Sunday, February 19, 2012

Fed Independence 2025

Headline: The Fed just  forced mortgage servicers  that got caught submitting "documents that were not properly notarized," among other sins, to cough up money towards principal reduction, for people unaffected by the notarization scandal, as well as to fund "nonprofit housing counseling organizations" and other policy objectives. 

Deeper question: What will the Fed look like in 2025? How long can it stay independent as it takes on more and more power, and uses that power for these kinds of political policy actions?

Act 1:  Three recent news items add up to a scary picture.

Item 1: Led by the White House, the state Attorneys General announced their "settlement" with banks.

Here's what happened. Suzie, Bob, and Joe each bought  $300,000 houses, that are now worth $200,000. Suzie stopped paying, and was foreclosed.  Bob borrowed $280,000, so he's "underwater," but he likes his house, doesn't want to ruin his credit, and is still paying his mortgage.  Joe only borrowed $200,000 and is also still paying.

The banks got caught robo-signing Suzie's paper work. The Administration and Attorneys General (with the laudable exception of Oklahoma) used the threat of prosecution to get the banks to lower Bob's principal by $20,000. Suzie might get a small check. Joe gets nothing.

There is a story for doing this. Bob might decide to stop paying his mortgage, forcing the bank to foreclose. The foreclosure might lower the value of his neighbor's property.

There are also costs. This money comes from somewhere -- the mortgage investors, the bank equity holders, or eventually the taxpayers. Maybe they had better things to do with $20,000. Maybe banks and investors, seeing their contracts torn up ex-post by the government, are going to be a whole lot more careful about who they lend to in the future. We live in a time of 3.5% mortgages that nobody can seem to get. To say nothing of the blatant unfairness, and moral hazard, of giving Bob this little present for taking out a huge loan, or the larger moral hazard of using the threat of prosecution for procedural errors to force anyone to cough up money towards unrelated policy goals.

As you can guess, I think it's a rotten idea. The Fed's own White Paper on Housing puts the ineffectiveness of the policy and its costs better than I can, citing the relevant research. Look at the top of p. 21.

But that's not important here. Even if you think it was a great idea, you have to admit it is a controversial policy, one on which there is likely a strong partisan divide. You also have to admit that the Administration threatened the banks with prosecutions to force them to finance a  policy goal having nothing to do with the actual legal case.

Ok, that's the kind of tough hardball that the executive branch plays. Which is why, in our society,  they have to face the voters.

Item 2: The Federal Reserve thinks foreclosures and underwater mortgages are a big problem too, and has been cheering the Administration's various mortgage-modification programs.  See Governor Elizabeth Duke's Speech on September 1, or Ben Bernanke speech on February 10, titled "Rebalancing the Housing Market" -- a new job for the Fed -- or the Fed's extensive White Paper on Housing. (Actually, reading this stuff, the Fed seems much more keen on "government-facilitated rent-to-own programs," but that's an intervention for another day.)

Item 3: In case you missed it, the Federal Reserve is taking on regulation of financial institutions at a very detailed level. I reviewed its massive plan to regulate large banks in an earlier oped and blog post The Fed just announced its plans to actually go forward and "designate" non-banks as "systemically important" and subject to its mercies as well. Together with the new "Consumer Financial Protection" bureau, located in the Fed, the Fed can and will tell large banks what to do at an amazingly detailed level.

Let's put two and two together. How long will it be until the Fed starts acting like the Administration. "Nice bank you have there. Wouldn't want anything to happen to it. Those consumer financial protection nerds can be a real pain in the butt, can't they? To say nothing of those wonks down in the systemic risk department. Say, we notice you're still sitting on a lot of reserves, and nobody's lending to support the housing market in Detroit. Sure would be nice if you pitched in and helped a bit. And why aren't you writing down mortgages instead of foreclosing on all those houses?"

I don't mean to ascribe any bad motives here. The people I know at the Fed are all well-meaning and really smart.  The problem is the power. If you really believe that "the market is not functioning as it should." (Elizabeth Duke, Sept 1), i.e. that the housing markets are impeding recovery, and that banks could do a lot about it;  if your institutional mandate includes micromanaging the state of the economy by watching individual markets, and detailed regulation of bank's activities,  the outcome is inevitable: You will soon be using your regulatory power to force the banks to accomplish policy goals.

Act 2: It's already happening

As I was writing this, I thought I was writing one of my usual doom-and-gloom worries about  the far-off future. Browsing the Fed's website, it turns out it's already happening.  For the Fed is a party to the Administration's deal, and is using its banking supervision powers to force mortgage reductions.

The Fed announced its actions in a February 9 press release 
The Federal Reserve Board ...has reached an agreement in principle with five banking organizations regarding the issuance of monetary sanctions against the organizations totaling $766.5 million. The monetary sanctions would be assessed for unsafe and unsound processes and practices in residential mortgage loans servicing and foreclosure processing.

... the Board is acting in conjunction with a comprehensive settlement agreed in principle between the five banking organizations, the state Attorneys General, and the Department of Justice on February 9, 2012 ("Settlement Agreement"). The Settlement Agreement requires these organizations to provide $25 billion in payments and other designated types of monetary assistance and remediation to residential mortgage borrowers. 
It's right there in print:

1) The Fed is using its banking supervision powers, to call the robosigning scandals "unsafe and unsound" banking practices.

2) The Fed is acting in conjunction with the Administration -- so much for independence and standing outside of politics.

3) The Fed is forcing the banks to write down mortgages and provide other "assistance," policy goals unrelated to the actual "unsound processes and practices." 

The details, in the followup Feburary 13 press release are even more astonishing. Reading from the Ally Financial settlement,
WHEREAS, the Mortgage Servicing Companies [Ally Financial Subsidiaries], ... allegedly:

(a) Filed or caused to be filed...numerous affidavits.. making various assertions, such as the ownership of the mortgage note and mortgage, the amount of principal and interest due, and the fees and expenses chargeable to the borrower, in which the affiant represented that the assertions in the affidavit were made based on personal knowledge or based on a review by the affiant of the relevant books and records, when, in many cases, they were not based on such knowledge or review;

(b) Filed or caused to be filed in courts... numerous affidavits and other mortgage-related documents that were not properly notarized,..

(c) Litigated foreclosure and bankruptcy proceedings... without always confirming that documentation of ownership was in order at the appropriate time, including confirming that the promissory note and mortgage document were properly endorsed or assigned and, if necessary, in the possession of the appropriate party...
Heavens, what a scandal...Documents not properly notarized! Notice it does not even "allege" that anyone was actually kicked out of a house who was paying their mortgage.
WHEREAS, as part of the Settlement Agreement the Ally Parties agreed to provide consumer relief, which may include mortgage principal reductions or refinancing, and other assistance to certain residential mortgage borrowers (the “Borrower Assistance”)

NOW, THEREFORE, ..and solely for the purpose of settling this matter without a formal proceeding being filed and without the necessity for protracted or extended hearings or testimony, it is hereby ORDERED by the Board of Governors,... that:

1. Ally Financial, ResCap, and the Mortgage Servicing Companies are hereby jointly and severally assessed a CMP [civil monetary penalty] in the amount of $207,000,000...

2. ...the Board of Governors shall remit up to $207,000,000 of the CMP by an amount equivalent to the aggregate dollar value of the Borrower Assistance provided....

3. .. the Board of Governors shall also remit up to $207,000,000 of the CMP... by an amount equivalent to the aggregate amount funds expended by Ally Financial, ResCap, and the Mortgage Servicing Companies on funding for nonprofit housing counseling organizations, approved by the U.S. Department of Housing and Urban Development, to provide counseling to borrowers who are at risk of or are in default or foreclosure, or to provide assistance to borrowers in connection with the independent foreclosure reviews required by the Consent Order...
Again, right there in print:

1) Ally is to provide "relief" to borrowers, not victims of the lack of notarization.

2) They're doing it to avoid the threat of huge legal bills.

3) Legally, the Fed can't tell Ally to write people checks. So, the Fed is  going to levy a $207 million penalty because Ally's lack of notarization is an "unsafe and unsound" practice. Then the Fed will "reduce the penalty" by exactly the amount that Ally spends on "borrower assistance."

4) It's not just writedowns,  but all the hilarious stuff in the last paragraph -- "funding for nonprofit housing counseling organizations!" Stuff that the Administration wouldn't dare put in a budget it sent to Congress.

It's a bit puzzling that the Fed signed on to this agreement, actually. As above, the White Paper on Housing and Fed official's speeches are pretty negative on mortgage writedowns. One sniffs a lot of pressure coming form the White House.

Which is the danger, for the Fed, of getting involved in these policies at all: Who knows what great ideas the Santorum Administration will have for the Fed to "support manufacturing," or the Romney Administration will have for its idiotic "day 1" currency war with China?  Now we know what the Fed is,  it is only a matter of the price. It would be have been far better for the Fed to say, "as the price of our independence, we're not allowed to do things like this."
     
Act 3: Independence

The Fed is set up to be politically independent, and central bank independence is a cherished principle of monetary economists.

Academics typically think the Fed's main job is to control short-term interest rates: too high and we get unemployment, too low and we get inflation. Fed "independence" helps it to make this decision without too much political interference. Such interference might skew the decision to temporary stimulus at the expense of long-term inflation.

Before the financial crisis, thinking around the world was moving towards the idea that the central bank's job is really just to control inflation. Efforts to micromanage the economy  were largely seen as illusory.  This view was embodied in the ECB's mandate and many "inflation-targeting" regimes. The whole banking supervision part of the Fed was a separate backwater, unrelated to the Fed's macroeconomic policy roles.

That all seems so quaint now. The Fed is now the Gargantuan Financial Regulator, as well as Controller and Stimulator of the Macroeconomy.  Its macroeconomic role is increasingly the Supporter of Particular Markets and the Allocator of Credit. It's also getting in to the business of running whole markets, i.e. the details of how mortgages are written and serviced. And it's loudly cheering for particular Administration policies such as mortgage modifications. Monetary policy is way down the list.

The price of independence is limited power. Central banks that only try to control inflation, and only using one tool, such as purchases and sales of Treasury debt, can be walled off from the political process. As a country, we can decide that the price level will not be used for political purposes and assign its maintenance to technocrats.

The Fed was assigned great power after the financial crisis. It's more competent than most of the other agencies, and as a result of its historic independence can act with great power. But this situation cannot last. The Federal Reserve cannot command that one group of voters cough up $20,000 checks to another group of voters, and not expect those voters to want a say in the matter. Locating financial regulation in the Fed may turn out to have been a terrible idea.

What to do? Good question. My preferred answer would be to save the independence, competence, and a-political nature of the Federal Reserve. That means breaking up its functions. Focus monetary policy on the price level, and stop pretending to micromanage activity. In any case, separate monetary policy from financial regulation -- break the institution up so that financial regulation tools cannot be used to promote macroeconomic policy goals, except by direct political intervention, by politically accountable officials.

The alternative is to bring the whole of the Federal Reserve's activities under much more direct control and accountability to elected officials. I have no more faith in the wisdom of elected officials than the next person, so I foresee a politicized Fed will be disastrous. But our society is not built on faith in the wisdom of an unaccountable aristocracy with huge power and no supervision. That will be even more disastrous. That's where the Fed is going, and it cannot last.


20 comments:

  1. The bankers involved in robo-signing should just have gone to jail. That would have been much better.

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  2. Just to be clear - (begin rant) perjury (the swearing of false affidavits) is a felony and when it is done as part of an organized scheme is an enormous threat to the proper functioning of the judicial system. False affidavits can ruin people's lives. It is not something to be laughed off with a comment like "Heavens, what a scandal".

    The people complicit in the swearing and use of the false affidavits could and should go to prison for a long time and the government should not have let the banks buy their way out of this one. (/end of rant)

    Lack of proper back room documentation is a threat to the functioning of the banking system. We can argue over whether or not the Fed is the right agency but the banks (broadly defined) should have a legal obligation to keep proper records so that we can avoid situations like MF Global where a billion dollars is missing ("vaporized") and no one can say where it went. MF Global quality book-keeping is a systemic risk.

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    1. Should banks also have the "responsibility" of increasing home ownership amongst blacks, poor and underprivileged sections of society that vote for Democrats?

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    2. Absalon, there's no reason to believe that the use of robo-signers leads to bad or faulty bookkeeping. There is no indication that the banks were signing false affidavits, and again, they didn't even allege that any wrong documents were signed, intentionally or by mistake. Comparing the use of robo-signers to perjury is outlandish, assuming the documents were correct. The use of "proper notarization" isn't necessarily a better or more efficient system, it's just an arbitrary regulatory burden. If anyone should be put in jail, it's the people in charge who are coercing the people they don't like to give money to the interests that they do like. Such authoritarian rule *does* ruin lives, and generally make society poorer, less productive, and ultimately worse off.

      MF Global was responsible for more than bad "book-keeping." Indications are that they literally stole customer funds and used them for their own account. That's stealing, an actual crime, for which jail time seems warranted. The fact that you think that the government would do a better job than private industry at book-keeping seems strange to me. There are government receipts for millions of dollars which have been wasted literally because it's cheaper than going through the byzantine process of checking inventory back into the system. Private industry at least has decent incentives to encourage efficiency.

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    3. Abir - My answer to your question is no.

      Jason - Mr. Cochrane's article quotes from the settlement as follows: "the affiant represented that the assertions in the affidavit were made based on personal knowledge or based on a review by the affiant of the relevant books and records, when, in many cases, they were not based on such knowledge or review;"

      What is described there is perjury in those cases where there had been no personal knowledge or review.

      With MF Global - if there had been proper book keeping theft would have been harder and recovery would have been easier. There is nothing wrong with the government ordering financial institutions to maintain accurate records in a robust record keeping system. I never said that the government should be doing the book keeping for the financial sector.

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    4. You want to put people in jail for perjury every time they claim to have read something they haven't? Sounds to me about like putting people in jail for clicking the "I Have Read and Accept" box on terms and conditions pages. If the papers were all in order, and they appear to have been, the method of their organization shouldn't concern the government.

      Companies ought to be responsible for their own book keeping because it is in their own best interest to do a good job. Government regulation in this instance can only increase compliance costs. MF Global may have done a bad job at book keeping, but they also were stealing, so laws and regulations were obviously not big concerns, and wouldn't therefore have contributed anything more to that circumstance than the laws already on the books against theft.

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    5. Jason

      Do you know what an affidavit is?

      An affidavit is under oath. It is as though it were evidence given personally in court under oath. The courts rely on them to make court orders which are then enforceable by the full coercive domestic power of the state. When someone repeatedly swears false affidavits then yes I want them and everyone complicit in that pattern of conduct to go to prison.

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    6. Jason,

      We tend to think it's pretty important that someone can prove they own someone else's property before they take it.

      When the person in charge of swearing to a judge that they have reviewed all the documentation for important things like whether the bank does, in fact, have proof the homeowner was delinquent and whether the bank does, in fact, have proof it owns the loan (and the house), turns out to be lying. That seems to be a pretty big deal.

      "Litigated foreclosure and bankruptcy proceedings... without always confirming that documentation of ownership was in order at the appropriate time,"

      Oh and the ho hum sarcastic "oh heavens" was right after they pointed out that banks were foreclosing on homes without being able to prove the homeowner was delinquent or that the bank owned the homes.

      Being able to show you own something before you take it from someone else is not a mundane bureaucratic requirement.

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    7. "Being able to show you own something before you take it from someone else is not a mundane bureaucratic requirement."

      For 'free market libertarians, it does appear to be an onerous duty, where the Dead Hand of government crushes the independent spirit of entrepreneurs.

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  3. I've only read your first point "Act 1" and although I firmly believe something needs to be done about the current banking system, I believe direct intervention is a dangerous device.

    With reference to your comment;

    "if your institutional mandate includes micromanaging the state of the economy by watching individual markets, and detailed regulation of bank's activities, the outcome is inevitable: You will soon be using your regulatory power to force the banks to accomplish policy goals."

    I would also liken to this to the recent situation over here in the UK with the uproar over Stephen Hester's bonus where there was public dissent (also coming from many politicians) saying that he shouldnt accept approx £1million bonus (far below market value), arguing that he is essentially a public servant. The problem I have with this (which corresponds to what I interpret to be your concern behind the above quote) is that although RBS received a huge bailout he was brought in afterwards to run the bank, with the bank remaining a private company, hence he just like the business he runs should be subject to market forces in the way any other private bank should be. If the government wanted someone to run it as a civil servant they should have nationalized the bank and sent someone from the (UK) Treasury to do so.

    Like I say I think there are serious market failures in banking at the moment. But if governments do wish to help correct such failures in a free market environment that is conducive to business they need to create positive market incentives that induce banks to behave in a way that correct such failures through MARKET FORCES. If they do wish to directly intervene they need to do so through their own government entities, or risk blurring the line between free market economics and a puppeteer economy.

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  4. John, major banks have been colluding with each other and committing various unsavory violations non-stop in the last 10 years. How many multi-billion dollar settlements have we had in the last 10-15 years? Enter the libor fixing scandal just few weeks ago
    Conditional on this, we can assume that it is very likely there is enough material in the mortgage mess to go after these guys. Given this, would you prefer that government and/or Fed spend enormous resources on litigation, or is justice better served by using those resources to help victims of these fraudulent practices ?

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  5. I see no evidence now that the Fed is in any meaningful way "independent". Bernanke seems to be doing almost exactly what the treasury wants him too, or maybe it is the other way around and he is creating both Fed and Treasury policy.

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  6. The Fed should steer clear of this sort of regulation. Beyond its purview.

    That said, the Fed needs to be more independent---right now, the Fed appears completely cowed by partisan right-wingers screaming about inflation (as long as Obama is President, anyway).

    Really, John Taylor, Allan Meltzer, Ben Bernanke and Milton Friedman all go to Japan, and tell Japan to print a lot more money.

    But it is politically incorrect anymore to say "print more money," at least for the USA, at least while Obama is president. Indeed, Rick Perry suggests Bernanke should be executed for printing more money.

    So, the Fed is suffocating the USA economy, to placate partisan sentiments and fevers. See the Bank of Japan and the Japanese economy for how this will turn out. Wages down 15 percent real terms since 1992 in Japan, industrial production down 20 percent, stock market down 75 percent and property down 80 percent. Tight money is an epic failure--oh, but wait! The yen is up! Salvation!!!

    Yes, I want an independent Fed. Cochrane misses the big point. Partisan blinders?

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    1. So all of our problems are because the Fed won't print money?
      (even though they have indeed printed a lot of money)

      Not because of wasteful spending, disarray among our trade partners, horrible debt, and an extreme anti-business regulatory regime?

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  7. Kyle8-
    We had all those structural impediments before 2008.

    I am completely against wasteful federal and state and local spending (would like a ceiling on public sector outlays).

    But in fact, much of the USA economy is less prone to inflation than in the 1970s, thanks to international trade and de-unionization. I could argue that we are less regulated than in the 1970s, if you remember how telephones, airlines and banks used to regged (remember passbook accounts and Regulation Q)?

    Yes, the Fed has failed to provide enough cash to the economy. We are doing a Japan.

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  8. Perhaps I have got everything wrong but it seems to me that this kind of intervention is direct consequence of independence. I mean, the whole idea of independence of a central bank is based on the fact that there are technical decisions where politics should not rule. In those areas, politicians should step aside in order to leave the space for the people with techical undersanding.

    The thing is that the very idea of the existence "government activities that are too critical to be putten in the hands politicians" means that there are people better qualified to run issues and that these people should be in a superior position - not answering to electors. So what?

    So when there is a crisis and nobody realy knows how to solve it, people tend to run to the specialists - the people that by definition knows a lot about employment and inflation. That's what is happening and what this whole thing about.

    The problem is that when it happens, the elected people tend to give power to the non-elected sages (sorry, technocrats). What happens then?

    The sages (sorry, technocrats) start to acumulate functions which are essencialy political (besides the fact that are obviously related to their mandate). This starts a process where they receive more and more power from elected oficials and, once there is no such a thing as a free lunch, they start playing politics.

    How can this problem be solved? I have no idea. Central banking is an human activity and in the end of the day we are only humans after all ....

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  9. Professor, thanks for quoting the Fed's accusations that servicers made false statements in affidavits. I just wish you acknowledged the significance of that in your own comments.

    As far as significance of incorrect documentation, a recent investigations of 400 foreclosures in San Francisco by the County Assessor-Recorder (see http://www.nytimes.com/2012/02/16/business/california-audit-finds-broad-irregularities-in-foreclosures.html) found among other things that:

    " ... 58 percent of loans listed in the MERS database showed different owners than were reflected in other public documents like those filed with the county recorder’s office."

    There seems to be a temptation these days to say that activity cease to be a crime if it is committed routinely as part of a business. Not a good idea I think.

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  10. There's one other disgusting footnote to this: the principal cram downs are tax-free, thanks to the "Deadbeat-specuvestors Tax Relief Act of 2008" (Ok, it's actually called the "Mortgage Forgiveness Debt Relief Act")

    If you or I have debt of $50,000 that's forgiven, we'd have to pay 30 or 35% tax on it, depending on our bracket (that's $15,000). These deadbeats won't have to pay it. That's right; the get a $15,000 gift from We, the Taxpayers, and they still will have the nerve to think of themselves as "victims."

    Then there's the aspect of "phantom rent". Because they get to live rent free for a year while the house is being foreclosed, that's another $12K-$36K a year of tax-free income.

    I hardly feel sorry for folks who won the foreclosed house lottery.

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  11. I have another idea! Let's review all the "stated incomes" on "stated income" mortgage applications and compare that to the income these deadbeats reported on their 1040. If it doesn't match, make them pay the taxes, with interest and penalties.

    Just because the banks are sleazy, doesn't mean the borrowers are innocent.

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  12. http://fairlysafedelusions.blogspot.com/

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