By Stephan Zimmermann, on October 27th, 2008
Will companies that issued derivatives based on bundled student loans be the next financial dominoes that will require a government “bailout”? The country’s long dedication to education makes it a virtual certainty.
The emphasis of the role of government in education predates the establishment of the United States as a country. As early as 1642, a year before the founding of Harvard, laws of the Massachusetts Bay Colony broke with English tradition of purely private education and introduced a role for the state. The law essentially suggested that the colony’s government would assume the duty of teaching children if parents failed to do so.
A century later, the new Congress of the United States enacted the Northwest Ordinance of 1787. It set forth the role and obligation of the state in education. Article 3 of the Ordinance stated that
Religion, morality, and knowledge, being necessary to good government and the happiness of mankind, schools and the means of education shall forever be encouraged.
Early in the 19th century, Horace Mann took a leading role in the advancement of public education. Both as a Senator from Massachusetts and later as Secretary of the State Board of Education in 1837, Mann was instrumental in establishing textbooks and libraries, doubling the wages of teachers, and securing state aid for education. He argued that the country’s wealth would increase by educating the public and should be borne by the taxpayer. He was immensely successful in the task. Mann ultimately became president of Antioch College in 1853, six years prior to his death.
The fundamentals for universal public education were established and accepted on both a private and state level. However, it took nearly three quarters of a century, in 1935, for direct federal government loans to be debated. First, government student lending began on the state level when Indiana initiated the waiver of fees to students who successfully competed in statewide tests.
By 1944, the Serviceman’s Readjustment Act (commonly known as the G.I. Bill) was passed. It was the first legislation to provide direct aid for students on the federal level. The bill was amended and expanded following the Korean and Vietnam conflicts. Now called the Montgomery G.I. bill, it forms a crucial benefit to men and women voluntarily joining the military services.
The next half century saw a rapid rise in various federal, or federally-guaranteed, student loans and grants. Loans are to be repaid at subsidized low interest rates, while grants are outright gifts, requiring certain criteria and qualifications.
Some examples include:
- National Defense Education Act was launched after Russia orbited Sputnik I in 1958. It was centered on science, mathematics and language. The federal program is now called the Federal Perkins Loan program for low-income students with ten years to repay at five percent interest.
- The Health Professions Educational Assistance Act 1963 for medical and health program students was later broadened to add scholarships in addition to loans.
- The most significant and sizeable is the Federal Stafford Loan Program. It was initially passed by Congress in 1965 as the Guaranteed Student Loan Program. The program used private banks and other lenders, guaranteed by the federal government.
- Outright grants, such as the 1965 Educational Opportunity Grant Program and the 1972 Basic Educational Opportunity Grant, now known as the Pell Grant, consist of outright gifts to students in low income brackets. Eligibility is based strictly on need.
Later yet, government educational funding started to be offered to middle and upper income families such as the 1978 Middle Assistance Act and the 1981 PLUS loans.
Finally, loan consolidations and the William D. Ford Direct Student Loan Program of 1993 expanded loans available directly from participating schools.
As the population increased, and students availed themselves of the increasing variety of grants and loans, so did defaults on student loans.
A report published in October 2007 by Education Sector, an independent non-profit, non-partisan think tank, shows that student loan default rates were approximately five percent. Twenty percent, the largest percentage of those defaulting, owed $15,000 or more after attaining a four-year undergraduate degree.
According to the report,
Black students who graduated in 1992–93 school year had an overall default rate that was over five times higher than white students and over nine times higher than Asian students. … Hispanic students’ overall default rate was over twice that of white students and four times higher than Asian students. (www.educationsector.com)
The current financial crisis offers some serious food for thought.
Most significant is that, unlike mortgages, student loans have no underlying asset value. While defaults on mortgages have the backing of real estate – no matter if it has depreciated in market value – student loans are unsecured. Recourse to recover default payments may exist through attachment of wages and other measures, including tracking of an individual through IRS records, but has no tangible value except the student’s future earning power.
Despite the high-risk exposure, private firms in the student loan industry, such as SML Corporation, generally known as “Sallie Mae,” realized some $18.5 billion in derivatives sales in 2007. According to Bloomberg.com on October 22, Sallie Mae lost $185.5 million for the third quarter, compared to $344 million year-to-date. The company increased contingencies for bad student loans by some 31%. It also had extraordinary legal expenses in connection to a failed sale of the company to a third party. The stock declined from a high of $48.24 to close at $4.50 October 22, year-to-year.
According to Bloomberg, SLM “is partly insulated from the crisis because the company’s loan portfolio is 82 percent government guaranteed. The U.S. Department of Education is offering funding for those loans through July 2010.”
SLM Corporation owns or manages some 10 million student loans in addition to its ancillary businesses of college savings accounts and collection agencies. It was originally formed in 1972 as a “government-sponsored entity” similar to Fannie Mae and Freddie Mac. It became a totally independent company in 2004.
The question remains: if SLM Corporation’s management underestimates its potential student loan defaults and overestimates its cash and asset positions, will the federal government be in yet another “bailout” mode?
The history of government’s historic and stated position regarding education is clear. It remains for legislators to determine how best to reduce or eliminate student loan defaults. Don’t let the fear of college debt keep you from getting your degree. See the affordable degree options available at Belhaven College.
Stephan is a former department chair for economics and taught at various colleges and universities at both graduate and undergraduate levels. If you would like Stephan to answer your economics-related questions, read his post “Got an Economics Question?” and submit your questions in the comments area there.
By Evelyn Black, on October 27th, 2008
Why, oh why, did the biggest financial crisis since the Great Depression have to hit during a presidential election year?
The ‘Fear Index’, also known as the VIX (or, officially, the Chicago Board Options Exchange Volatility Index) is a financial tool that measures market swings or volatility. The higher the VIX goes, the scarier the market looks, and the more panicky investors feel. Until very recently, few people had heard of the VIX and even fewer cared about it, but ever since the credit crunch took hold a few weeks back, the VIX has been a staple number on nightly cable news channels. On October 17, it hit 70.3, the highest fear rating ever recorded since the VIX was first introduced in 1993.
I don’t know about you, but I don’t really need a VIX rating to convince me that people are scared. Insiders and investment specialists do have a practical use for an exact day-by-day volatility measurement. People like me, however, who write for economics blogs and read the financial sections of the major newspapers for sport, tend to get a general sense of the mood of the country simply by watching how many people in our own communities are completely melting down at any given moment.
Here’s a basic formula I’ve devised that any nonprofessional can use to measure financial fear:
1) Take the number of personal friends and family members who have lost at least 30% of their 401(k), and 2) divide that by the number of emotional outbursts about the economy that you have personally fallen victim to on the day you are measuring, then 3) multiply that final figure by the chocolate available in your household by 10:00 p.m. on any given weeknight, and 4) eat all the chocolate before someone else in your house gets to it.
Perform that equation and I guarantee you will discover that Americans are pretty scared right now.
Sadly, fear is a big stick that can be useful in political campaigns, especially with only days left until November 4th. Think you might need some help with that adjustable rate mortgage pretty darn quick? Socialist! What, do you think the government is supposed to wipe your chin and put you to bed! On the other hand, do you think you deserve the tax breaks you got under George W. Bush for finally, after 50 plus years, making it to a 50% income bracket? Fat cat! What are you, some kind of AIG executive or something? I’ll bet you eat homeless people for breakfast, you scoundrel!
The rhetoric surrounding the already significant economic mess is off the charts emotionally right now, and I submit it does not help the current situation one bit. What can we make of the term ’socialist’ in an environment in which the U.S. Treasury has just admitted it is considering nationalizing the banks? Which is more ’socialist’: a nationalized banking system, or a universal healthcare system? Don’t taxes by definition always redistribute wealth (unless we’re talking about a flat tax, which we aren’t)?
On a related note, if people who earn over $250,000 are actually about to be financially eviscerated by Barack Obama’s plan to rescind the Bush tax cuts, how is it that Cindy McCain paid just 20% of her 2007 income ($2 million of a total income of $10 million) but my household got stuck paying 27% on a microscopic fraction of that amount? OK, I know that question isn’t entirely logical, but it does beg a related question: Are taxes really the central issue here? Or do we just need access to much, much better accountants?
The economic political waters are about as muddy as they can get right now, and that’s useful because confusion and rhetoric throws people back on their own fears and emotional prejudices instead of their capacity for rational analysis of the issues at hand.
I’ll be frank: I have no clue what is going to happen next.
There, I said it.
You know, there are people in the world who spend years and years in Zen meditation practice just to someday, hopefully, somehow, train their minds to live completely in the present moment. Here in America, we’ve suddenly been given that gift free of charge by means of a financial meltdown. If we want, we can choose to simply admit that we are at a completely unrecognized moment in historical time, that no one is certain how this is all going shake out, and then we can just wing it, as it were.
That’s what will ultimately end up happening anyway.
In Zen meditation, when practitioners get caught up in projecting what might or might not happen and in thinking so fast it starts to make a soft whirring noise inside their own heads, the Zen master will often come up behind that practitioner and whap him or her upside the head with a big stick to snap that person out of it. Right now I see an excess of stick wielding Zen masters and a shortage of humble practitioners. If one more Zen master starts in on my own head, seriously, I’m going to…
Well, I’m going to do exactly what I’m currently doing: baking lots of chocolate things and eating them while I still can.
Here’s the scoop (as I understand it): We are either in for the hardest, longest recession in U.S. history or a mild downturn of one to two years followed by complete recovery. We are either about to become a socialist nation with requisite neo-WPA posters in every heavily-taxed home, or else we’re about to give the obscenely wealthy all the rest of our money and stuff, whatever little we have left, even our cats. These dueling outcomes will destroy us by fire or ice, but the important thing for us to understand is that, either way, we will indeed be destroyed.
No wonder people are scared!
I submit we may soon be looking at C) None of the above.
In the meantime, keep your stick to yourself, would you please?
 Join the forum discussion on this post - (1) Posts
By G.L.C., on October 24th, 2008
More than 20 countries have set up sovereign wealth funds while a dozen more have expressed interest in establishing them. Many of these sovereign wealth funds are picking up stakes in U.S. companies, which is raising concerns about the need for regulating them. Up until the $700 billion bailout, which effectively is a U.S. Treasury-directed fund, the United States did not have a sovereign wealth fund.
This fund is the world’s largest, beating the $600 billion sovereign wealth fund of the oil-rich emirate of Abu Dhabi in the United Arab Emirates.
The fund has many characteristics of sovereign wealth funds. It endorses the latest trend – the most powerful financial entities are not risk-happy investment banks but state-sponsored investment entities that are more cautious.
So far, the United States government has stayed away from investing in the markets. The fund presumes that the government must play a crucial role in deciding how best to deploy a nation’s investment capital.
Critics have long argued that sovereign funds be allowed the privilege of holding positions in public companies when the U.S. government did not do so. When the fund was approved by Congress, it took the sting out of this argument. But there is a difference between this fund and sovereign wealth funds. Sovereign wealth funds invest surplus funds, and in many cases they are doing so abroad for the purpose of financial diversification. The money for this fund has to be borrowed by the Treasury: $700 billion. It will only be investing in the United States. It will make no investments abroad.
The mandate to the fund is clear - avoid further financial collapse by extending a lifeline to U.S. institutions hobbled by their exposure to toxic mortgage assets. This is similar to the goal of sovereign wealth funds – advancing national economic goals. The only difference is that sovereign wealth funds openly state that their goals are political. This fund on the other hand seeks the best prices for the assets it buys.
There are some who feel that the fund does not resemble a sovereign wealth fund, but some sovereign wealth funds are beginning to look like the fund. The present credit crisis is not restricted to the U.S. alone. It is having a worldwide impact. There is tremendous pressure of many of the sovereign wealth funds to come to the rescue of home markets that have wobbled in recent months.
The U.S. Treasury fund’s mandate will run out after two years. But the government might have other ideas if, at the end of two years, it has more than $1 trillion in assets - it has the benefit of starting to buy at what may well be the rock bottom. It could become a permanent fund, and its mandate could be broadened to allow it to invest abroad. It would then become a full-fledged sovereign wealth fund.
By Evelyn Black, on October 20th, 2008
A recent article splashed across the front page of the mid-size mid-western city where I live tells a surprisingly unfamiliar story about how ordinary people have pocketed hundreds of thousands of dollars by investing in subprime real estate. Though the current financial crisis has brought about intense discussion about the moral hazard of borrowing beyond one’s means, as well as the irresponsible underwriting that went hand in hand with the subprime borrowing fever, much less attention has been paid to the phenomenon of mortgage fraud.
We know mortgage fraud mushroomed during the boom times of subprime loans. Yet it continues to hover just off the main radar screen, remaining conveniently just outside of public awareness. What exactly is mortgage fraud anyway?
In the case recounted in my local paper, two men–let’s call them Mr. Smith and Mr. Jones–decided to go into the real estate development business by buying up properties in depressed neighborhoods, ‘flipping’ (that is, renovating) the houses they bought, and then selling the houses or renting them out and thereby making a profit on their investment.
So far, that doesn’t seem like a bad idea, especially when credit is readily available and the houses in question are close to a university or a major manufacturing center, or are part of a boom market like some areas in Florida or California. We’ve all watched TV shows on the Learning Channel and on the Discovery Network that chronicle the adventures and misadventures of these flipping entrepreneurs, and many of us have vicariously enjoyed their journeys while eating Cheetos and keeping our own hands soft and clean.
What we don’t see, however, are the house flippers who never flip, never sell, and then default on the loans.
Here’s how it works:
Mr. Smith buys a home in a slum neighborhood for $20,000. He hires an appraiser to value the home at $80,000. The appraiser is committing a crime at this point–the house is not worth $80,000 in anyone’s imagination–but the appraiser and Mr. Smith know each other and are working together to defraud the mortgage industry. Mr. Jones comes along and offers to buy the house (which is actually worth $20,000 or slightly less but is now appraised at $80,000) for $100,000. Mr. Jones is a ’straw buyer’. He doesn’t really want to own the house; he is working with Mr. Smith and the fraudulent appraiser.
Mr. Jones approaches an out-of-state mortgage broker who, not knowing or caring too much about the value of local real estate, is only too happy to make Jones a loan of $80,000 or even $100,000. When Mr. Jones explains he will be improving and then reselling this hot property, the broker envisions repeat business and repeat commissions when Jones buys and flips his other houses.
Mr. Jones then repeats this same process with a dozen or more other properties, all in league with Mr. Smith and his fake appraiser. They pocket the profit on the homes ($60,000 or $80,000 on just the first one alone) and then Mr. Jones proceeds to default on every single mortgage, sticking the out-of-state company who wrote the first mortgage with a $100,000 debt on a nearly worthless house.
 Although FBI tables show that mortgage fraud has increased dramatically in recent years, the cases that are actually investigated are really just the tip of a very large iceberg. The FBI doesn’t have anything close to the staff it needs to launch a thorough and comprehensive investigation into this kind of scam because of the sheer volume of cases since 2006 alone.
In my own town, with our own local Mr. Smith and Mr. Jones, neither man has ever been formally charged with anything and neither have paid anything to the mortgage companies that made them the loans. The FBI will neither confirm nor deny whether the two of them are under investigation for fraud. These two men, under their own initiative, have purchased, sold, and defaulted on over 60 homes in the worst neighborhood in this city over the past two years for a net profit of over $1.5 million for Mr. Smith and over $750,000 for Mr. Jones. Their defaults account for more foreclosures in that specific neighborhood than all the other individual foreclosure cases combined.
Both Mr. Smith and Mr. Jones now claim to be disabled and speak to the press only through their spouses, who both insist no wrongdoing has occurred. None of the homes were ever rented or improved. All of them are currently vacant and in a state of serious disrepair. Mr. Jones never took out a single building permit. He claims that he planned to do the work himself but health issues intervened.
Is it possible that these two men are just a couple of enterprising fellows who fell down a flight of stairs at the same rather convenient time? I guess so. Is it likely?
What do you think?
A new and particularly nasty wrinkle on this scheme is called foreclosure fraud. While many different scenarios can be set up, by far the most common involves a ‘foreclosure rescue’ agency that approaches (or is approached by) a longtime homeowner behind on his or her house payments. You’ve probably seen signs posted around your town that say, “We Buy Houses!” Many of these agencies are set up to defraud people in danger of foreclosure. If you try to track them down or investigate them, all you will find is a list of post office boxes and vague nonspecific names attached to no specific person.
Here’s how it works: The foreclosure rescue agency offers to buy the house from the mortgage company about to foreclose on the property and then rent it to the homeowner for a set period of time, during which the homeowner hopes to improve his or her financial situation. At the end of that mutually agreed-upon period (typically two or three years), the foreclosure rescue agency promises to then resell the property to the homeowner on terms they can actually afford. The rescue agency claims to make their money on fees and appreciation, the people get to stay in their house, and everybody is happy.
Except, what really happens is that the minute the homeowners sign the house over to the ‘foreclosure rescue’ folks, the rescue agency runs right out to the easiest lender on the farthest block, cashes out the equity in the home, then disappears off the face of the earth, leaving the homeowner still about to foreclose and owing more in some cases than the house is even worth.
 Foreclosure fraud is off the charts in recent years and is growing so fast no one is quite sure how many people have been hit. If you are in danger of foreclosure, read up on some of the most common schemes before you agree to talk about your situation with anyone except your original lender.
As we listen to the most recent attempts to bail out and/or stabilize the U.S. economy, we have also been hammered by lots of campaign rhetoric meant to push our emotional hot buttons by assigning blame for the current mess to individuals we might already mistrust or dislike: certain ethnic groups, minorities, members of certain financial occupations, Wall Street bankers, mortgage brokers, Democrats or Republicans, and so forth. What we are witnessing is a veritable frenzy of blaming, and it gets to be contagious. For some reason, it feels reassuring in times of crisis to find a scapegoat, to blame somebody, anybody, for what is happening. Blame, when properly or improperly placed, always creates the illusion of control. We think that if we find the right person or persons to blame, we can then proceed to hold them accountable and then fix the problem at hand.
While the need to assign blame is completely understandable, especially in an election year, it unfortunately obscures the sheer volume of criminal activity that took place at every level of commerce during the height of the housing bubble. Even at the most basic level–the level of buying a single house–an underpaid local reporter was able to uncover millions of dollars of what was, for all intents and practical purposes, most likely out and out fraud. And that’s just in one small mid-western city. All the poor people on that entire side of town didn’t cause as much damage as those two guys and their fast thinking. And that’s at the very lowest, most transparent level of the whole mess. Now multiply that scenario by every city in the U.S., and square with every level of finance and speculation, and you’ve got the mother of all criminal messes.
So far, few people are going to jail for any of this. But maybe at some point a few should.
At the very least, it’s food for thought.
By J.D. Seagraves, on October 9th, 2008
On October 1, 90-year-old Addie Polk, distraught over her home’s impending foreclosure, shot herself twice in an attempted suicide.
Fortunately, Ms. Polk’s attempt was unsuccessful. Even better for her, Fannie Mae – which had taken possession of her mortgage after numerous missed payments – forgave Ms. Polk’s debt and signed the house over to her, free and clear.
What part of this story makes any sense? A woman shoots herself after falling behind on payments she agreed to make, and, as a reward, she gets a free house? Since when did Fannie Mae, now essentially a wholly owned subsidiary of the U.S. government, get into the Extreme Makeover: Home Edition business?
In 2004, Ms. Polk took out a 30-year mortgage for $45,620 at 6.375% interest. That same day, she also took out a line of credit for $11,380. Four years later, her inability to make her payments had reached the point of foreclosure. Police had made 30 attempts to evict her before the October 1 shooting incident.
Now, you can feel sorry for Ms. Polk all you want. But the fact of the matter is that she took money and agreed to pay it back, and she didn’t. Yes, the lenders may have “taken advantage of her” – only because they knew the government would step in and bail them out if Ms. Polk and others like her couldn’t pay – and yes, the Federal Reserve System creates money and credit out of thin air, which is “predatory” by its very nature. But these were the rules of the game when Ms. Polk took out her loans, and if she didn’t know them, she had no business playing.
What message does Fannie Mae’s forgiveness of this loan send to other people facing foreclosure? Attempt suicide, and if you’re lucky enough to survive, you get a free house? This story is a fitting microcosm for a corrupt system in which lenders are criticized for making loans to people who couldn’t repay them and then are rewarded with a $700 billion bailout as “punishment.”
Under a free market, interest rates would be set by savings and investment. No entity would have the power to create money and credit out of thin air and, as a result, no “predatory” lending could take place. When companies made bad loans, they’d suffer the consequences, and when people took secured loans they couldn’t repay, they’d lose the underlying properties.
The free market is self-correcting. But what we have in America is far from a free market. As one Republican congressman put it, we have “capitalism on the way up, and socialism on the way down.” In order to maximize utility and respect individual rights, we must return to a more laissez-faire form of capitalism where the people who take bad risks – both mortgagor and mortgagee – are made to bear the consequences of their actions.
By G.L.C., on October 6th, 2008
The Federal takeover of Fannie Mae and Freddie Mac has not put an end to the woes of these two companies. The two companies have now received subpoenas from federal prosecutors in New York seeking information on the companies’ accounting, disclosure, and corporate governance. The two companies have also received requests from the Securities and Exchange Commission that they preserve documents.
The investigation focuses on activities starting in 2007. The bookkeeping practices of the two companies have always been questioned by critics. In fact, a Fortune magazine story said new accounting procedures at Fannie Mae masked potential losses on bad loans.
Accounting irregularities are nothing new to Fannie Mae and Freddie Mac. Both have had to restate earnings in past years following discoveries by federal regulators of irregularities on the companies’ books. Few years back, both companies were forced to restate billions of dollars in earnings after federal regulators discovered accounting irregularities at both companies. The scandal led to the replacement of the companies’ top executives. Freddie’s former chief executive, Gregory Parseghian, was ousted in December 2003. Fannie Mae CEO Franklin Raines and Chief Financial Officer Timothy Howard were swept out of office a year later.
Fannie Mae has also paid a record $400 million to the SEC in 2006 to settle charges that senior executives fraudulently used “cookie jar” reserves and other accounting gimmicks to hide $10.3 billion in losses from 2002 to 2004 to maximize bonuses.
Freddie Mac paid $125 million in fines in 2003, while earnings between 2000 and 2002 were restated after it discovered derivative-related errors after replacing one of its former auditors, Arthur Andersen. At the time, regulators charged that the company manipulated its accounting to push about $5 billion in earnings to future quarters.
The two companies have been in the conservatorship of their regulator, the Federal Housing Agency, since the government seized them. There is increasing pressure on the administration to hold accountable the companies and top executives. Both companies have said that they will cooperate fully with the prosecutors. The Federal Housing Finance Agency, which controls the companies, said that it will work with the companies to assure a smooth and efficient process and will work with the government agencies as they undertake their inquiries.
The Federal Bureau of Investigation is already looking at potential fraud by these two companies and insurer American International Group, Inc. The inquiries will focus on the financial institutions and the individuals who ran them. A number of members of Congress, including several on the Senate Judiciary Committee, have urged the FBI to be more aggressive in pursuing possible criminal charges against major players in the crisis. If the top executives of these companies were cooking the books, manipulating, doing things they were not supposed to do, then every American taxpayer would want them held responsible.
By J.D. Seagraves, on September 19th, 2008
On Monday, the Dow Jones Industrial Average – the bluest of Wall Street’s blue chips – lost 4.4% in a single day. Fannie Mae and Freddie Mac have been “seized” by the government. Oil continues to drop while gas prices rise. Inflation runs high while jobless claims continue to soar and gold falters. What a strange economic cocktail! Let’s look at the issues one by one:
First, “Black Monday.” It was prompted by the announcement that investment-banking giant Lehman Brothers would be filing for bankruptcy protection. This, after a weekend spent trying to negotiate a government bailout. For once, the government blinked. A week earlier, the markets soared on the news that the feds had “seized” control of the mortgage industry through Fannie Mae and Freddie Mac. Smart traders who hadn’t already taken the hint knew that those gains were illusory.
Now how is it that oil can continue to fall while gas prices have been on the rise? Two words: Hurricane Ike. It threatened refining capacity, which has nothing to do with the price of crude oil but everything to do with your pain at the pump. The real question is why does oil keep falling? That’s actually a troubling sign given the inflation being felt elsewhere in the economy. And the answer is: demand is softening…even in the face of monetary expansion. That does not bode well.
Is there really any question why consumer prices continue to rise? It can’t be blamed on OPEC (oil is dropping), or greedy corporations (profits are down), or labor unions (they hardly exist anymore), or the greatest scapegoat of them all, illegal immigrants (they’re moving back to Mexico!). No, instead, we’re finally confronted with the reality that the Federal Reserve creates “price inflation” (higher prices) through monetary inflation (creating new money). Just this past Tuesday, they unleashed another $70 billion into the economy. Think that won’t find its way into the price of your milk? Think again.
That jobless claims continue to rise shouldn’t confuse anyone unless they’ve had an economics class recently. Just three years ago, when I was taking introductory Micro- and Macroeconomics courses, my professors still taught the widely discredited Phillips Curve – the Keynesian idea that there’s a “trade-off” between inflation and unemployment (i.e., if you have high inflation you should have low unemployment and vice versa). Of course, this was objectively destroyed by the 70’s stagflation, and we’re headed there again.
But how is it that gold, presumably a measure of the dollar’s value, is falling even as dollar-denominated consumer prices rise? Well, as I stated earlier, it’s because gold was overbought – with Fed-created fiat money – and became its own bubble. As the Fed continues to inflate, though, look for gold to rise.
By G.L.C., on September 18th, 2008
The present financial crisis has resulted in an increase in the number of lawsuits filed in the country. The mortgage meltdown is forcing financial institutions to leave the negotiating table and turn to the courts to resolve subprime-related disputes with their partners. In the past, large financial institutions often shied away from suing each other, preferring to work out problems quietly because they did not want to jeopardize future business relationships. Now, if the cases filed in the courts are any indication, then these companies are dropping their reluctance to sue each other.
HSH Nordbank AG is suing UBS AG in a New York state court over losses HSH sustained on a $500 million portfolio of collateralized debt obligations linked to the U.S. mortgage market. M&T Bank Corp sued Deutsche Bank AG and others in June to recover more than $82 million it said it lost by investing in collateralized debt that had been billed as nearly risk free. Another lawsuit involved Barclays PLC and the now defunct Bear Stearns over the high-profile collapse of two mortgage-linked hedge funds.
The severity of the subprime losses means that more such corporate disputes are likely to land in court. The stakes involved are so high, and many experts are not surprised about the increase in the number of lawsuits.
The increase in litigation is not restricted to litigation between financial institutions. A study by Navigant Consulting found that the volume of private lawsuits in the U.S. stemming from the current financial crisis has already surpassed levels seen in the aftermath of the savings and loan debacle two decades ago when 559 lawsuits were filed over six years. From January 2007 to the end of June of this year, 607 civil cases were filed in federal courts. These cases related to the meltdown in the subprime mortgage market. More than half of the lawsuits were filed in the first six months of this year.
As the present crisis gets more serious, the litigation will also increase. The result of the study is scary – it shows only the lawsuits filed in federal courts and doesn’t reflect the number of lawsuit filed in the states.
As the present crisis deepens, we are likely to see an increasing number of bank failures resulting in another wave of lawsuits. Eleven banks have already been seized by regulators.
A study by Stanford Law School and Cornerstone Research found the number of class action lawsuits filed against Wall Street firms surged in the last year, fueled by the meltdown in the subprime mortgage market. There was a 43% jump in the number of securities fraud class action lawsuits last year. Forty-seven Wall Street firms sued in 2007, more than four times the number sued in 2006. New York City’s retirement and pension funds for city workers filed lawsuits against mortgage lender Countrywide Financial Corp., claiming the lender misrepresented the risk of its mortgage-backed securities.
An increase in volatility in the market, like the one that is now taking place as a result of the subprime mortgage problems, is directly correlated to an increase in the number of lawsuits filed. If economic conditions were to decline in the future, then a strong resurgence of lawsuits would likely follow.
By Evelyn Black, on September 17th, 2008
OK, I know Lehman Brothers just tanked, Fannie and Freddie have been seized, and AIG has been taken over by the Fed, but can we put all that aside for just a few minutes and talk about me for a change, please? I have liquidity problems of my own, and that being the case, I only have so much patience for Wall Street melodrama anyway anymore. It’s getting exhausting. I mean, seriously, what are are you and I going to do about it right this minute? Won’t things still be totally, terminally screwed up tomorrow? Am I right? Of course I am. So let’s take a little “me” break today for a change of pace.
Here’s what’s going on this month in Evelyn’s life:
Last Friday, I got a letter from the escrow department of my mortgage company letting me know that the dying, rust-belt city where I still own a small house in a bad neighborhood (because I couldn’t sell it after I moved to another state to take a job) has decided to hike my property taxes by $610 a year, thus causing a shortfall in my escrow account. I now have a choice. I can send the mortgage company $610 today, or I can pay an extra $50 each month on the house payment for the next twelve months.
The city, which is in northern Indiana, was once a major manufacturing center but has been decimated in recent years by the fall of the U.S. steel and auto industries. The government there is now in serious financial trouble. The tax base has eroded, companies have moved overseas, businesses are failing, unemployment is off the charts, and now, thousands of people are losing their homes to foreclosure.
Because the situation is so dire, and because the city has already cut essential services to the bone and still can’t generate the revenue needed to maintain normal operations (not public services, just day-to-day government operations), the city has seized on an opportunity and is hiking property taxes in the poorest neighborhoods so that the owners will be forced into foreclosure and the city can then sell the property back to the mortgage companies for pennies on the dollar (plus the cost of the back tax bill).
That strategy is indeed generating a small but steady stream of revenue for my old home town. It is also creating boarded up, bombed-out slum neighborhoods full of squatters, crack addicts, and meth labs, just like inner Detroit or the neighborhoods in Flint, Michigan. My dying city is literally eating itself to stay alive, and appeals by concerned citizens to turn the trend around fall on deaf ears. When there is nothing else to eat, we eat each other. Just shouting, “Stop it!” isn’t effective in such situations, no matter how passionate the shout may be.
“Scrapping” (the practice of pulling scrap copper and steel out of abandoned homes and buildings) has become a huge cottage industry here, and though such break-ins are illegal and the trade is dangerous, it continues to grow. A few months back, two homeless men were killed by other scrappers who wanted their haul. They stole the stolen scrap from the men, killed them, and stuffed them down a manhole. Such is life in the post-industrial Midwest in 2008.
On the block where my little house is located, fully half of the buildings are vacant and boarded up. I had my house on the market for a year and a half, asking only what was left on the mortgage and offering to pay all closing costs, everything negotiable. Not one person ever viewed the house, much less made an offer. The house has a new roof, a new furnace, new siding, and new appliances, and I couldn’t get anyone to even view it, much less make an offer, and this at a negotiable asking price of $39,000.
After a year, my real estate agent started to get testy. “People want nice kitchens and bathrooms. Why don’t you put some money into these two rooms and see if that helps?” I have no money to put into upgrading a house in a slum neighborhood in a dying city; I can barely pay my own bills where I am, and honestly, if no one is looking at the house, what difference would it make if I installed gold leaf appliances? A house two doors down is still for sale for $8900. Four years ago, when I bought this house, it was in a nice neighborhood. A new grade school was built right across the street in 2005. All that doesn’t matter.
So when my realtor asked me after a year and a half of not showing my house even one single time why didn’t I remodel the place, I said, “Why don’t you?”
That was the end of my realtor.
After flailing around for a couple more months once the realtor fled, I was finally able to rent the house to my daughter’s mother-in-law. She likes it there, and renting to her also means that our kids get to keep their privacy. But now, with the tax increase, I pay more on the mortgage than I take in for rent. I still take the homestead deduction because, if I don’t, the property taxes will shoot up to $4000 a year on a house I can’t sell at any price: not for the $37,000 I owe on it, not for $20,000, and not for $4000.
People tell me, “Walk away. Don’t waste another cent.” But I do still see some good coming out of renting it: one less bombed-out house in my town, a place where my daughter’s mother-in-law is happy, the knowledge that I am not directly contributing to the decay of a major urban center. So for now I will pay the extra $50 a month and pray for the best. But I know it can’t last.
Like a lot of Americans right now, I am always one disaster away from bankruptcy. So, apparently, is our entire financial system. That cheers me up a little bit (as in, at least it’s not personal), but it’s hard to maintain my good humor when I keep getting love letters from the city, the mortgage company, the insurance company, and God knows who else. I get depressed sometimes. And now the bank where I took the job (the one that landed me farther north with an unsold home in Indiana) is on a short list of four or five big regional banks most likely to tank in the near future, right behind WaMu.
So, OK, Wall Street is (once again) having a very, very bad week. That’s a problem. Pundits are all over the TV and radio explaining that this promises to be the worst financial disaster since the Great Depression, and that no easy fixes loom on the horizon. A hard correction is in process, they say, and it won’t be finished this year, next year, or maybe the year after that. (A few weeks ago, these same pundits were saying that it was way too early to call the current economic slowdown a recession.)
Here’s what bugs me today: while Wall Street is having its Very, Very Bad Week, Main Street is having a very, very bad yesterday, today, tomorrow, and what’s more, a fairly miserable foreseeable future. For every Bear Stearns that goes down, thousands of cities lose jobs, tax income, and infrastructure. For every Lehman Brothers that cashes in, millions of people like you and me lose homes, cars, and retirement benefits. For every AIG that goes bust by betting high on the wrong horse, another couple generations of kids can kiss college and all hope of progress goodbye.
So yes, I’m worried about Wall Street.
What I want to know is, when will Wall Street worry about me?
|
|
Most Popular Posts