Missing Piece in Obama Housing Plan: Arrests
Almost everyone, from President Obama to his ideological foes in the Republican Party, wants the government out of the business of guaranteeing almost every mortgage loan made in the U.S. That's all well and good, but there is no reason to think that private investors will be willing to fund the types of mortgages people expect at rates they consider "affordable" in the absence of government guarantees. The government could help assuage investor fears by proving that it is committed to upholding the rule of law and punishing individuals who commit financial fraud.
Those who bought mortgage-backed securities packaged by the big banks during the go-go years have been justifiably scarred by that experience. Yes, it's hard to be too sympathetic to people undone by their own short-sightedness and greed -- after all, nobody forced them to chase slightly higher yields than they could have earned from owning U.S. Treasury bonds. Even so, MBS investors have plenty of reasons to be upset with institutions that systematically misrepresented what they were selling.
The government, in turn, has shown almost no interest in charging individuals with criminal conduct. Somehow one of the most destructive and widespread frauds in recent history happened without anyone causing it -- except for Fabrice Tourre, apparently. Bank shareholders have certainly spent money on settlements, but the actual perpetrators, whoever they were, have gone unscathed. Given this backdrop, who would pour money into a rejuvenated "private-label" MBS market in sufficient size to offset a large decline in government support?
From the perspective of investors, lying about the quality of the loans they were packaging into securities wasn't even the worst thing the banks did. In many cases, banks failed to ensure that the securities they were selling were even legal. David Dayen explains the problem well in a recent column for Salon. It's worth taking the time to read the entire piece in detail, but the big takeaway is that "at least $1.4 trillion in mortgage-backed securities are, in fact, non-mortgage-backed securities." Dayen also notes that the defects plaguing bubble-era bonds have yet to be fixed.
Of course, the lack of proper documentation didn't prove much of an obstacle to banks that wanted to foreclose on delinquent (and current) borrowers -- they just forged the paperwork they needed. As I explained in a previous post, these fraudulent foreclosures harmed investors and the broader economy, although they boosted the earnings of the big banks.
State attorneys general and the Department of Justice eventually settled with the big banks over this practice. None admitted wrongdoing, and no individuals were punished. Far less money actually reached the victims of these fraudulent practices than was expected -- and many had to endure long delays before getting what little they were owed. As if that weren't bad enough, the court-appointed settlement monitor says that many of the banks are still breaking the rules. No one has been punished for failing to follow the law (again).
The government's failure to prosecute wrongdoing has created an environment of legal doubt that keeps investors away. (This is very different from the notion that regulatory "uncertainty" has been holding back business investment.) As my colleague Jonathan Weil recently noted, Attorney General Eric Holder has an embarrassing tendency to overstate the DOJ's record of prosecuting financial crimes. Not only are investors unable to trust the government to enforce the law -- they can't even trust the government to tell them how bad a job it has done enforcing the law. It all leaves you wondering why anyone would buy private-label MBS until that changes.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)