The United States is still struggling to understand and recover from the financial crisis that flared up in 2007-8. The story of the housing market, subprime mortgage lending practices, and the mistakes responsible for the crisis is both complex and essential to understand in order to avoid repeating. In this exceptionally informative Q&A, Jennifer Taub, author of Other People’s Houses: How Decades of Bailouts, Captive Regulators, and Toxic Bankers Made Home Mortgages a Thrilling Business, explains what you need to know about the housing market failure.
Yale University Press: There are numerous news stories of late, which talk about the comeback of the housing market, in particular in urban centers like New York City. Is the housing crisis—and the associated economic downturn—safely behind us?
Jennifer Taub: Stories of all-cash bids for New York City apartments and soaring sales of luxury homes in San Francisco belie the hard reality that the housing market has not recovered. After a few years of gains, we now see signs of stagnation. According to new data from Standard & Poor’s, home prices appear to be flattening. Volume is also down with sales of new and existing homes falling.
Applications for home purchase mortgage loans slid by nearly 18% this April compared to last year, according to the Mortgage Bankers Association. Completed home mortgage loans (including refinancings) dropped more; this quarter they were down 58% compared to the same time last year. This is the lowest level since 2000, according to Inside Mortgage Finance.
This is a tale of two recoveries. Wealthy purchasers seeking investment properties or vacation homes can draw upon stock market gains to bid up prices. In contrast, most Americans rely upon wages for income and their main assets are their homes. This means a shortage of willing and able buyers and sellers. As recently described by Neil Irwin in the New York Times, there are more than 2 million “missing” households, those who under normal circumstances are of the right age to purchase homes but are not taking that step. Many are renting or living with parents and other extended family members. This is likely because unemployment is still high, wages are low, and those with jobs feel less secure and are burdened by debt.
Meanwhile, the shortage of sellers stems from the fact that about 9 million households are still deeply underwater on their mortgages (owing more on their home loan than their property is worth). Thus many people cannot sell without facing a loss.
YUP: Are there still problems with bank lending practices and if so what are they? Do we need more regulation or less, in your opinion?
JT: Banks and bankers behave badly when there are incentives—including competitive pressures—to do so. Ideally, consumer protection regulation acts as a counterweight. Sensible regulation creates a level-playing field so that responsible lenders are not at a disadvantage when they avoid abusive and deceptive practices that are profitable to them in the short run, yet harm consumers and society in the long run.
There are incentives for banks to return to high-risk mortgage lending. Most of the pick-up in home loans we saw in recent years was due to an extraordinary level of mortgage refinancings. With interest rates now rising, refinancings have dropped off. With the decline in volume, we should be concerned that originators will once again push predatory mortgages and unreasonably relax underwriting standards.
There are also significant problems with payday loans—money lent in advance of the borrower’s paycheck. More than 12 million Americans use payday loans. At a March hearing conducted by the Consumer Financial Protection Bureau, experts revealed that payday loans are not really short-term in nature and can turn into a debt trap. Many large banks are now backing away from offering these or providing financing to payday lenders. However these fringe lenders are still flourishing.
Proponents of payday loans suggest restricting them will hurt those Americans who have little other sources for credit. A good alternative might be postal banking as suggested by Professor Mehrsa Baradaran. This would involve the U.S. Postal Service taking deposits, making small loans, and providing bill payment services.
YUP: Do the conditions that caused the prior market meltdown still linger and are we still vulnerable to a similar financial crisis?
JT: Unfortunately, yes. In 2009 Federal Reserve chairman Ben Bernanke defended the multi-trillion-dollar bailouts, explaining that “it wasn’t to help the big firms that we intervened. . . . When the elephant falls down, all the grass gets crushed as well.” Today, the elephants are larger than ever, and the grass is still crushed.
The top banks are bigger than they were before the crisis, and they still borrow excessively in the short-term and overnight markets to purchase risky securities, leaving them vulnerable to runs. The Dodd-Frank Act provided the regulators plenty of tools to prevent another meltdown. So far, the modest improvements to the safety of the system are encouraging, but woefully inadequate.
Read an excerpt of Other People’s Houses on Salon
YUP: What should be done?
JT: It’s time now for more bold action, such as the 21st Century Glass-Steagall Act sponsored by Senators Elizabeth Warren, John McCain, Maria Cantwell, and Angus King. We should also reduce banks’ dependence on short-term wholesale funding. In addition, we should create a pre-paid risk fund to finance the “orderly resolution” process created under Dodd-Frank, so that the banks themselves have to front the resolution process instead of the taxpayers. Such an upfront assessment was included when Dodd-Frank was in progress, but, under pressure from the banks, it was removed before the law was enacted.
YUP: How did we get to this point? Was this just a one-off market failure for 2008 or an indication of a larger pattern with banks and financial institutions?
JT: The 2008 meltdown was not a one-off market failure; it was a repeat performance, a more severe relapse of the same underlying disease that caused the S&L debacle in the 1980s. In both cases the same reckless banks, operating under different names, failed, while the same lax regulators overlooked fraud and abuse. Furthermore, today as the legal problems plaguing JPMorgan Chase demonstrate, the situation is essentially unchanged.
Though deregulation and desupervision enabled the S&L crisis the subsequent legal reforms failed to eliminate risk to borrowers, lenders, taxpayers, or to the entire system. Instead, risk grew, but through sophisticated financial innovation, it was strategically directed away from Wall Street to homeowners and taxpayers.
We are repeating the cycle. Today, our biggest banks are larger than before the crisis, are still excessively leveraged, are bumbling and behaving badly, sometimes criminally, but with little to no personal accountability. This poor conduct goes well beyond abusive consumer lending practices. With scandal after scandal, we see that these financial firms are too big and too complex for their own executives to manage and for the government to regulate or prosecute.
The problem is amplified when after a crisis, the strongest survivors swallow up the failing competition along with the target’s troubled corporate cultures and toxic assets. We saw this with JPMorgan Chase and now fresh evidence includes Bank of America’s announcement in late April of this year that it submitted incorrect data to the Fed as part of the annual stress tests. In an accounting error related to sales of bonds inherited from Merrill Lynch, Bank of America overstated its equity capital by $4 billion. The Fed required the bank to suspend a dividend increase and stock buyback plan.
Listen to Jennifer Taub on The Takeaway (starts 28:01)
YUP: While there are headlines about this spike in luxury apartment buildings, there are also statistics that the amount of “underwater houses” is on the rise (an underwater house is a home mortgage with a higher balance outstanding than the market value of the home.) What are the latest statistics on underwater homes: are there improvements?
JT: Despite some improvement in home prices, many millions of homeowners in America remain deeply underwater on their mortgages. These include families who purchased homes at inflated values or who were encouraged to take on more debt as property values rose during the bubble. Collectively, the negative home equity holds back our nation’s economic recovery.
According to RealtyTrac, more than 9 million homes have mortgages that are “seriously underwater” meaning the borrower owes at least 25% more on the loan than the home’s estimated market value. This is about 17% of all properties with mortgages. While this is an improvement from early 2012 when 12.8 million homes were deeply underwater, the housing market and the economy are stagnating in part due to this problem. By comparison, CoreLogic calculates that 6.5 million of mortgaged homes are underwater, down from an estimated 11.2 million in 2010.
YUP: At your book’s core is the story of Nobelman v. American Savings Bank. In that case, the U.S. Supreme Court decided that even filing for bankruptcy would not provide any help for underwater homeowners: that the mortgage loan principal could not be reduced. Is this still the status quo? Are there any indications that policy might change here to help distressed homeowners and stave off foreclosures?
JT: Our nation’s bankruptcy system is designed to offer a fresh start to borrowers who owe more than they own or who cannot make ends meet. Before the Nobelman decision in 1993, struggling homeowners in more than twenty states could turn to bankruptcy courts to save their homes. An underwater borrower could reduce the outstanding mortgage loan balance to the sunken value of their home. And, knowing this relief was available, lenders were more willing to voluntarily restructure mortgage loans.
The Nobelman decision is still the law of the land. This means that middle class homeowners are singled-out. Whereas the amount owed on a boat or vacation home can be reduced in bankruptcy, a purchase mortgage on a principal residence cannot. There is a solution— a simple amendment to the Bankruptcy Code. Such a proposal passed in the House in 2009, but over industry opposition and without support from the Obama Treasury department this important amendment failed in the Senate.
This simple amendment should have been included in the Bush bailout legislation in 2008. On the campaign trail, then-candidate Barack Obama had vocally supported changing “our bankruptcy laws to make it easier for families to stay in their homes” and to remove what he called a “Washington loophole” that “if you’re a family that owns one house, bankruptcy judges are actually barred from helping you keep a roof over your head by writing down the value of your mortgage.” However, in late September of 2008, while the bailout legislation stalled, he suddenly reversed his position encouraging the exclusion of bankruptcy reform from the legislation.
YUP: In your book, you point to the increasingly popular view that the 2008 meltdown in the housing market was the fault of borrowers. That these “subprime” borrowers had no business taking out loans for homes they could not afford, and that was the reason for the bursting of the housing bubble. Is that a fair assessment, in your view?
Read Joe Nocera’s op-ed “Bankrupt Housing Policy” in the New York Times.
JT: Subprime mortgage borrowers have been unfairly scapegoated. If every single subprime mortgage had defaulted, as author and former investment banker Nomi Prins has noted, the total unpaid principal would have been a fraction of what was committed by the Fed, Treasury, and FDIC in the financial crisis.
It is not credible to blame homeowners alone for the crisis. True, some homeowners participated in fraud, and others were simply unrealistic or were speculating that housing prices would continue to rise. However, a much larger number were victims either of abusive lending practices or of the housing bubble and burst that diminished their home values and retirement savings.
It was the desire of banks to make profitable trades, and hedge funds and other large institutions to speculate in mortgage-linked securities that drove the production of unsafe mortgage loans and brought down the system. It was the side bets, made knowingly by some and unknowingly by others, that put far more at risk than the total value of all the subprime mortgages.
The most influential bankers testified under oath that they alone should take the blame. Bank of America CEO Brian Moynihan told the Financial Crisis Inquiry Commission: “Over the course of the crisis, we, as an industry, caused a lot of damage. Never has it been clearer how poor business judgments we have made have affected Main Street.” In addition, JPMorgan Chase CEO Jamie Dimon told the Commission, “I blame the management teams 100% . . .and no one else.”
YUP: Is there anything the average citizen can do to help bring about change to protect themselves from predatory lending and under-regulated banks?
JT: Consumers concerned about a predatory or misleading banking practices can contact the Consumer Financial Protection Bureau, which was created under Dodd-Frank. They can seek assistance from an attorney with consumer law expertise. Those frustrated with too big to fail banks can also move their savings to a smaller institution. For example there are nearly 7,000 community banks in about 50,000 locations in this country as well as thousands of credit unions.
Consumers should share their stories with and express their concerns to their state and federal representatives. Phone calls, emails and letters matter greatly. To stay informed on legislation and policy matters, they can also follow the work of advocacy organizations including Americans for Financial Reform, Better Markets, and The Center for Responsible Lending.
Jennifer Taub is an associate professor at Vermont Law School, where she teaches courses on contracts, corporations, securities regulation, and white-collar crime. Formerly she was an associate general counsel at Fidelity Investments. She frequently speaks and writes about the financial crisis of 2008. She lives in Northampton, MA.