogger, I won't illustrate this post with a picture of George W. Bush in his flyboy days. Instead you get a chart. And it's really pretty remarkable. The study included ratings of 47 pairs of candidates, and as you can see the more attractive candidates had a better chance of winning (black dashed line). But that's not all! In an effort to add some value to this study, I drew red lines at the one-third marks, and the results are truly astounding. In the middle, things are kind of a crapshoot. But when one candidate has a strong appearance advantage over the other, the results are almost foregone. All of the eight ugly candidates lost and six out of seven of the dreamboats won.

I don't know if similar results hold for women, but if it does maybe Republicans would be wise to nominate Sarah Palin after all.