Economy from The Washington Independent - U.S. news and politics - washingtonindependent.com

Excuses, Excuses

Mary Kane — Fri, 16 May 2008 15:35:24 GMT

In Orange County, Calif., home foreclosures hit a new record during the first quarter of 2008. The housing crisis here and in other parts of California is part of everyday life, with foreclosure bus tours, blogs dedicated to the housing market's woes, and constant chatter about real estate.
But when it comes to the mortgage rescue plan in Congress, some in Orange County are saying "No thanks."

Even before the Senate tries to work out a compromise on a bill to use government money to insure $300 billion worth of home loans, the Orange County Register already has weighed in. In an editorial denouncing the entire notion of government help for borrowers, the paper urged President Bush to veto the bill. Any bill. No matter what how it ends up.

What's fascinating to me is one of the reasons why the paper is so opposed:

It has become fashionable to blame the mortgage crisis on "predatory" lenders who have aggressively pushed bigger mortgages than people can afford to pay onto hapless homebuyers. Insofar as some lending was fraudulent, appropriate legal remedies are readily available. It should be noted, however, that the government itself pressured lenders to make mortgage money available to people with marginal credit.

Actually, I think the editorial is particularly off track here. The trend goes the other way: It's more fashionable lately to cite "the government made me do it" theory as to how lenders got into trouble in the subprime market.

I would need the word length of a magazine article to go into all the reason why that argument is ridiculous. But let me point out just one: During much of the housing boom, interest rates were at historic lows. The only way to make some money in the mortgage market was to move into higher yield subprime loans. I can't imagine lenders crying and wringing their hands as the government forced them to seek profits in the housing market.

But then again, I don't live in Orange County, Calif. Apparently it's a different world there.

Housing Advocates Score a Big One

Mary Kane — Fri, 16 May 2008 13:31:01 GMT

I just got off the phone with David Berenbaum, and he is one happy housing advocate.

Berenbaum, executive vice president of the National Community Reinvestment Coalition, said Fannie Mae's decision to drop using zip codes as a basis for loan decisions is big victory in the fair housing fight. Fannie Mae announced the changes today. Berenbaum's group led the fight against the policy.

In an e-mail to his group's membership, Berenbaum wrote that "This is a very positive development and it is a direct result of our intervention."

Berenbaum said the hope among housing advocates is that Fannie Mae's move will encourage its competitor, Freddie Mac, and other lenders and private mortgage insurers to also make similar changes and discard using zip codes to determine loan prices.

Berenbaum's group contended that using zip codes where home values are declining as a basis for requiring higher downpayments or fees amounted to redlining. The policy changes, he said, mean Fannie will move to a "national pricing model" rather than using different underwriting standards for high foreclosure areas. This means borrowers in those areas won't necessarily pay higher downpayments, or in some case, higher fees, based solely on where they live.

Housing advocates don't have an issue when entire metropolitan areas, or even states, are tagged as declining markets, because then the risks and costs are shared fully among all borrowers. Redlining comes into play when lenders specify zip codes as declining and charge certain groups of borrowers more.

Fannie Mae's move may be just the beginning of lenders coming to terms with pricing issues raised by the housing crisis. The Federal Reserve and the Federal Trade Commission are considering requiring lenders to disclose any decision to base a mortgage loan price on something other than credit scores. Berenbaum said he's also supportive of that change.

Even with these developments, there are still battles ahead. Pricing mortgages has been a source of controversy for several years now. Berenbaum calls loan fees a less overt form of redlining, or "discrimination with a smile." Housing advocates who want to make sure a new form of redlining doesn't reappear as the mortgage market shakes out expect they'll be facing many more fights ahead.

But for today, at least, score one for Berenbaum's side.

Fannie May Alter Redlining Policy

Mary Kane — Fri, 16 May 2008 13:19:39 GMT

As we wrote yesterday, a policy by mortgage industry giant Fannie Mae to require higher downpayments and fees for borrowers in certain zip codes with declining house values raised charges of redlining. A powerful coalition of housing advocates and even lending industry groups such as the National Association of Realtors quickly challenged it.

It seems their efforts are paying off. Fannie Mae is expected to announce today that it will make changes to the policy, the Wall Street Journal reports.

Fannie apparently will no longer require higher downpayments for borrowers in certain zip codes. It also may allow for more flexibility, so if appraisers can prove that home values in certain neighborhoods are rising, then those communities won't be designated as declining markets - even if the metropolitan areas that surround them are experiencing price declines, the Journal said.

The move comes as Fannie Mae and the lending industry as a whole have been charging higher fees for some borrowers based on where they live, prompting charges of a new kind of redlining that will price out of the market first-time homebuyers and those with modest incomes.

There's no word in the Journal report about whether Fannie still will charger higher interest rates to those categories of borrowers. Some housing advocates had less of a problem with higher downpayments, saying that if they are combined with careful and accurate appraisals, they can be a legitimate way for lenders to make loans without taking on too much risk. But higher fees based simply on a borrower's neighborhood, they said, only would make it harder for some borrowers to pay their mortgages and would actually add to a loan's risk.

The fight over the policy shows how contentious lending may become as the housing market reacts to the credit crunch caused by the subprime market's collapse.

From the Journal:

The concessions from Fannie and Freddie illustrate the conflicting pressures that they are facing. Many critics say they are taking far too many risks, increasing the danger that taxpayers may end up having to bail them out.

But politicians and the housing industry are pushing them to do more to prop up the housing market.

Regardless, any changes to the policy represent a victory of sorts for fair housing advocates, who don't usually win battles this quickly.

Redlining Redux

Mary Kane — Thu, 15 May 2008 13:29:42 GMT

This story has been updated to reflect news that broke after its publication.

In the middle of the housing boom, when virtually anyone could get credit, redlining wasn't even in the picture. It was an almost forgotten remnant of the past -- a piece of lending history that involved lengthy legal battles and community organizing work to change a dark banking industry practice of denying credit based on where people lived or because of their race. But now, in the aftermath of the mortgage market meltdown, the cost and availability of credit for some borrowers is again becoming a concern -- raising questions about whether a new kind of redlining is on the horizon.

A recent policy by the mortgage industry to charge higher fees for loans to borrowers in certain zip codes has been behind some of the concerns. It quickly led to charges of redlining and violations of fair housing laws. That reignited old battles over access to credit -- fights that housing advocates thought they had settled years earlier.

Those advocates - the veterans of many past housing wars -- responded swiftly, and aggressively, though no one predicted during the housing boom that the lending industry might even consider going down this road again. They formed alliances with realtor's groups, and they challenged moves by lenders to make credit more costly or unavailable to certain groups of borrowers.

Their work paid off. Mortgage giant Fannie Mae on Friday announced it would no longer assess loan risks by using a "declining markets designation," meaning borrowers in certain geographic areas would pay more for loans because their communities show a higher rate of foreclosures, short sales and falling home values. Fannie Mae, Freddie Mac, other lenders and private insurers have been using the designation for a few months, as part of their automated underwriting systems. In some cases, a borrower doesn't know whether he resides in such a market until he applies for the loan.

If the notion of extending or pricing credit based on a borrower's neighborhood sounds suspiciously like the redlining practices of old, in which lenders refused to lend money in poor and minority communities, well, that's because it is another form of redlining, plain and simple, fair housing advocates say. Even though Fannie Mae has agreed to no longer use different underwriting standards for borrowers in high foreclosure areas, other lenders and insurers still employ the practice.

"It's our position that loan underwriting based on zip codes is a modern form of redlining," said David Berenbaum, executive vice president of the National Community Reinvestment Coalition, which represents fair housing groups. "I don't have a problem with lenders looking closely at the economics of the marketplace to ensure they are able to do business and are able to lend. But they need to do it in a way that doesn't have a discriminatory impact on neighborhoods and on certain groups of borrowers. This is just sort of a knee-jerk reaction to a difficult marketplace."

Gregory Squires, a George Washington University sociology professor who has studied predatory lending and redlining practices warned, "This should have set off alarm bells."

The fight over the policy shows how contentious things may get over access to credit as the mortgage meltdown shakes out. In many ways, lending to low-income and minority borrowers has come full circle -- from redlining practices that denied them access to loans in 1950s and 1960s, to the "democratization of credit" in the 1990s that led to a credit glut and predatory lending, or reverse redlining, as Squires has described it.

Mortgage brokers and lenders began aggressively marketing subprime loans in the same neighborhoods once written off by traditional lenders, selling high-rate mortgages with hidden costs and fees. In neighborhoods long cut off from credit, these transactions, involving readily available mortgage money, often took place door to door, or by word-of-mouth spread through local churches.

Black and Latino borrowers were far more likely to take out high-priced subprime loans than white borrowers, even when their credit scores were similar, research shows.

This kind of lending came well before the housing bubble that began in 2005. That was when the subprime practices and lax underwriting spread to the rest of the mortgage market -- especially in California, Florida, Nevada and other areas with hot housing markets, that attracted investors, house-flippers and mostly prime borrowers.

With so many loans gone bad, the subprime market no longer exists. Wall Street investors, accused of turning a blind eye to subprime abuses in their pursuit of profits, are wary of providing capital for new loans. As lending standards tighten, first-time home-buyers and borrowers with modest incomes now sometimes find themselves priced out of the mortgage market, even with the falling values that make some homes more affordable.

Once the credit squeeze eases, however, it's still not clear that the problems with loan pricing will end. The declining markets designation is just one example of how the market may have changed for good as a result of the housing collapse.

Housing advocates fear that all the progress made in four decades of fair housing fights will be set back significantly. The zip code controversy, they say, shows that borrowers with modest incomes could wind up paying higher prices or find mortgages or refinancing out of reach, directly as a result of speculation and lax lending standards among lenders and prime borrowers at the top of the market.

"It's all quite disturbing," said Patrica McCoy, a University of Connecticut law professor who has studied subprime securitization. "We're on this precipice of another transformation in the mortgage market. Every single pillar of the market has to be rethought. We're back to the drawing board and we're not sure how all this is going to play out. It's a fairly precarious time for fair lending."

Adding to the uncertainty is the fact that even as the future of lending opens up to debate, its past is being reconsidered.

Some lenders and investors contend that the subprime mess stemmed from the financial industry being forced by government regulations, like the Community Reinvestment Act, to make bad loans in poor neighborhoods. At mortgage banking conferences, academic seminars and in the blogosphere, the notion has taken hold and grown in the same way as an urban myth does.

The CRA was created by Congress in 1977, as a way to combat redlining. It required banks to make sure credit was available in the communities in which they operated. In the 1990s, CRA ratings for banks took on increasing importance, with regulators citing them when institutions applied for mergers or expansions. Regulators could deny a bank acquisition of another financial institution based on a poor CRA rating.

According to the CRA theory, advocacy groups like ACORN complained about redlining and pushed regulators into pressuring banks and lenders to make the bad loans.

Stan Liebowitz, an economics professor at the University of Texas-Dallas, called CRA regulations "the real scandal" of subprime lending in a recent New York Post column:

From the current hand-wringing, you'd think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards -- at the behest of community groups and "progressive" political forces.

In the New York Sun, economist Jerry Bowyer contended that "the fault lies with the small army of hard-left political hustlers who spent the early 1990s pushing risky mortgages on home lenders."

Housing advocates find the argument absurd. Some believe lenders are just using the CRA criticism to fend off future lending requirements and to avert blame for the subprime mess.

"This is the big lie," Berenbaum said. "There's been absolutely no pressure from advocacy organizations to expand home ownership by underwriting risky loans. That is just so far from the truth."

Contentious arguments over fair lending have a long history, going back to when the federal Fair Housing Act was passed outlawing discrimination in housing, one week after the assassination of Martin Luther King Jr. in 1968. But the law didn't end battles over the denial of credit.

In the late 1980s, The Atlanta Journal and Constitution published "The Color of Money," documenting racial discrimination in mortgage lending. In 1994, Chevy Chase Federal Savings Bank reached a settlement with the Justice Dept. over allegations that it failed to make loans in black neighborhoods in Washington and suburban Prince Georges County, Md.

As subprime loan brokers began flooding poor neighborhoods in the 1990s, consumer advocates and legal aid lawyers complained, but the lending continued. In the mid-1990s, Associates First Capital Corp. earned $19,000 in fees by flipping an initial $20 loan 10 times over four years, to an illiterate borrower who signed his loan papers with an X. Citigroup purchased the Associates in 2000 and continued to make subprime loans.

In the last few years, fair housing groups have brought suits over lenders refusing to make loans for less than $100,000, or for denying "rowhouse loans" in Baltimore.

As the market restructures, industry leaders Fannie Mae and Freddie Mac will be under great financial pressure to provide mortgage money and still cover their costs, McCoy said. Asking for higher down payments in declining markets and careful use of accurate appraisals can address those concerns adequately, she believes. No one wants lenders to go back to making risky loans, but they also don't have to add on fees out of fear. "I'm not crazy about targeting zip codes and jacking up interest rates," she said.

Lenders and housing advocates should work toward access to sustainable credit - loans that a borrower can handle. It means that credit shouldn't always be available for everyone. For some people, it won't be the right time in their lives to take on a mortgage, which is a contrast to the relentless push for increased home ownership rates since the early 1990s, McCoy noted.

To Squires, changes in the market may also open the door to thinking about ways to support rental housing, or alternative forms of housing like cooperatives.

The one thing certain about where the mortgage market is heading is that fights over lending tactics will continue. "These are constantly contentious political issues," Squires said. "As Saul Alinsky used to say, there are no permanent victories."

Housing advocates, however, are in a different position than they were at the beginning of the credit fights in the late 1960s, Berenbaum said. They are far more organized, sophisticated and able to respond quickly. They now work hand in hand with some in the lending industry.

They don't have much choice. As the mortgage industry enters its next phase, so will the battles over who gets access to credit and mortgage loans -- and how much it will cost them. To the players in this fight, zip code designations are a reminder of the past, and a sign of what is soon to come.

Bush's Nose Grows

Mary Kane — Thu, 08 May 2008 16:41:22 GMT

Over at Economist's View, Mark Thoma points out that the placement of the play button on this video of President Bush (at the bottom of the post) makes him look like Pinocchio as he argues against plans to limit foreclosures.

Will Republican opposition to housing bailouts hurt the party in the general election? That's hard to say, because many Americans paying on their mortgages don't have a lot of sympathy for helping out lots of people who got in trouble on theirs.

Economist Paul Krugman, however, says that things look good for the Democrats on economic issues in general:

The political scientists I talk to basically have the view that nothing much matters in presidential elections except the rate of change in economic conditions — not the level — in the year or less preceding the election. If that’s true, the Democrats should have it in the bag. This year’s economy will almost certainly be at least as bad as 1992, and stands a chance, in terms of stagnant real personal income per capita, of being as bad as 1980.

Even Pinocchio can't fib his way out of that.

Housing Bill Would Only Help 10%

Mary Kane — Thu, 08 May 2008 14:09:52 GMT

While Democrats in Congress and the White House continue wrangling over a housing bailout bill, it's worth keeping the following in mind:

Even if Bush had a sudden change of heart and chose to enthusiastically embrace the bill and sign it with a flourish, the measure would, at best, benefit only about 10 percent of homeowners underwater on their mortgages.

That estimate came from economist Martin Feldstein, who also argued in the Financial Times that the plan misses the point entirely:

What is missing is action to prevent positive-equity mortgages from becoming negative-equity mortgages. The federal government could achieve that by providing low-interest loans with full recourse that would allow any homeowner to pay down a significant fraction of his mortgage. Homeowners would be in effect giving up the potential to default on their mortgage loans in exchange for lower interest costs.

More homeowners are underwater on their mortgage than at any time since the Great Depression. So now there's a major political battle being waged over something that won't have all that much effect, anyway. Sort of like Saul Bellow's famous comment about academia - that the politics are so vicious because the stakes are so low.

Feldstein mentioned the bailout measure in a longer piece noting his belief that the economy is in worse shape than statistics suggest. A nice contrast to Treasury Secretary Henry Paulson's recent sunny declaration that the worst is over.

Fed Stirs Nightmares of Return to '70s

Charles R. Morris — Thu, 08 May 2008 13:51:45 GMT

The press release announcing the Federal Reserve Bank's latest interest rate reduction on April 30 had the ominous sentence, "uncertainty about the inflation outlook remains high." That is an unusual warning in a period of anemic growth. For anyone who can remember back 30 years, it stirs deep-seated fears.

Inflation is usually a by-product of overly ebullient markets. The absurd run-up in house prices during the first half of the 2000s is a classic example of an inflationary bubble. But there have been times when loose monetary policy overflowed into rapid price inflation even as the economy was slipping. The most notorious case is the devastating 1970s period of "stagflation,"’ when consumer prices jumped by double-digit rates amid a nasty recession.

The visible rise in inflation in the wake of the Fed's aggressive monetary easing is stirring nightmares of a return to the 1970s stagflation hell. The broad money supply expanded by a 12.6 percent annual rate in the first quarter. The March-to-March growth in the consumer price index was 4 percent, and an uncomfortable 2.4 percent, even after excluding food and energy costs. That’s hardly stagflation territory, but still well above the Fed’s comfort zone.

There is, in fact, little question that the Fed’s high-wire bank rescues have increased inflation risks. But the mechanisms are complicated and require some untangling.

For years, America’s biggest export has been the dollars it sends overseas to buy real goods and services – more than $700 billion, net, in 2007, only modestly down from the all-time record the previous year. The huge buildup of dollars in foreign hands pushes down the value of the dollar in currency markets, and drives global price increases in dollar-denominated goods like oil.

More subtly, the build-up of dollars fuels inflation in states, like most of the Asian exporters and most of the Gulf states, that try to keep their currency value "pegged to the dollar. When Washington lowers interest rates, they are forced to do the same; otherwise their higher local interest rates would attract currency traders and push up their exchange rates relative to the dollar. America's second biggest export after dollars, in short, is local inflation.

The best defense against imported dollar inflation is to let the local exchange rate rise to its economic level. Countries resist doing so for a variety of reasons. China isn’t yet ready to disrupt its U.S. trade bonanza, while the Saudis fear being left on their own to deal with fractious local Shiites. But even the steadfast Chinese are showing signs of cracking. Some Chinese goods are being priced in euros rather than dollars, while cost inflation at home is starting to work its way into Chinese export prices. Having sent its inflation abroad for so long, the United States is now importing some of it back.

The devastating run-up in oil prices is partly the result of a real shift in demand, as consumers in newly wealthy markets like China and India discover the joys of driving. But it is also, substantially, a monetary phenomenon. The president of the Organization of Petroleum Exporting Countries recently said that a 1 percent fall in the dollar works through0 as a $4 rise in the price of a barrel of oil.

But subtler unintended consequences of the Fed’s monetary easing are also driving oil markets. Oil companies normally sell futures – in which buyers contract to take oil at a specific price at a future date – to stabilize revenue streams. Since futures buyers are protecting oil companies against price drops, they usually get contract prices somewhat lower than current-market or ‘spot’ prices.

Over the last few years, however, Wall Street has been advising their wealthy clients to diversify their holdings into commodities, especially oil. Speculative oil futures buying by outsiders has pushed futures prices higher than the spot markets – an unusual position called "contango." With high futures prices and low interest rates, it now makes sense for speculators to sell oil futures and lock in their profit by buying the oil now and storing it for future delivery. As a consequence, the rapid run-up in crude oil prices has been accompanied by increases in inventories, which is very unusual. Interest rate-driven oil speculation, in short, is making the oil squeeze worse (pdf).

The price of grain, the world’s most important food staple, has been rising at about the same clip as oil prices. It’s hard to blame the grain price run-up on the Fed, since it seems mostly a reflection of real supply constraints. The same emerging market consumers that are buying cars are shifting to richer, meat-based diets that require far larger grain inputs.

But the nutty U.S. corn-based ethanol program is a big contributor too – despite the farm lobby’s insistence to the contrary. (Corn-based ethanol offers little or no advantage in energy and climate terms over gasoline.) The World Bank points out that from 2004 through 2007, global maize (corn) production increased by 51 million tons, but virtually all of it – 50 million tons – went to the U.S. ethanol program. All other maize consumption rose by 33 million tons, causing a drop of about 30 million tons in global stocks. More unintended consequences (pdf).

The biggest difference between the 1970s and the current price run-up is that workers aren’t getting any of the inflationary upside. In those benighted days, workers usually had cost-of-living escalators, so their pay kept pace with expenses. Now, worker productivity is rising, but hours worked and real incomes are falling.

For Wall Street, that’s the ideal inflation firewall.

Charles R. Morris, a lawyer and former banker, is the author of "The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash." His other books include "The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy" and "Money, Greed, and Risk: Why Financial Crises and Crashes Happen.”

Adoption Rules Tighten Abroad

Mary Kane — Wed, 07 May 2008 13:18:33 GMT

For the first time since international adoption began growing in popularity two decades ago, so many countries have either shut their doors to adoption, tightened their rules or increased domestic adoption that it's now far harder to adopt overseas. This is changing the course of a "revolution" in which Americans flocked abroad to bring home orphans in record numbers and create a new and different community of adoptive families.

"Everything's not closing down, but there's no question there's a constriction happening," said Adam Pertman, author of "Adoption Nation: How The Adoption Revolution Is Transforming America" and executive director of the Evan B. Donaldson Adoption Institute, a research organization. "I haven't seen anything like this in 15 to 20 years."

Tom DeFilipo, president of the Joint Council on International Children's Services, which represents international adoption agencies, said that for the first time in his organization's 35-year history, there are more U.S. families willing to adopt children than there are children legally available for adoption. "This is a transformational period for international adoption," DeFilipo said, "there's no question about it."

Vietnam is the most recent country to pull back on adoptions, announcing last week that it will close it doors to U.S. adopters once an agreement with Washington expires on Sept. 1. Vietnam shut down temporarily in 2003, after allegations of corruption and baby selling plagued its program, then reopened in 2005 to a rush of new adoptions.

Vietnam's announcement came after the U.S. embassy in Hanoi released a report detailing new corruption allegations, and citing a suspiciously high number of children listed as abandoned, which makes it impossible to prove they were truly orphaned or that their parents knowingly agreed to relinquish them.

But the very popularity of international adoption also drew greater scrutiny to its practices and abuses, as wealthy Americans and foreigners descended on impoverished countries with available children, paying fees that could reach $30,000 or more -- money that sometimes wound up in the pockets of corrupt local officials and adoption facilitators rather than orphanages in need. The Vietnamese government strongly denied the accusations, saying it will shut down rather than deal with what it described as disrespectful U.S. officials. The two countries remain at an impasse.

Guatemala, also a popular county for U.S. adoptions, said on Tuesday that it would suspend the adoptions of 2,300 children by U.S. citizens for at least a month to investigate whether they were handled legitimately. On April 1, the State Department announced a total halt to new adoptions in Guatemala, as its government works to address longstanding problems with corruption and charges that women were enticed to put their children up for adoption for money.

Other countries are changing their policies for different reasons. China may deny travel permission for adoptions during the Olympics this summer because of traffic congestion, and waiting times to adopt children has increased from nine months to more than two years. In recent years China has moved to limit the type of families who can adopt, excluding from its program single parents and people who are obese or take anti-depressants.

Russia is working to encourage domestic adoption, and last year, for the first time since it opened its doors to foreign adoptions, more Russian children were adopted domestically than internationally, DeFilipo said. Korea -- the trailblazer of international adoption after poverty engulfed the country in the aftermath of the Korean War -- also has fewer children available for adoption as it has grown more prosperous and has encouraged Korean families to adopt.

As a result of all the cultural changes, restrictions and shutdowns, international adoption began to decline beginning in 2005, and its numbers are expected to keep falling, Pertman said. Adoptions had grown from 7,000 annually in 1990 to a peak of almost 23,000 in 2004, with Americans accounting for about half of all adoptions worldwide. The total fell to 19,411 in 2007. Last year, despite declining adoptions, China still ranked as the top country for adoptions, followed by Guatemala and Russia.

The influx of adoptees comprised the "revolution" that Pertman spoke of: playgroups for children from Asia, families with a mix of biological children and babies from overseas, culture camps to connect children with the heritage of their countries and the greater acceptance and high visibility of adoptive families. Celebrity adoptions only fueled the popularity, with New York magazine declaring blended families with children adopted internationally hip and trendy, thereby offending many adopters.

But the very popularity of international adoption also drew greater scrutiny to its practices and abuses, as wealthy Americans and foreigners descended on impoverished countries with available children, paying fees that could reach $30,000 or more -- money that sometimes wound up in the pockets of corrupt local officials and adoption facilitators rather than orphanages in need.

Adoptions ended in Cambodia after numerous scandals, some involving birth mothers placing their children temporarily in orphanages so they could be fed and cared for, then returning to find them "adopted" by foreigners. The Irish Independent in 2006 caught on tape a Vietnamese-American facilitator talking about how she forged birth certificates, paid off local officials and passed off children with parents as abandoned in order to put them up for adoption. She grossed $1 million for handling 150 adoptions.

To Pertman, international adoption is now at a turning point. The next phase of the adoption revolution, he believes, will be smaller countries with fewer children opening up to adoptions, like Ethiopia, while larger countries begin cutting back. He predicts fewer international adoptions, and more adoptions domestically of children in foster care.

he scrutiny, Pertman explains, is a natural part of the growth of international adoption and the process of moving to its next phase.

"We want to get adoption to the point where it's as ethical, as thoughtful, as humane and as efficient as we can make it," he said. "We want to make sure that adoptions are done right, and done for the right reasons, because kids need homes. We want to see that adoption is done not because demand drives the process, but because the need drives the process."

The changing nature of international adoption can be for the good, as agencies open programs in countries where they haven't been before, DeFilipo said. Ethiopia has grown in popularity as an adoption source, and other countries in Africa, Latin America and parts of Asia are considering programs.

But the world still has 143 million orphans, and the fact that so few are available for adoption "is a tragedy for the kids," he said.

That reality is likely to prompt more international disputes like the one in Vietnam.

DeFilipo's group and other adoption advocates are launching a campaign next week to pressure the State Department to settle its dispute with Vietnam and restart adoptions. He pointed out that Washington said last December, prior to the embassy report, that it planned to end the adoption agreement with Vietnam. Then it turned around last week and leaked the report about corruption to the press.

He and other advocates contend the State Department is bullying Vietnam and shutting down all adoptions, when it could work instead to end the abuses while allowing legitimate adoptions to continue. Vietnam remains open for adoptions from other countries.

"What the U.S. is doing is just another example of 'The Ugly American,'" DeFilipo said.

He's not the only one pointing the finger at the State Department. Thomas Atwood, president of the National Council for Adoption, an advocacy group, contended that frequent turnover among State Department staffers assigned to adoptions is behind some of the problems.

In Vietnam, staff come and go every two to three years, and officials don't understand the psychology and culture of adoptions, he said. A woman might list her child as abandoned on paperwork out of shame, not because the adoption is tainted. "They'll go through the paperwork and find something nefarious there when it's not," Atwood said.

The State Department has said it stands by its findings. Steve Royster, spokesman for consular affairs, said it's just not true that the U.S. government opposes adoption in Vietnam, or that it opposes international adoption in general.

The U.S. is working closely with countries to comply with the Hague Convention, an international adoption treaty aimed at reforming adoptions and ending abuses. Royster said the Hague agreement will put all countries "on the same page" when it comes to adoption rules and regulations, making the whole process more uniform and less vulnerable to exploitation.

"We're fully committed to international adoption when it's the best way to get families for these kids," he said.

The fight over adoption in Vietnam is likely to be mirrored elsewhere, as more countries work to comply with the Hague agreement and as U.S. adoption agencies begin operating in countries establishing international adoption programs for the first time. As Atwood pointed out, "America is not exactly at the height of its popularity right now," ensuring that longstanding charges of bullying and "American imperialism" when it comes to adoptions in other countries will persist.

Even as international adoption moves to a new phase, old controversies will no doubt follow along. And that leaves the fate of the world's orphans as unclear as ever.

Buffet: Big Banks Getting Just Desserts

Mike Lillis — Mon, 05 May 2008 15:04:34 GMT

As one investment bank after the next posts billions in losses resulting from the mortgage and credit crises, billionaire investor Warren Buffet said yesterday that the banks are simply getting what they deserve, according to numerous reports today.

Speaking at the annual conference of Berkshire Hathaway Inc., the world's wealthiest man told the 31,000 assembled pilgrims that the Korean stock market is a safer bet than U.S. banks.

According to The Associated Press:

The complexity of the tactics that financial institutions often employ makes it difficult to determine what those companies are worth - even for Buffett.

"There are some financial institutions I can't value," Buffett said.

Makes the spot beneath that mattress all the more attractive.

Did He Walk or Did He Run?

Mary Kane — Fri, 02 May 2008 21:01:11 GMT

Baseball's Jose Canseco is making the news again, this time for the fact that his $2.5 million Encino, Calif. house has been foreclosed on.

But some of the remarks made by the former American League MVP, who once earned $6 million at the height of his career, has more than a few people wondering whether he might have done an intentional walk. Like millions of homeowners, he apparently realized he owed more on his mortgage than his house was worth.

Did he decide to just walk away? Speaking to the television show "Inside Edition," Canseco said it didn't make financial sense for him to keep paying on a home "that was basically owned by someone else." He said he realized he's in a better position than most when it comes to facing foreclosure. Then, he added:

Like I said, my situation was a little more different than most. I decided to just let it [the house] go, but in most cases and most families, they have nowhere else to go."

Just another reason why Canseco isn't a likely candidate for the front of the Wheaties box anytime soon.

How Fraud Fueled the Mortgage Crisis

Mary Kane — Thu, 01 May 2008 16:25:32 GMT

The debate over what caused the mortgage mess and how best to fix it is now taking a sharp turn, as new problems surrounding liar's loans and payment-option mortgages reveal the pervasive fraud, lying and deceit that permeated the market at its height.

As loans made to borrowers with decent credit begin to fail at a surprisingly rapid rate, it's becoming clear that widespread fraud helped support the entire mortgage system -- from borrowers who lied on their loans, to brokers who encouraged it, to lenders who misled some low income borrowers, to the many lenders, investors and ratings agencies that conveniently and deliberately looked the other way as profits rolled in.

Despite its widespread role, fraud hasn't yet been at the forefront of proposed rescue plans, which center on refinancing people out of loans now resetting to higher rates. That may begin to change as the mortgage market continues a meltdown that seems to have no end. As fraud becomes a focus, the question of who did most of the lying and cheating will be crucial in deciding who deserves help in any housing rescue plan.

And the search for causes of the crisis may challenge long-held but erroneous beliefs about what homeowners did and why. Many people think borrowers got in trouble by buying bigger houses than they could afford, but the numbers show the majority were refinancing their homes.

Fraud problems drew headlines this week, as Countrywide Financial Corp., announced an $893 million first quarter loss and a 36 percent delinquency rate on subprime loans. The lender that once led the subprime market is facing a federal probe involving allegations that sales executives purposely allowed for inflated income figures on many mortgage applications, The Wall Street Journal said Wednesday.

At the same time, delinquency rates are climbing for payment-option mortgages, or adjustable rate loans that allowed the borrower to choose the size of the monthly payment, the Journal said. Countrywide and other lenders are being hit by state investigations and lawsuits from borrowers who contend they were misled into taking out the complicated loans, which sometimes result in monthly payments going up even as house prices decline. Lenders deny responsibility, saying borrowers knew what they were getting into.

The meltdown of these mortgages is prompting a new spotlight on the extensive role that fraud played in loans gone bad, and who was responsible for it. Lending that required little proof clearly opened the door to widespread cheating, by borrowers who inflated their incomes, or by brokers who did it for them, with or without their knowledge.

A landmark study by the Mortgage Asset Research Institute concluded that almost 60 percent of stated income loans it examined were exaggerated by at least 50 percent. "They earned their name," MARI's Merle Sharick said of liar's loans.

Fraud concerns escalated recently when a task force of states attorneys general and the Conference of State Banking Supervisors found widespread mortgage fraud at the end of the housing boom. Their report said some 28.5 percent of subprime loans that don't face even their first reset to higher rates until next year are already delinquent. In addition, some 70 percent of subprime borrowers seriously delinquent on their loans aren't involved in any effort with lenders to modify the terms to prevent foreclosures. The report urged servicers to work harder on modifications and loan workouts.

At the influential housingwire site, publisher Paul Jackson pointed out that only massive fraud could be responsible for loans going sour so quickly, and that it's unfair to blame servicers for loan workout problems. Borrowers who may have cheated or lied to get a mortgage aren't going to be eager to call up their lender. "What incentive to they have?" Jackson asked. "Offering strong and credible proof that they were party to mortgage fraud?"

He represents a growing belief that mortgage fraud is a major problem yet to be recognized in the housing mess, and one that has been overshadowed by the attention to adjustable rate mortgages that reset to higher rates. Until the scope of the fraud is understood, adequately addressing the market's troubles isn't possible, according to Jackson:

It’s time borrowers, consumer groups and erstwhile working groups stop floating a revisionist history of the “hapless borrower” — you know, the one where greedy, mean lenders duped those innocent and pure borrowers? — as a substitute for what’s really going on in the real world.

Others familiar with the mortgage industry contend that pervasive fraud was, indeed, a problem - on the lender's side. At the peak of the housing boom, they say, the nation's mortgage system was set up to promote and encourage outright fraud in order to close a loan - and everyone, from brokers to loan officers to Wall Street, looked the other way. Borrowers also were put into products like payment-option arms that were unsuitable -- and lenders knew it. "They were pushed like Vioxx, with very little regard for their dangers," said Kathleen Keest, senior policy counsel with the Center for Responsible Lending, a research group that investigates predatory lending.

Patrick Madigan, an Iowa assistant attorney general who has investigated mortgage fraud, said it makes no sense to conclude that lenders are somehow victims. Madigan's office engineered a settlement two years ago with Ameriquest over its subprime practices, including high-pressure "boiler room" sales tactics. Regardless, Madigan said, there is a movement to "blame the borrower."

"There's a perception out there that there's this hapless lender who got duped by middle class and lower income subprime borrowers," Madigan said. "It's ridiculous. Our investigations have shown that most of the fraud happens at the suggestion and direction of the loan originator, who had significant financial incentives to close the loan, no matter what misconduct was required."

The question of fraud and responsibility matters because it can tilt the direction of any plans to rescue the housing market from its freefall. So far, the largest government effort has been FHA Secure, which is supposed to help subprime borrowers facing higher rate resets get refinanced into new mortgages. But with loans going bad even prior to their rates going up, the program doesn't address fraud as the true cause of failing loans, noted Robert Simpson, president of Investors Mortgage Asset Recovery Co., in Irvine, Calif. "These problems are not related to reset issues," he said. "That's a ruse."

As the debate over bailout plans continues on Capitol Hill, borrowers perceived as victims of predatory lending might be more likely to be seen as sympathetic and in need of help than borrowers who took part in lying to buy an expensive house. Lenders under pressure to modify more mortgage loans might get themselves off the hook a bit if borrowers take the hit for lying on liar's loans. If lenders are looked at as the perpetrators of fraud, there might be support for ideas like the one just proposed by Federal Deposit Insurance Corp Chairwoman Sheila Bair, who wants the Treasury Department to make loans directly to troubled borrowers.

If the whole mortgage market is viewed as riddled with fraud on both ends, some, like Simpson, argue that nothing should be done except letting those house prices that have been artificially propped up because of inflated incomes begin to fall -- and enduring the economic pain that will result.

Even if fraud has become a larger part of the mortgage meltdown picture than first realized, it's not simple to figure out who should take most of the blame. Many people point the finger at investors playing the market or homeowners who bought more expensive houses than they could afford -- the "irresponsible" borrowers cited by both President George W. Bush and probable Republican nominee Sen. John McCain (R-Ariz.).

But the numbers don't exactly tell that story - which proves that much in this crisis taken as fact is poorly understood. That also makes a difference, when it comes to deciding whether it makes sense to bail out the market. At the request of The Washington Independent, the trade industry publication Inside Mortgage Finance in Bethesda, Md., ran some numbers and analyzed the resulting data.

Did most people simply buy big homes they couldn't afford? In 2007, 62 percent of all securitized Alt-A loans involved refinances, and 38 percent were for home purchases. In the subprime market, 64 percent were refinances and 36 percent, home purchases. The percentages were the same in 2006. Those borrowers may have been tapping equity for reasons as varied as fancy vacations to overdue medical bills, but the majority were not buying new homes.

Were they just trying to make a quick buck? Regarding investors versus homeowners, in 2007, about 5 percent of all securitized subprime loans and 14 percent of Alt-A loans were reported as investor loans. That compares to 5 percent of subprime loans and 13 percent of Alt-A loans in 2006. These numbers don't include second homes, so the percentages are probably higher, but not significantly so.

Then there's the question of who really lied on the liar's loans. Madigan, the Iowa assistant attorney general, cites repeated cases where borrowers were encouraged by brokers to suddenly create businesses in their basements, like day care centers, to boost their incomes. If they questioned it, brokers would say that lenders required it, or not to worry. Still, borrowers signed on the bottom line, some knowing the information was false. Consider this borrower's account in the San Francisco Chronicle of a sales conversation with a broker:

" He didn't say anything illegal out loud," she said. "He didn't say 'lie,' he just made a strong suggestion. He said, 'If you made $60,000, we could get you into the lowest interest level of this loan; did you make that much?' I said, 'Um, yes, about that much.' He went clickety clack on his computer and said, 'Are you sure you don't remember any more income, like alimony or consultancies, because if you made $80,000, we could get you into a better loan with a lower interest rate and no prepayment penalty.' It was such a big differential that I felt like I had to lie, I'm lying already so what the heck. I said, 'Come to think of it, you're right, I did have another job that I forgot about.'"

Countrywide, for example, had a loan program called "Fast and Easy" that required no pay stubs, tax forms or employment verification. The FBI investigation is finding extensive fraud on loans across the board at Countrywide that didn't require full documentation, The Wall Street Journal reported.

"It really is a case of everybody's at fault on this," said Guy Cecala, publisher of Inside Mortgage Finance. "There's clearly plenty of blame to go around."

The result is a housing market that still has a long way to go to reach the bottom. A report by Barclays Capital on Tuesday warned that half of all subprime and Alt-A borrowers soon could owe more than their homes are worth -- meaning delinquencies are likely to increase, regardless of whether some loans reset.

How those delinquencies will influence the politics of any possible mortgage bailout is anyone's guess, especially as fraud and its part in the meltdown begin to draw more attention. As Cecala points out, finding the right people to blame can be a complicated issue. In some ways, he says, "it's just next to impossible" to solve a crisis that so many had a hand in creating. whether they are willing to admit to it or not.

McCain Policy Defies Math

Robert Borosage — Tue, 29 Apr 2008 21:33:54 GMT

Sen. John McCain (R-Ariz.) says that his age provides him with the “experience that is the basis for sound judgment.” That raises a simple question. How could an experienced senator run for president in the midst of a recession and put forth an economic plan which is, frankly, incredible?

McCain has just finished his “time for action tour” of “forgotten” America. Clearly designed to reassure affluent independent voters that McCain is a “compassionate conservative,” it offered relatively little to the working and poor people who turned out to hear him. After echoing the president for months that the economy’s “fundamentals are strong,” McCain has been loath to admit how serious this recession, indeed, the entire economic situation, is.

He has been slow in addressing those losing their homes, provides no relief from trade policies shipping jobs abroad, offers no major initiatives for the rising numbers of poor and has no plan to cover the 43 million Americans without health insurance. McCain's big answer to the recession seems to be a “gas tax holiday” for the summer -- a tax break more likely to end in the pockets of the oil companies than consumers.

The core of the McCain economic plan consists of heroic promises to cut taxes on the wealthy and the corporations. Cobbled together to appeal to conservatives in the earlier Republican primaries, when the economy was growing, these aren’t designed to counter the recession and won’t kick in completely until 2012. McCain starts by pledging to extend all the Bush tax cuts -- which he opposed in 2001 because he could not "in good conscience support a tax cut in which so many of the benefits go to the most fortunate among us.” That will cost an estimated $2 trillion over the next 10 years, according to the Tax Policy Center, a nonpartison group.

Then McCain proposes new tax cuts – even more skewed to the wealthy than the Bush cuts. The soon-to-be Republican nominee would eliminate the Alternative Minimum Tax. He calls this a “middle-class tax cut,” but most of the benefit of eliminating the provision – as opposed to limiting its reach to middle income taxpayers – goes to those making more than $500,000 a year.

He would also lower the rate and coverage of the estate tax. He’d cut the top corporate tax rate across the board from 35 percent to 25 percent; allow corporations to write off all investments in their first year, and make the corporate research and development tax break permanent. He would double the child tax deduction -- providing the greatest benefit to families paying the top tax rates, and offering nothing to those making less than $28,000 a year.

The Tax Policy Center did the math. When all the McCain tax cut promises kicked in by year 2012, they would cost more than $550 billion a year -- with an estimated total of nearly $6 trillion over 10 years.

He would lower tax receipts from 20.3 percent of gross domestic product to 16.7 percent. The decrease is about 17 percent of the federal budget – as much as the size of the military budget and more than the entire sum spent on domestic discretionary programs like, education, energy, environment, homeland security, public health, everything the government does outside of the military and entitlement programs like Social Security and Medicare.

McCain claims that he would still seek to balance the budget in his first term. So how does he pay for the cuts?

McCain’s first response to this – and virtually any question about the budget – is to say that he will eliminate earmarks. But earmarks – many of which involve programs like increases in veteran’s housing that McCain himself supports – total about $18 billion a year. McCain says he can find $100 billion in savings for “earmarks, program review and other budget reforms.”

He says he’d save another $30 billion from corporate tax loopholes. He’ll save $2 billion by requiring that retirees with incomes above $87,000 pay for their prescription drugs.

That still leaves staggering deficits as far as the eye can see.

When asked, McCain argues furiously that he will freeze domestic spending for a year and “scrub” every program, arguing that every American knows there are “hundreds of billions of waste that can be eliminated.” That may be true, but when politicians call for balancing the budget by eliminating unspecified waste, fraud and abuse, Americans should hold on to their wallets. Eliminating waste is an ancient refuge for politicians unwilling to pay for their promises.

Meanwhile, McCain’s new promises will cost more than any waste he’d eliminate. McCain is famously committed to sustaining the war in Iraq, at $12 billion a month not projected in current budget estimates. He argues that we need to increase the military by 150,000 soldiers, develop a new civilian corps to manage foreign occupations, create a new secret intelligence agency beyond the Central Intelligence Agency for covert operations and revive a separate information agency to sell America’s story abroad. He admits “this will cost real money,” so McCain sees the military budget going up, not down, saying “we can afford to spend more on our defense.”

In addition, in recent weeks, McCain has promised he’ll create a new program to bring the Internet to poor areas that don’t have it, expand a wage insurance program for older workers that lose their jobs when companies move abroad, expand education and training to help younger workers retrain, have the federal government backstop companies offering student loans and more. He pledges a new “Medicaid Trust Fund” that will help those with pre-existing conditions who can’t get health care under his plan – “we’re not going to leave anyone behind” -- a commitment that will cost hundreds of billions, if he is serous.

So McCain’s program violates basic addition. He admits this by saying that he’d go with his tax cut plans even if the spending restraints weren’t in place. In presidential politics, arithmetic is for sissies.

Americans are sensibly cynical about such promises -- even from someone who advertises his “straight talk.” The real rub is that there is no reason to think that McCain’s plan will help either the economy or working people.

Essentially, McCain is offering a sequel to the Bush years – top-end and corporate tax cuts, costly war abroad, corporate trade policies and constraint on domestic spending. George W. Bush tried this mixture, presumably with fewer spending cuts than McCain.

We have seen the result. Gilded age inequality exacerbated by the tax cuts. Key domestic agencies --from FEMA to the Consumer Product Safety agency – starved for resources and staff, leaving Americans at risk. Bridges, levees and sewers collapsing as vital public investment is postponed. Large budget deficits and dramatically increased national debt, even as the United States racks up unsustainable foreign debts. And for most Americans, stagnant incomes that don’t keep up with rising costs in health care, education, gas and food. Despite low interest rates, top-end tax cuts and the military buildup after 9/11, Bush’s plan gave us a “recovery” of relatively slow growth, weak job growth and declining incomes – the median income never recovered the level it had reached in 2000.

And McCain would inherit a very different world than Bush did. Both would inherit a recession in the wake of a bursting speculative bubble --but Bush inherited a surplus; McCain a deficit and a country far deeper in debt. Bush inherited a strong dollar; McCain a currency already debased and likely to fall further. Now disparities of wealth and income have reached levels not seen since 1929, just before the Great Depression.

McCain, of course, is not selling Bush redux to America; he’s selling “change” and “character.” “They know that I’ll take action,” he says. But his policies offer only to keep digging the hole we are in.

And what does it say about character that, as a senator, McCain opposed the Bush tax cuts because they were too favorable to the wealthy, were not tied to spending constraints and were passed during a war; but now, as a candidate, he not only embraces extending the Bush tax cuts, but calls for more? What does it say about the character of a presidential candidate that, in the middle of the worst financial crisis since the Great Depression. he offers an economic plan that he must know is simply fantastical?

Robert L. Borosage is the president of the Institute for America’s Future and co-director of its sister organization, the Campaign for America’s Future. He has contributed to The Washington Post, The Los Angeles Times and The American Prospect magazine.

Gas Math

Mike Lillis — Tue, 29 Apr 2008 20:40:38 GMT

Yesterday, Sen. Hillary Rodham Clinton (D-N.Y.) joined the popular movement calling for a summer moratorium on the 18.4-cent/gallon federal gas tax. This is the same idea for which Sen. John McCain (R-Ariz.) introduced legislation earlier in the month. Both of the presidential hopefuls say the proposal would provide consumers much-needed relief during the peak driving months.

The trouble is (as we pointed out two-weeks ago), it makes not even an ounce of economic sense. In fact, if the laws of supply and demand mean anything to anyone anymore, dropping the price of gas will encourage greater consumption, pushing up demand and hiking the price.

So quite aside from removing an important source of federal revenue (and therefore increasing the federal debt -- the interest on which already consumes 9 percent of all federal spending), the plan would lead to higher gas prices at the end of the summer, if not before. This says nothing of the environmental impact of spewing more carbon from millions of tailpipes.

On top of that, the proposed relief is hardly significant. Consider this: A typical car holds about 13 to 15 gallons of gasoline, meaning that under the McCain/Clinton plan, a driver would save roughly $2.76 with every tank refill -- about the cost of a Starbucks coffee or a cold Bud at Happy Hour. How many times does a typical driver refill the tank in a week? Two? Three? Five? Not exactly the kind of cash to help prevent a foreclosure, for example.

Sen. Barack Obama (D-Ill.), who opposes the gas-tax moratorium, had another theory about why the other presidential contenders might be pushing their plan. From a speech he gave today in North Carolina, according to The Boston Globe:
"This is the problem with Washington," Obama declared. "We're arguing over a gimmick that will save you half a tank of gas. It's not an idea to get you through the summer. It's an idea to get them through an election."

From the Folks Who Brought You the Subprime Mess in the First Place...

Mary Kane — Mon, 28 Apr 2008 13:15:04 GMT

The mortgage industry is fighting the Federal Reserve's attempts to put limits on lending following the meltdown of the subprime market, the New York Times reports today.

Keep in mind the industry put up the same kind of battle the last time the Fed tried to expand its powers under the Home Ownership Equity Protection Act, a tool it can use to restrict lending. The lenders won that time around a decade ago, and the Fed wound up applying that law to fewer than one percent of all mortgages, the Times noted.

Had the Fed been more forceful, consumer advocates say, much of the subprime lending abuses that took place and that have led to high default rates could have been avoided.

This time around, the mortgage industry -which apparently lacks any sense of irony - says that new rules on lending will make loans more expensive and restrict credit.

Keep in mind that we're talking about the Fed here, not a quasi-Communist movement that wants to take over the private sector. All the Fed is considering asking is that lenders disclose to borrowers sales fees that previously had been hidden, make sure borrowers actually can afford their mortgages, and prohibit misleading advertising.

That's hardly onerous - it's just requiring lenders to play by the rules. Consumer groups already are worried the Fed is going to water down even those modest proposals in the face of industry pressure.

Goes to show you that not everyone learns from their mistakes, even the Fed.

Is the Worst Over?

Charles R. Morris — Mon, 28 Apr 2008 10:00:00 GMT

It would be too much to say that champagne corks were popping on Wall Street last week, but there was an almost audible sigh of relief wafting through the trading rooms. While almost no one was prepared to say that the credit crunch was over, there was a palpable sense that the violent market turmoil of the past year might finally be coming to an end.

There was plenty to be happy about. The dazzling financial pyrotechnics at the Federal Reserve over the past several weeks did indeed seem to ease some of the tensions in credit markets. Though bank first-quarter announcements are the usual dismal litany of losses and write-offs, some of the most beleaguered, like UBS, Washington Mutual and the Royal Bank of Scotland, still seem able to raise new capital. First quarter earnings at big industrial companies like IBM (pdf), and General Electric – if one ignores the results of GE’s financial businesses – were actually quite decent.

So is the worst over? Not by a long shot. We still have a long way to go.

A single number tells most of the story. Between 2000 and 2007, Americans withdrew $4.2 trillion in free cash flow from their homes – in other words, $4.2 trillion in new mortgage debt that was not invested in new housing or in paying down old mortgages. Instead, it was spent on other stuff, like new cars and plasma TVs. For the three years through 2006, the free cash flow from mortgages was more than 7 percent of disposable personal income. That’s why personal consumption could break all records at a time when real wages were falling.

But when house prices suddenly tipped into free-fall in mid-2007, home mortgage financing dried up. By the end of the year, mortgage finance flows were about half the average for the previous several years. Pathetically, credit card borrowing jumped to an all-time high in the third quarter of 2007, but dropped right back by year end, as card companies quickly tightened the screws.

In the last half of 2007, households also began a major sell-off of financial assets, like stocks and bonds. Much of that must have come from already-paltry retirement savings.

Now, take a closer look at those good results from the big industrial stocks. These are global companies. They sell all around the world, and they have learned the advantage of locating their factories, research labs and employment centers where they sell. Uniformly, revenue and profits in the United States for IBM, GE, and Goodyear have either fallen or slowed sharply. Americans benefit when American company stock prices go up, of course, but the immediately tangible payoffs – rising employment, more plant investment – will go where the sales are. Right now, America’s not where the growth is.

Mohammed El-Erian, the co-chief executive at PIMCO, a large global bond manager, recently observed that almost all the market disruptions from the credit crunch have transpired while the economy was still growing. What’s happened so far, in other words, is just prologue for when recession really bites.

House prices fell about 10 percent last year. A growing number of analysts expect another 15 percent - 20 percent price drop will be necessary to bring housing costs back in line with incomes. Some 8 million homeowners are stuck with mortgages worth more than the their homes’ market value, even as consumers are increasingly squeezed by flat wages, soft employment and back-breaking price increases for gasoline and food.

What’s happened so far, in other words, is just prologue for when recession really bites. The New York Times recently documented sharp drops in consumer spending on women’s clothing, furniture, luxury goods and airline travel, as well as a pronounced shift to lower-cost, non-branded basics from pizzas to beer. But surveys adduce plenty of evidence that consumers are still stretching to maintain spending in high-tension items -- like the video game that your kid really, really wants. In other words, recession is taking hold, but we haven’t yet adjusted to the reality.

And, regretfully, the banking crisis is far from over. Last week, the ratings agencies downgraded thousands more mortgage-backed bonds, and there are thousands yet to go. At best, only about half the mortgage-related problems are behind us. Many of the highly leveraged private equity companies taken over in the recent buyout splurge are very exposed to the consumer sector, and their debt is weighing heavily on many banks.

Smaller, regional banks may be about to join the party. Though they generally are not exposed to the kind of toxic instruments that brought Citigroup and Merrill Lynch low, they still have heavy straight real estate exposure, and are sure to start taking losses.

At this point, the Fed is finally running out of magic tricks. Banks know they are facing future losses, and are pulling in credit lines, hoarding capital for the crises on the horizon. More rate cuts by the Fed risks losing control over inflation.

For some 15 years, wise people have been nattering about America’s profligate spending and low savings. We all knew they were right. This time, winter is really coming.

America is a resilient country, and we will get through it. But the notion that we’ve paid our dues, and that good times are just over the next hill, is a dangerous hallucination.

Putting Financial Minds to Good Use

Mary Kane — Fri, 25 Apr 2008 13:01:52 GMT

The financial services industry has given the world many, um, innovations, such as subprime loans and securitization. Economist Mark Thoma suggests the industry put its expertise to good use to find a way out of the global food crisis.

To combat swings in demand and supplies, the financial services industry could come up with some sort of insurance that poor farmers could buy as a hedge against volatility in prices.

Thoma cites MIT economist Esther Duflo's explanation of why an increase in price volatility is so damaging:

Poor families in developing countries are already facing enormous risks (they are often self-employed, they are subject to the uncertainties of weather, and their health is fragile), and there is very little insurance against such risks, apart from their own savings or informal solidarity. Furthermore, these risks are more serious for households struggling to provide the bare minimum. A setback might mean sacrificing the children’s education, or not being able to save a little girl from a diarrhea attack. A passing difficulty can leave a permanent scar.

She goes on to point out what the world is beginning to understand: There's no time to waste.

Perhaps it is time to be creative and make the international financial services actually work for the poor: governments could provide price insurance for the poor (in the form of transfers to some when price are high, and others when price are low). Countries that are neither net sellers nor net buyers could do this internally, and countries that are either net sellers or net buyers should be able to sell this insurance on the world market. There is nothing straightforward about these solutions. The key point, however, is that it is urgent to think of something.

If the best financial minds on Wall Street can figure out how to bundle and sell high-risk loans and pass them off as good credit risks, there's no doubt they could come up with creative solutions to the worst food crisis in decades.

The Plunge Protection Team

kevin Phillips — Fri, 25 Apr 2008 10:30:00 GMT

Some people foolishly think that Washington's recent high-profile effort to steer, subsidize and protect the American financial sector is the beginning of something new -- a revolutionary development.

It isn't. Consider that the President's Working Group on Financial Markets – nicknamed “the Plunge Protection Team” by The Washington Post in 1997 & ndash; quietly observed its 20th birthday on Mar. 18.

“Quietly,” in fact, is an understatement. “Semi-secretly” would be more like it. The Working Group, or PPT, is much-pondered but reclusive group that has declined to submit to the federal Freedom of Information Act or to testify in detail before Congress about its activities. This is true even though its current chief, Treasury Secretary Henry M. Paulson Jr. – Federal Reserve Board Chairman Ben Bernanke is another prominent member -- made no secret of revving up its operations after he took took over at Treasury in 2006.

The curious reader will wonder: Just what does the PPT do?

Right now, Congress ought to able to pursue this basic question: Is the PPT a kind of committee for the extra-legal coordination, manipulation and subsidization of financial institutions and markets? Has it been stepping in when free-market forces have become too perilous to profits and asset values -- in financial crisis years like 1998, 2001 and 2007. Has Washington decided to protect the financial sector more than any other element of the U.S. economy?

Over the last decade or so, the Treasury Dept. and the Fed have both developed something of a scofflaw attitude toward strict interpretation of federal statutes and regulations. For example, both winked in the late 1990s, as federal regulators allowed Citibank to merge with Travelers Insurance, despite contrary law still on the books. Both winked in more recent years, as major banks set up huge multi-billion-dollar structured investment vehicles, or SIVs, to do on an off-the-books basis what they were not allowed under banking law. Now we have the federally funded J.P Morgan Chase takeover of Bear Stearns. The PPT may well have had a quiet role in some of these actions.

For the bigger picture, look back to the stock market crash of 1987 -- the sickening Oct. 19 fall when the Dow-Jones Industrial Average lost 508 points or 23.6 percent of its value in a single trading day. Alan Greenspan had just taken over as the Federal Reserve Bank chairman, and some believe that the Fed intervened to support the market the next day -- by either buying Standard & Poors futures or telling several collaborative broker-dealers to do so.

Tim Metz, in "Black Monday," contends that "some leaders and market makers at the New York Stock Exchange and Chicago Mercantile Exchange collaborated to save the stock market by rigging stock information and prices.” Tony Dye, a British fund manager, made a similar charge of intervention by U.S. authorities. London Sunday Telegraph, Mar. 22, 1998).]] Edward Chancellor, in his 1999 book, "Devil Take the Hindmost," noted that if these interventions occurred, they raised a major issue of “moral hazard.”

The likelihood they did occur is increased by the fact that a year after the PPT group's launch, a retiring Fed board member, Robert Heller, wrote a much-discussed article in The Wall Street Journal that in the case of an another emergency like 1987, there might be a better alternative than the Fed's usual remedy -- interest rate reduction. “Instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, " Heller wrote, "the Fed could support the stock market directly by buying market averages in the futures market, thereby stabilizing the market as a whole.” No public mention was ever made of the Fed or the Working Group embracing the Heller scheme, but that may have happened privately.

Such accusations are a long way from being conclusive. But they do help explain the milieu in which the Working Group, or PPT, was set up by presidential proclamation – Congress had no role -- in March 1988. The proclamation authorized the Working Group to “enhance the integrity, efficiency, orderliness and competitiveness of financial markets” -- language that may have been intended to provide a broad and loose authorization for intervention in the 1987 mode, should it be required again.

Media discussion of the Working Group, negligible in 1988, rekindled after the tribulations over the Asian and Russian debt and currency crises of 1997 and 1998. Washington's ambitions to manipulate seem to have been on the upswing. In a January 1997 speech in Belgium, Greenspan indicated that the Fed could pursue “direct intervention in market events” -- a bold new legal interpretation.

A month later, The Washington Post ran a big article, revealing details never repeated by any other major publication. The article describes how the Working Group had set up a financial "war room;" assembled a global as well as national list of key emergency contacts, and carried out simulated emergency drills.

In the wake of the Sept. 11 terrorist attacks, media attention to possible government market intervention and manipulation refocused again -- though less in the United States than in foreign English-speaking media. The London Observer reported, later that September, the Working Group-cum-PTT was “ready to coordinate intervention by the Federal Reserve on an unprecedented scale. The Fed, supported by the banks, will buy equities from mutual funds and other institutional sellers if there is evidence of panic selling in the wake of last week's carnage.”

The group was cited again a half-year later. The authoritative Financial Times quoted a Fed official, who declined to be identified, but acknowledged that policy-makers had considered “buying U.S. equities” -- not just futures. The Fed, said the official, could “theoretically buy anything to pump money into the system,” including “state and local debt, real estate and gold mines, any asset.” That sounds much like the same broad conception of empowerment Greenspan had injudiciously taken note of in 1997.

Two months later, the Australian Financial Review weighed in, wondering whether a 234-point intra-day surge on the New York Stock Exchange could be attributed to the PPT: “There is a belief that this team represents a powerful and secretive hand that is ready to act any time the Dow looks ready to tank big time.”

After 2001-02, there was little mention of the PPT group for several years. But come 2006, when Paulson decided to renew the Working Group as a major player, the British financial pages, if not the American, renewed their interest. The London Telegraph described the PPT as a “shadowy body with powers to support stock index, currency and credit futures in a crash.” It added that the former Clinton aide, George Stephanopoulos, had earlier described the group as having “an informal agreement among the major banks to come in and start to buy stock if there appears to be a problem.”

Over the last decade or so, the Treasury Dept. and the Fed have both developed something of a scofflaw attitude toward strict interpretation of federal statutes and regulations.

Not all U.S. financial journalists have been baaing sheep, ready to ignore the issue. John Crudele of The New York Post has pursued it in several columns, and others have acknowledged hearing about the buy orders from friends in the S&P trading pits. Another columnist, James Pethokoukis of U.S. News & World Report, described at length how in the final two trading hours on Aug, 16, 2007, the Plunge Protection Team might have encouraged one or two major institutions to buy stock index futures, because a 300-point Dow decline was briskly wiped away. But then he felt obliged to close with a semi-disavowal: “there's never been any official confirmation of this," and that insiders both in Washington and Wall Street “totally dismiss” these reports.

With the recent market panics and surges, the Working Group -- if not its deepest secrets -- might have again appeared on the front pages. But this did not happen.

However, in March 2008, the Senate Finance Committee's top Democrat, Max Baucus (D-Mont.), and top Republican, Charles Grassley (R-Iowa), were consumed by interest in whether Paulson pressured Bernanke into having the Federal Reserve broker the controversial deal in which J. P. Morgan Chase got $30 billion to help take over Bear Stearns.

Baucus and Grassley asked for all kinds of details. However, they seem not to have asked for information on how closely Paulson and Bernanke had been collaborating since 2006 in their mutual roles on the Plunge Protection Team. and how they interpreted their powers under the 1988 presidential proclamation. This is unfortunate.

Former Fed Chairman Paul Volcker, a well-respected senior statesman, stated his concern bluntly. “To meet the challenge," Volcker said, "the Federal Reserve judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending certain long-embedded central banking principles and practices.”

Volcker is regarded as one of the last honest men in U.S. finance. But since 1987, the lawful and implied powers of the Federal Reserve have probably been extended further than the former Fed chairman would like – and, conceivably, further than he knows.

Kevin Phillips is the author of the new book, "Bad Money: Reckless Finance, Failed Politics and the Global Crisis of American Capitalism." His previous books include "Arrogant Capital: Washington, Wall Street and the Frustrations of American Politics" and "Boiling Point: Republicans, Democrats and the Decline of Middle Class Prosperity."

Don't Bother Standing in That Long Line

Mary Kane — Thu, 24 Apr 2008 13:12:43 GMT

Repeat after me: There is no rice shortage in the United States.

That's worth keeping mind as stories about the big warehouse stores rationing rice begin to spread. Yes, some, but not all, Costco and Sam's Club stores are limiting bulk rice purchases by customers. But they're not responding to consumers who suddenly went to the pantry and found all the rice gone. Remember, those stores cater to small businesses as well.

USA Rice Federation Spokesman David Coia explained it this way:

"It's possible that small restaurants and bodega-type neighborhood stores may be purchasing rice in larger quantities than they do typically to avoid higher prices," Coia said about the warehouse chain restrictions.

Besides, as anyone who shops at Costco or Sam's Club all the time already knows, those stores run out of things all the time.

Another Food Crisis Cause?

Mary Kane — Thu, 24 Apr 2008 12:19:28 GMT

Did the World Bank and the International Monetary Fund somehow contribute to the global food crisis? That's the intriguing question Salon's Andrew Leonard poses. He points out that policies by both agencies in the 1980s and 1990s required developing countries to pull back on government intervention in their economies in return for aid. Developing nations also were encouraged to open their borders up for free trade.

While both those ideas sound good in theory, for some poor nations it didn't really work. Their agricultural sectors never got the government subsidies they probably needed, and cheap imports further depressed profits. Leonard points to the case of Malawi, which defied the agencies and provided fertilizer directly to farmers, in a successful move to boost its agricultural sector.

No one is saying the two agencies are in any way directly responsible for food shortages. As we wrote yesterday, there are many causes, including changing appetites in the China and India, biofuels, and an Australian drought. But as the crisis grows, actions by agencies directly involved in the development of poor nations also will be getting a closer look.