Foreclosure’s fallout: What we’ve really lost after the housing investment meltdown

By Kaia Sand, Contributing Writer

At the end of October, with little fanfare, Oregon Attorney General John Kroger joined a class action lawsuit against Bear Stearns, now owned by one of the world’s largest banking institutions, J.P. Morgan Chase.

Several weeks before Kroger joined the Bear Stearns lawsuit, he also teamed up with all other state attorney generals for a 50-state review of foreclosure improprieties.

The lawsuit and investigation are two efforts to chip away at the foreclosure behemoth that continues to rock the economic and social stability of Oregon and the nation.

Banks deemed too-big-to-fail might seem too-big-to-challenge. But attorney generals are now flexing their collective muscle.

“An individual attorney general on his or her own has little leverage,” explained Peter Letsou, Associate Dean of the Willamette School of Law. “They are much more effective as a force when they group together.”

Tony Green, Communications and Policy Director for the Oregon Department of Justice, declined comment on his subject matter because his office does not comment on pending lawsuits or investigations.

The two actions highlight how the foreclosure crisis pervades all aspects of the economy. The lawsuit focuses on recovering public funds while the investigation scrutinizes foreclosures that are forcing both homeowners and renters out of homes at record levels. The rate of foreclosure in Oregon has increased more than 500 percent since 2006, according to the Center for Responsible Lending.

Houses are an emblem of this recession, or more precisely, foreclosed houses are—shells of shelter gaping in our landscape. But the reckless speculation on housing did more than result in foreclosures, and more than plummet investments for public funds. Our entire economic foundation is changed.

Such a crisis lowers employment, said Lewis and Clark economics professor Eric Tymoigne, and the crisis lowers tax revenue and increases spending in the form of unemployment insurance and other costs of increased poverty.

A wide view of the problem includes the gutted state and local budgets. The Oregon state budget is $3.5 billion short of needed funds to preserve the current level of state services.

Meanwhile, the federal government’s anti-foreclsure Home Affordable Modification Program, passed last March, is having little impact. It was intended to prevent 3 million to 4 million foreclosures. But a report released in December by the Congressional Oversight Panel shows that it is only expected to prevent 700,000 foreclosures, less than one-fourth of those intended. The promised lower mortgage payments have yet to be granted.

Attorney General John Kroger’s efforts represent a fight back at the profiteers that are mostly unscathed: JP Morgan Chase reported a net income of $4.4 billion for the third-quarter of 2010.

Recouping Oregon’s losses

On Oct. 29, The State of Oregon joined a class-action suit against Bear Stearns, now owned by J.P. Morgan Chase, to recoup an estimated $17 million in investment losses to the Oregon Public Employees Retirement Fund. Oregon’s losses are a fraction of the lawsuit, which represents the sale of $17.5 billion of mortgage-backed certificates in 2006 and 2007.

The Oregon State Treasurer and the Oregon Public Employee Retirement Board are joining plaintiffs representing pension and health funds for state and local governments in Iowa, Michigan, Mississippi, New Jersey, and Florida, as well as the Boilermaker Blacksmith National Pension Trust.

This follows a July lawsuit against Countrywide Financial Corp. to recoup $29 million in pension-fund losses from mortgage-backed securities. Oregon Public Employees Retirement Fund is currently worth $55 billion, according to James Sink, Communications Director at the Oregon State Treasury.

According to the Bear Stearns/JP Morgan Chase lawsuit, the securities rating agencies Moody’s Investors Services, Inc, and Standard & Poor gave the maximum rating (a triple A rating) to over 92 percent of these mortgage-backed securities.

In other words, these were deemed safe investments, which the state sought in order to assure pensions to its employees. The ratings agencies predicted a high chance that the folks who held the mortgages could pay them off.

“Pension funds bought those securities thinking they were a safe investment because they had a triple A rating,” said Tymoigne. “It turned out that this rating was completely unreliable and the assets backing the securities were not good assets at all. Ninety-five percent of those mortgage-backed securities were later downgraded to “junk bond” investments.

What are mortgage-backed securities?

Mortgages are bundled up in groups based on risk, and rated according to that risk. So an investor doesn’t buy a single loan, but pieces of a bunch of loans. Bears Stearns bundled not only mortgages that it originated, but also mortgages it bought in bulk through auctions. Bundling and slicing and dicing mortgages and then selling those off as ‘securities’ was big money.

Oregon Economic Fairness Executive Director Angela Martin describes how in the past, mortgaging “was a complete circle between the homeowner and the lender. One entity’s success was the other entity’s success. The bank succeeded when you paid that loan off.”

Now she describes the relationship between home mortgager and the mortgage broker, loan servicers and investors as a chain. “So everyone’s liability to this loan, and the success of this loan, ends on the day they take their first profits.”

For Bear Stearns and others drawing fees and extracting profits, selling loans further down that chain, it didn’t matter whether a family could actually make its mortgage payment, because these investment banks sold off the mortgages after they extracted fees and profits. They passed the risk to others, such as the state of Oregon and other plaintiffs in the class-action suit.

This shift-of-risk emerged with the rise of mortgage-backed securities as a source of profit for financiers, aided in part by a lack of federal regulation of derivatives and federal legislation that made highly leveraged investments easier for investment banks.

While one potential outcome of the lawsuit will be the recovery of state losses, another possible outcome could be bank reform, explained Peter Letsou.

A major goal, he said, will be to force “the banks to keep some of the investment risk themselves.”

Such class-action lawsuits could wield a good deal of power. The Congressional Oversight Panel, which Congress set up in 2008 to review financial markets and regulation, issued a strongly worded report on “Mortgage Irregularities” on Nov. 16. Pointing to the “allegations” that banks “misrepresented the quality of many loans sold for securitization” the report speculates that banks might be forced to repurchase faulty mortgages that investors bought as part of mortgage-backed securities.

The report also proposes one scenario in which banks may be unable to prove that they own some mortgages because they cut paperwork corners in their haste to buy up mortgages and reshape them into mortgage-backed securities and other products.

Widespread challenges, the report states, could pose “risks to the very financial stability that the Troubled Asset Relief Program was designed to protect.”

Robin Hood in reverse

Moving from a Triple A rating to Junk Bond status is not a subtle shift.

What was first represented as exceptionally safe — people would be able to repay their mortgage obligations — was then revealed as incredibly unsafe — people were in fact in jeopardy of losing their houses.

What made these bundles of mortgages ‘junky’? The vast majority of them were created in ways that were really difficult for people to manage. According to the lawsuit, Bear Stearns assigned the top rating to what are called “negative amortization loans,” which means loans would get bigger and bigger, and the loan payer makes no progress, going further and further in debt. At a certain point, the loan payments skyrocket to impossible heights.

What is described as “junk” or “toxic” for an investment has a real-world implication on the other end: people are deemed likely to lose their houses.

“It’s always been the case that high rates of unemployment have trickled down to cause foreclosures,” said Angela Martin. “This is the first time where foreclosures triggered unemployment which triggered greater foreclosures.”

It is important to note that financial collapse does not ride on the shoulders of low-income people who could not pay their mortgages. It was the fancy financing that puffed around the mortgages.

In her 2009 book, “It Takes a Pillage,” journalist and former Goldman Sachs financier Nomi Prins estimates that $1.4 trillion in subprime loans was puffed into $140 trillion dollars of speculative investment. These numbers are difficult to pin down because so many financial products were unregulated.

The housing bubble resulted in a “reverse Robin Hood” phenomenon, says Randy Blazak, a sociology professor at Portland State University, where money is extracted from those who have less in order to create profits for those who have more.

Because the investment banks made more money the more mortgages they could stuff into securities, mortgages were sold far and wide, and drawn up hastily.

Attorney general’s investigation

Now the question is whether much of that paperwork was shoddy because investors cut corners to extract profits.

A week before Attorney General John Kroger announced that Oregon is joining a 50-state review into mortgage foreclosure irregularities, Rep. Earl Blumenauer issued a statement calling for a mandatory foreclosure moratorium, responding to what he described as “the sloppy nature of the foreclosure process.”

While millions of foreclosures are taking place, “the problem is that a lot of those foreclosures seem to be illegal,” said Tymoigne. “There is missing paperwork. The bank has to show that it owns the deed to the house and they are usually not able to prove that.”

“We need this kind of investigation,” he continued. “We need a lot more of this kind. There was a ton of fraud going on in the system.”

In the last two years, the Oregon legislature passed laws asserting that homeowners have a right to meet with their lender before foreclosure can be initiated and that an affidavit must be filed at least five days in advance of foreclosure. In an atmosphere where homeowners struggle to reach the same person on the phone, an aim of legislation is to create some level of communication.

Lenders must inform homeowners of their right to request a loan modification and must provide an explanation should the modification be rejected. The Department of Justice review in Oregon will investigate compliance with these laws.

At the very least, employees in some of the major mortgage institutions have admitted to signing hundreds, or even thousands, of foreclosure documents in one day, a process described as “robo-signing” for its robotic nature. This procedure was illegal in states where one must enter an affidavit based on personal knowledge. Early this fall, Bank of America, Ally Financial, and J.P. Morgan Chase placed a temporary moratorium on foreclosures in states that require foreclosure proceedings to go before a judge. Oregon is not one of those states.

Severing ties to Wall Street

While the Department of Justice is attempting to hold the big banks accountable through lawsuits and investigations, some local groups are asserting ways that Oregonians might gain some independence from these banks.

The Move Your Money campaign encourages people to bank locally in community banks and credit unions. Led by Real Wealth of Portland, the campaign is supported by a number of other groups, including Sustainable Business Network, the Economic Justice Action Group of First Unitarian Church, and the Portland chapter of Alliance for Democracy.

As organizers of Move Your Money investigated ways individuals could assert financial independence, they began to wonder how to get credit flowing for small businesses in the state and established Oregonians for a State Bank, said Barbara Dudley, co-chair of Oregon Working Families Party.

Under this plan, the Oregon State Bank would be a ‘bankers bank” that would buy loans from community banks and increase credit for small businesses. A state bank would use the state’s tax revenue for its depository base, rather than depositing that revenue outside the state in major banks responsible for so much of the financial crisis.

North Dakota has operated a state bank for over 90 years.

Dan Leahy, a former professor at Evergreen State College, issued an independent report titled “Introduction to Oregon’s Banking System” on Nov. 22. According to Leahy’s report, five banks dominate deposits in Oregon.

“As of June 2010,” Leahy wrote in his report, “(the state of) Oregon placed 61 percent of all its bank deposits in five banks: U.S. Bank, Bank of America, Wells Fargo, JP Morgan Chase and Key Bank. (The city of) Portland puts 83.37 percent in these same five banks.”

“This is our own money,” Leahy said. “Where does that money go? That money shouldn’t be going to these big banks. There’s no reason why that money shouldn’t be the depository base of a state bank.”

In a state-bank model, profit would return to the state. Barbara Dudley argues that lending could be restored to a circle of accountability.

“It seems likely that if one has the state bank involved then they are able to do more and better mortgage lending,” Dudley said.

As it is, millions of families nationally struggle through the isolation of fending off foreclosure, contending with paperwork hastily pulled together in order to sell their mortgages, and sell them, and sell them. And homelessness is becoming a new reality for families once living the American Dream.

Kaia Sand is a poet and essayist whose Happy Valley Project explored housing foreclosures and high finance through poetry, videos, and a magic show titled “A Tale of Magicians Who Puffed Up Money that Lost Its Puff.” The project is documented at thehappyvalleyproject.wordpress.com. Sand is the author of “Remember to Wave” (Tinfish Press 2010) and other books.