The scandal at the center of our latest mortgage mess is not the “robo signers” who played fast and loose with the affidavits submitted in foreclosure cases. It is that after years of propping up the banks and the alleged reform of the financial system under the Dodd-Frank bill, we still are teetering on the same precipice upon which we found ourselves in the wake of the Lehman Bros. collapse: Enormous amounts of toxic mortgage-backed securities remain on the banks’ books at imaginary valuations while prices for the $1.3 trillion in mortgage-backed securities are crashing, inspiring “too big to fail” institutions to seek special political favors. Fannie and Freddie are poised to insert themselves into the mix for political purposes, and normal financial processes are grinding to a halt as both regulators and the banks themselves put a hold on foreclosures. Meanwhile, thousands of would-be homebuyers have been cast into limbo because it is no longer clear that they can legally take possession of the foreclosed properties they are buying.
Didn’t we just do financial reform?
The United States has a 21st-century system for trading mortgage-backed securities but a 19th-century system for keeping track of actual house titles. That is the product of the shared interests of local governments that treat titling fees as one more cash cow in the golden herd and parochial business interests, such as title-insurance companies, that profit from the inefficiency of our antiquated system. As the turbocharged securitization process crashes into the crude title-recording system, thousands of foreclosure cases are stalled because it is proving difficult or impossible to prove who actually owns the title to a particular house, and who therefore has standing to sue for foreclosure.
One possible result of this mess is that billions of dollars in securitized mortgages, many of them low-quality subprime loans, could end up back on the balance sheets of the banks that sold them, setting the American financial system up for a replay of 2008. The government-sponsored enterprises, Fannie Mae and Freddie Mac, either insure or own most of the mortgages in the country, and the two politically connected firms still enjoy the outrageous privilege of unlimited financial backing from the U.S. government. Once again, taxpayers face the prospect of being on the hook.
The Obama administration was warned months ago that the foreclosure system was in trouble and chose to do nothing in response. But anybody who noted the rise in lawyers invoking the “show me the note” defense in foreclosure cases since 2008 could have predicted this scenario. (A very similar situation is likely to play out among credit-card defaulters: The bill-collector law firms that buy defaulted debt at pennies on the dollar from credit-card issuers are no more ready to show their paperwork than the mortgage servicers in the foreclosures cases.)
The Left already is presenting this as a case of the wicked bankers fraudulently throwing families out of their homes and onto the street. That does not seem to have happened: The vast majority of people who have been foreclosed upon are in fact not making their mortgage payments; in the tiny number of cases in which homeowners have been foreclosed on wrongly, it seems to have been from genuine error rather than malfeasance. (It goes without saying that these homeowners should be made whole and their grossly negligent tormentors punished civilly or criminally, as appropriate.) But the Obama administration has a new Consumer Financial Protection Bureau at its disposal, with left-wing scold Elizabeth Warren waiting in the wings to run it, and some Democrats already are arguing that the administration should use this mess to twist the arms of mortgage lenders until they offer the significant writedowns of principal and interest that the Left has been after since 2008. Their implements of torture: Fannie and Freddie, whose enormous clout could be used to bully the banks. This “solution” would do little or nothing to alleviate the threat of a second financial crisis; it would be merely punitive. In any case, the banks risk taking another beating, either from government strong-arming or from the unraveling of mortgage-backed securities, which will dump a load of bad loans back onto their books.
How bad a beating? Nobody knows. It could be mild, or it could be catastrophic. The critical issue of oversight — gathering intelligence about the financial system rather than attempting to micromanage it — has been comprehensively neglected by the Obama administration, which came into power on a slick of Goldman Sachs money and little appetite for intelligent, market-oriented reform. While the Democrats have been frittering away time and energy on non-issues like executive compensation and risible non-performing initiatives like the Home Affordable Mortgage Program, the deeper problems, as usual, have been ignored or misunderstood by the law professors and career politicos who have installed themselves as regents of the nation’s financial system.