We Are So Screwed

Apparently, our recently discovered national thriftiness is dooming our economy (via Megan McArdle):

Consumers are pulling back because they've realized that they're too far in debt. The economy is shrinking in large part because consumers are pulling back. And the result, almost surely, is to leave household balance sheets worse than ever. I can't do this accurately until the Federal Reserve's flow of funds data have been updated, but almost without question the ratio of household debt to personal income has been rising, not falling, as consumers try to save more.

So to escape the debt trap we're in, we must spend more. This is cruel irony indeed, but the lesson really is that we ought to have been a little more thrifty when our economy could afford it as opposed to now, when our economy is diving off a cliff. Our economy has survived on a combination of debt and consumerism, and we shall now pay heavily for our short-sightedness.

Credit Card Crisis

In case you were wondering what economic bubble could be waiting just around the corner to be popped, your answer has arrived...credit card securities (via Matt Yglesias):

The troubles sound familiar. Borrowers falling behind on their payments. Defaults rising. Huge swaths of loans souring. Investors getting burned. But forget the now-familiar tales of mortgages gone bad. The next horror for beaten-down financial firms is the $950 billion worth of outstanding credit-card debt—much of it toxic.

That's bad news for players like JPMorgan Chase (JPM) and Bank of America (BAC) that have largely sidestepped—and even benefited from—the mortgage mess but have major credit-card operations. They're hardly alone. The consumer debt bomb is already beginning to spray shrapnel throughout the financial markets, further weakening the U.S. economy. "The next meltdown will be in credit cards," says Gregory Larkin, senior analyst at research firm Innovest Strategic Value Advisors. Adds William Black, senior vice-president of Moody's Investors Service's structured finance team: "We still haven't hit the post-recessionary peaks [in credit-card losses], so things will get worse before they get better." What's more, the U.S. Treasury Dept.'s $700 billion mortgage bailout won't be a lifeline for credit-card issuers.

The big firms say they're prepared for the storm. Early last year JPMorgan started reaching out to troubled borrowers, setting up payment programs and making other adjustments to accounts. "We have seen higher credit-card losses," acknowledges JPMorgan spokeswoman Tanya M. Madison. "We are concerned about [it] but believe we are taking the right steps to help our customers and manage our risk."

But some banks and credit-card companies may be exacerbating their problems. To boost profits and get ahead of coming regulation, they're hiking interest rates. But that's making it harder for consumers to keep up. That'll only make tomorrow's pain worse. Innovest estimates that credit-card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009.

Those losses, in turn, will wend their way through the $365 billion market for securities backed by credit-card debt. As with mortgages, banks bundle groups of so-called credit-card receivables, essentially consumers' outstanding balances, and sell them to big investors such as hedge funds and pension funds. Big issuers offload roughly 70% of their credit-card debt.

But it's getting harder for banks to find buyers for that debt. Interest rates have been rising on credit-card securities, a sign that investor appetite is waning. To help entice buyers, credit-card companies are having to put up more money as collateral, a guarantee in case something goes wrong with the securities. Mortgage lenders, in sharp contrast, typically aren't asked to do this—at least not yet. With consumers so shaky, now isn't a good time to put more skin in the game. "Costs will go up for issuers," warns Dennis Moroney of the consultancy Tower Group.

There are two substantial differences between credit card backed and mortgage backed securities. One, the market for credit card backed securities is a lot smaller. That's good. Two, whereas mortgage backed securities have at least some underlying value (the homes the mortgage are tied to) credit card backed securities, which consist of unsecured credit card debt, do not. That's bad, because there is in theory at least no bottom value for the security to reach. So the questions are, when do these securities reach the tipping point and begin to dramatically drop off in value, how much damage can they do on their own and more importantly, how many trillions in credit default swaps are tied to these bad securities?

What's to Come?

John Cassidy writes an interesting review of George Soros' new book "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What It Means" in the New York Review of Books this month. The review is titled "He Foresaw the End of an Era" and it discusses Soros opinion of the credit crisis we are enduring, and how it came about. Soros is apparently at odds with the popular orthodoxy, the Chicago school of economics, an approach championed by the likes of Milton Friedman that favors less government intervention in favor of reliance on the rational expectations of the market to provide a sufficient check on excess speculation and investment. Of course this school of thought assumes that actors in the market will behave rationally at all times, or at least frequently enough and in great enough numbers to prevent the market in general from acting against its own short or long-term interests. This is the approach that Alan Greenspan (and most American economists) adhered to, and it is reflected in comments he made before the Senate rebuffing calls for greater regulation of the derivatives market: “Risks in financial markets, including derivatives markets, are being regulated by private parties...There is nothing involved in federal regulation per se which makes it superior to market regulation.”Soros disagrees with this approach, believing that incorrect assumptions and perceptions cause people to work against their own interests, and that doing so can even fuel misperception. Here is an excerpt from his book that Cassidy highlights:

Reflexivity can be interpreted as a circularity, or two-way feedback loop, between the participants' views and the actual state of affairs. People base their decisions not on the actual situation that confronts them but on their perception or interpretation of that situation. Their decisions make an impact on the situation (the manipulative function), and changes in the situation are liable to change their perceptions (the cognitive function).

Cassidy explains with an example:

Imagine that ABC Corp. makes profits of $W per share, pays dividends of $X a share, and is growing at Y percent per annum. If you assume that this rate of earnings growth will persist indefinitely, it is a matter of high school arithmetic to figure out what ABC Corp.'s stock is worth on a fundamental basis, an amount I will call $Z. In the world of the Chicago economists, well-informed investors bid the price up to $Z and stop there. If prices rise above that level, they step in and sell; if prices fall below $Z, they buy. All is rational: all is efficient.

Now imagine that a group of irrationally exuberant investors come to believe that ABC Corp.'s growth rate is about to accelerate to 2Y percent, and, as a result, they bid up its stock up $2Z and keep it there for a while. What happens next? One possibility is that ABC Corp. could issue more of its highly rated shares and use them to purchase a rival, DEF Corp., whose stock price has been lagging—hence presenting a relative bargain. Thanks to the magic of acquisition accounting, the mere act of ABC Corp. buying DEF Corp. would make it appear that its earnings per share were growing rapidly. Voilà, the inflated earnings expectations that drove up ABC Corp.'s stock would have turned out to be justified. Most likely, the stock would rise even further—for a while, anyway.

As Cassidy explains, Soros did something to this effect when he was younger, leading a wave of mergers that artificially drove up the stock price of under-performing companies. At least, it did until the under-performing companies ran out of high performing companies to buy out, upon which the scheme collapsed as investors realized there was no real added value to the under-performing company. But Soros was gone before this happened, having made millions in the process. Soros behaved quite rationally, but for the other investors who genuinely believed that their stock price was skyrocketing, the popping of the merger bubble was what deflated their irrational exuberance...costing them millions in the process.

Soros goes onto explain how this irrational behavior led to the present crisis:

Turning to the current situation, he says that, in large part, the recent housing bubble in the United States fit the historic pattern, except that in this case reflexivity was centered on the real estate rather than the stock market. As house prices shot up between 2001 and 2005, credit standards deteriorated sharply. Rather than restricting their lending, mortgage financiers deluded themselves into believing that the collateral for the loans they were making would continue to rise in value. The very act of extending more and more credit, on easier and easier terms, kept demand for real estate buoyant, which, in turn, ensured that for several years the lenders' optimistic expectations were validated. It was only when borrowers who had taken out loans they couldn't afford started to default in large numbers that the housing bubble finally burst.

What distinguishes this process from earlier downturns, and what makes it so dangerous, is the historical and international economic situation in which it is taking place, Soros says. "Superimposed on the US housing bubble," he writes, "is a much larger boom-bust sequence which has finally reached its inflection, or crossover, point." The housing slump is following the normal historical pattern, he suggests.

As described by Soros, the "super-bubble" developed over the past quarter-century and is the result of three underlying trends: globalization, credit expansion, and deregulation. By globalization, he means not just expansion of trade in goods and services, and the rise of China and India, but the US's emergence as the world's biggest debtor. In the past couple of years, he reminds us, the United States has been running a current account deficit of more than 6 percent of GDP—a level usually associated with a developing country about to suffer a foreign exchange crisis.

The lending boom extended far beyond the housing market. Over the past generation, the overall expansion of the US economy has increasingly become an asset-driven phenomenon. In 1980, the total amount of credit market debt outstanding in the United States was roughly the same as the GDP: by 2007, it had risen to about 350 percent of GDP. The bundling of residential mortgages into widely traded securities—"securitization"—played a significant role in this transformation, but so did increased federal lending resulting from large-scale budget deficits, the securitization of credit card debt and auto loans, and an expansion in corporate debt issuance.

You may recall an earlier post where I quoted economist Satyajit Das, who said "Essentially, the world has just has far too much debt." Soros echoes this sentiment. Debt has driven the U.S. economy at all levels, from the individual consumer to the corporate conglomerate to the giant investment bank to the U.S. government. We are awash in debt because, for a decades, it has seemed entirely rational to incur vast amounts of debt to in turn invest that debt in something else, and as long as the collateral the debt is premised on retain its value this approach works. But when the housing bubble burst, the value of mortgage backed securities plummeted, and in turn so did the value of derivatives keyed to those securities, on the orders of tens of trillions of dollars. Vast sums were premised on the idea that houses in the U.S. would not only retain what value they had, but continue to increase in value; thus, in this view, mortgage backed securities were a wise investment that would never decline in value. Unfortunately for all of us, this was a misunderstanding of the forces at play. Easy credit drove up housing prices, and the increase in value resulted in more easy credit; a cycle that was self-reinforcing and completely insupportable and that came to a quick end when what homeowners borrowed began to outstrip even the small amounts they were being asked to pay. The housing market is now correcting itself but unfortunately, so is the market for the trillions in investment premised on the inflated value of homes.

So where do we go from here? Soros again:

So what does the end of an era really mean? I contend that it means the end of a long period of relative stability based on the United States as the dominant power and the dollar as the main international reserve currency. I foresee a period of political and financial instability, hopefully to be followed by the emergence of a new world order.

The present debate bears out Soros' remarks. This article wonders if American capitalism as we know it (the lasseiz-faire, anti-regulation approach) is at an end, and European leaders are presently debating what system should replace it with French President Nicholas Sarkozy calling to "re-found the capitalist system." It seems clear though that what is in order is a fundamental re-evaulation not only of our approach towards regulation of the market, but of the value of a debt as an engine of economic progress. What drove investment in mortgage backed securities and derivatives in general is the need of those with excess funds to do something with all that money they have, beyond simply sitting it in a bank. But what drove speculation far beyond the actual ability of most firms to account for what they owed, was the ability to borrow far more than they should have been able to and in turn leverage that into investments that were fundamentally unsound. Few on Wall Street thought it strange that an investment fund could borrow on the order or tens or hundreds times more what capital it possessed, and nobody wanted to look to closely at this scheme anyway, so long as everyone was making money. But of course such massive debt seems blatantly and obviously wrong to you and I, just as it seems wrong that a homeowner making $50,000 a year could borrow $500,000 to buy a house (though nobody wanted to look too closely at that either, so long as everyone was making money.) But the market failed to accurately price the risk inherent in mortgage backed securities (in fact, the market was eager to price the incorrectly so they could be sold to others) even though rationally, market actors should question the vast sums of debt and wonder who will finally get paid what and when. Regulation is in order, but the days of easy credit for both consumers and financiers also appear to be at and end as the value of vast amounts of debt contracts (and our economy contracts with it.) The old approach to the market is dead; what will replace it?

Credit Card Insiders Recount Hard Sell Tactics

In case you were wondering if that credit card reform bill we discussed yesterday is really necessary:

As an account manager for credit card giant MBNA, Cate Colombo spent four years speaking to customers, answering questions about interest rates and waiving late fees.

Kathy Ellingwood did the same. She lasted only a year and a half before quitting this summer.

The women worked in different departments at the sprawling customer call center in Belfast, Maine, yet they share similar stories about aggressive selling tactics they claim they were told to use to push cash advances, sometimes getting customers to max out their credit cards.

"Every customer who calls in is a mark. It's a great big con," said Colombo, who estimates that she alone sold almost a quarter of a billion dollars in the four years she worked for MBNA before it was bought in 2005 by Bank of America.

Colombo and Ellingwood said that within seconds of a customer's call, they would have his or her entire credit history on screen, and they were trained what to say to sell people money. Ex-bank employees spill secrets »

"I would say 90 percent of the time, people were pragmatic. They would say, 'I don't need $100,000,' and we would find a way to convince them they needed the money," Ellingwood recalled.

She said they would look for trigger words like, "I'm in financial difficulty" or "I can't make my payments." Colombo said other triggers were, "I have to send my son to college. My car is not running. I'm moving."

Colombo said some people even asked about getting a $50,000 cash advance -- usually at zero percent interest -- for a down payment on a house. And although that's illegal, the former employees say they were trained to get around it by saying, "I cannot give you money to use as a down-payment on a home. However, what I can do is, I can deposit some money into your checking account, and once it's there, the funds are there, it's yours to do with what you please."

...Colombo and Ellingwood say they were told to sell hard to everyone. Once the customer agreed, they say, they would speed through intricate disclosure notices. Among the details, how a zero-percent or low interest rate could convert to as much as 28 percent if a payment was even a day late.

"You're basically looking at people who need the money most, who may not be able to afford it," Ellingwood said.

Colombo remembers having a conversation with one man in his 90s.

"He had all this available credit, maybe $100,000. I have my manager screaming, 'Colombo, you need to sell. You need to sell. You need to sell,' " she said.

That's the market in action folks.

Economy still tightening

You feeling the squeeze yet? If you are, you're not alone. Millions of Americans are right there with you. Starry-eyed predictions that the mortgage crisis would quickly pass and America would be in good shape by the end of the year (last year) have proven to be ridiculously false. Not only that, the housing market is still falling further:

A widely watched housing index released Tuesday showed home prices dropping by the sharpest rate ever in the second quarter.

The Standard & Poor's/Case-Shiller U.S. National Home Price Index tumbled a record 15.4 percent during the quarter from the same period a year ago.

The monthly indices also clocked in record declines. The 20-city index fell by 15.9 percent in June compared with a year ago, the largest drop since its inception in 2000. The 10-city index plunged 17 percent, its biggest decline in its 21-year history.

No city in the Case-Shiller 20-city index saw year-over-year price gains in June, the third straight month that's happened.

And don't let anybody tell you it's bottomed out yet. It hasn't. It may be that it's slowing down, but it's still got further to go. It's a hard, hard hit for people who bought homes thinking they were rock-solid investments and a source of income, only to be rudely awakened when the American economy could no longer stand the strain of all that debt. And the news is not going to get better for a while. From Business Week Online:

Still, the loudest complaints on Main Street relate to rising commodity costs and inflation, especially expensive fuel and food. Gasoline prices have become a key issue in the Presidential campaign. U.S. consumers are spending less as retailers and restaurants struggle.

So have inflation worries finally replaced credit conditions atop the list of investors' biggest concerns? Is the credit crunch finally waning? Not a chance.

An August survey of economists conducted by the National Association for Business Economics did show an uptick in worries about energy prices and inflation, to 16% and 15%, respectively. However, 46% of economists said the credit crunch and the state of the financial system was their top worry.

Here's the thing: there is not going to be a point at which the housing market has bottomed out and the only direction is up. The problem is that utterly, fundamentally, the money has disappeared. Or rather, I should say, the illusion of money has disappeared. There was no real equity in those houses to begin with. Well, there was, but the banks told people that it's not actually just more debt. The illusion of money disappeared, but the debt didn't. When a new administration comes into office (because the current one obviously has no qualms with corporate misbehavior) it's almost certain that credit and lending regulations will be tightened with the probability of more legislation being passed. The circumstances that allowed this crash to occur are not likely to be present again for a long, long time. There have been other recessions, but despite the rhetoric issuing from this administration, this one is bad. We haven't seen the worst, and we have no way of knowing when we'll recover. The problem is really that the US's sources of income are pretty narrow. We make a lot of money off services. We no longer manufacture and export like we did, which is what helped us recover from the Great Depression and brought us our enormous post WWII prosperity.

Here's a fact: the economy will be given negative stimulus from the housing sector until housing demand is growing and high again. Here's another fact: according to the studies I've read and quoted in one of my other posts, If they quit building homes today, there would be enough of a surplus to last for two years or so (and longer if demand slows down even further). But it's a self-reinforcing cycle: the harder it is to get credit for a home, the fewer homes are sold. The fewer homes that are sold, the more the housing sector detracts from the market. This can last quite a while until other segments of the economy begin to make up for it and pump enough cash in to cause growth. If that occurs. I mean, it's not a given we'll recover. Cambodia was rich too, a long time ago.

Using that example, it may be that the death knell of the credit driven society is sounding. We may never borrow our way to prosperity again. The best time to make a commitment will be at our lowest point. That way the fewest people will be hurt. If this change does occur, we will be living in a vastly different society from the one our parents did. Of course, until consumer good prices come in line with consumer earnings, we may see sales of our luxury toys (like big screen lcd tvs) falling off sharply to reach the point where people actually have to save up money in advance to buy them. Wouldn't it be amazing? Inconvenient as hell, yes, but much more resistant to the kinds of slowdown we're seeing now. Our society may become merely as rich as the aggregate real wealth of it's people, not the aggregate amount of debt we can get into. Strange, I know. We'll see.

Billions for Home Equity

That is, banks spent billions to convince homeowners to borrow against whatever equity they owned in their homes. But of course the debt crisis can only be the fault of irresponsible borrowers who fraudalently borrowed money they could never repay. That banks wanted them to do this, and spent money to convince them to do it, is completely and utterly irrelevant.

Medical debts shouldn't count

I saw this interesting article on MSN Money, of all places, that rings true:

It's a good thing Greg Hilfman of Los Angeles has health insurance because an unpaid medical bill has sent his blood pressure soaring.

Hilfman's wife was in a hospital two years ago for pancreatitis, and Hilfman said she was treated by a "cadre" of doctors and specialists. All but one submitted bills to their insurer, Blue Cross of California, in time to get paid.

Six weeks ago, however, a woman from a neurologist's office contacted Hilfman, explaining that the office "didn't have the right address for Blue Cross" and thus hadn't submitted the bill within the one-year period required for reimbursement. She demanded that Hilfman cough up $540.

Hilfman was furious. He'd never heard of the doctor and insisted he'd seen no bill or any indication there was a problem with payment. Now he's worried he'll have to pay a bill that should have been covered by insurance or risk damage to the couple's credit reports.

"How is this fair?" he asked. "They can say anything they want (to the credit bureaus), and I have no recourse."

Hilfman is right to be concerned. The Your Money message board is littered with complaints from folks whose otherwise pristine credit was sabotaged by a medical collection. Sometimes their records were besmirched over absurdly small amounts that nonetheless had big impacts on credit scores.

Poster "sunny_light," for example, recently discovered a medical-collection account for just $7.

"I pulled my credit report last week and found out," sunny_light wrote. "I promptly paid the collections people. But now my credit score is down by like 80 points."

A similar thing happened to me two years ago. I was out insurance and had to visit an ER for a bronchial infection. Even though I promptly paid my bill, it still got reported and my credit was ruined for a good while.

Even when medical debts are legitimately owed and left unpaid, though, some experts question whether they belong on credit reports.

There's no question that medical bills pose huge risks for the finances of many families. Medical problems were cited as a factor in nearly half of the bankruptcies studied by Harvard University professor Elizabeth Warren.

Still, many mortgage lenders who specialize in serving low-income communities have discovered that discarding medical debts often gives them a better picture of a borrower's true creditworthiness, said Michael Stegman, the director of policy for the MacArthur Foundation's program on human and community development.

"If all their other credit accounts are in good shape, or they haven't established credit but they've had no delinquencies on their rent," Stegman said, "the fact you have a bad medical debt or an outstanding judgment over a medical bill is not a good predictor of default."

So true, I take extremely good care of my finances. I didn't even have a credit card at the time of my medical bill and the only reason I have one now is because you need to establish credit to get a home, a car, etc. Medicals debts shouldn't be held against you the same way not paying for all the clothes you bought with your credit card does. But, of course, medical debts are big business for collection agencies.

The article has a few helpful tips near the end about what you can do if you're in this situation, but we need state or federal legislation to help protect people from this crap.

Warning: Creditors Will Screw You

In a related pair of articles, we see that creditors are perfectly willing to play it fast and loose with debts that debtors don't actually owe to them. First, this report from Business Week that explains the growing market in discharged debts:

The case of Van Rathavongsa illustrates how canceled debts regain vitality. The Raleigh (N.C.) factory worker pulled himself out from beneath a mountain of bills by means of a bankruptcy proceeding that wrapped up in 2002. One of the debts the judge canceled, or "discharged," was $9,523 Rathavongsa owed to Capital One Financial (COF), the big credit-card company. But Capital One continued to report the factory worker's discharged debt to credit bureaus as a live balance, according to documents filed in U.S. Bankruptcy Court in Raleigh.

This kind of failure by creditors to update credit reports happens with some frequency, consumer lawyers and court-employed bankruptcy trustees say. And it can have consequences: In September, 2003, when Rathavongsa tried to close on a $274,650 mortgage for a new house, his would-be lender, Wachovia (WB), said he would either have to pay Capital One or show proof from the credit-card company that the debt had been discharged. Despite several calls and a letter from his attorney, he says, Capital One never revised the credit report. To obtain the home loan, Rathavongsa eventually did what many consumers in this situation do. He gave in and paid Capital One $9,523 he no longer legally owed.

Rathavoga got his money back, and fines to boot, but only because he was willing to go back to Bankruptcy Court and get a judge to force Capital One to acknowledge that his debt was legally discharged. But unbelievably, financial institutions are now trading in discharged debts:

Because of episodes like this, discharged debts have attracted the attention of little-known firms expert at buying and selling a range of delinquent consumer obligations. Back-due bills with a face value of billions of dollars change hands at a steep discount every year. Five of the companies in this business are publicly traded on Nasdaq. Others have large private-money backers. B-Line, in Seattle, was acquired last year by the Dallas-based hedge fund firm Lone Star Funds. The investment bank Bear Stearns (BSC) owns two bankruptcy-debt buyers: Max Recovery and eCast Settlement.

The very existence of this marketplace confounds even some veterans in the bankruptcy field. During a preliminary hearing in New York in March, U.S. Bankruptcy Judge Robert Drain asked a lawyer for JPMorgan Chase (JPM) how the bank had managed to sell consumer credit-card debts that had been discharged. "I don't know who would buy a discharged account," the perplexed judge said.

"Happens all the time, your honor," the Chase lawyer, Thomas E. Stagg, responded.

Once you complete bankruptcy proceedings and are granted a discharge (whether in Chapter 7, or at the end of a Chapter 13 repayment period) your legal liability for the debt is dissolved. In other words, you are no longer legally required to repay that debt, and creditors are not permitted to contact you in attempts to collect on the debt. So naturally, a bankruptcy court is going to be inclined to think that such a debt is worthless, since the owner of the debt can't legally collect on it and the debtor is no longer responsible for paying it. But of course, the debt gains value when a creditor or collector can actually coerce you into paying it, even if they're doing so illegally.

Congress, in drafting the bankrtupcy code, quite reasonably presumed that once they said a debt was worthless, it would actually remain worthless. For the longest time this has mostly been true, as sanctions for creditors that attempt to collect on discharged debts can be quite severe. Of course, if you acquire enough of these debts, and can con enough debtors into paying you even though they don't owe you the money, well then all of the sudden you have an instrument with value that is quite tradeable on the open market. Despite the fact that, of course, the value is premised on illegal behavior.

The only possible remedy is to punish transgressors even more severely for their bad behavior. And by severely, I mean as if God's wrath were coming down on their head. A corporate creditor will tolerate fines and sanctions and lectures from judges here and there on a few debts, if it can collect enough on the other debts it holds to make the whole adventure profitable. And it should be flat-out illegal to trade in discharged debts.

And in even more questionable behavior, mortage lenders are apparently tacking on fees and practicing poor book-keeping to get debtors whose homes are being foreclosed on to fork over even more money as they lose their family home:

Bankruptcy specialists say lenders and loan servicers often do not comply with even the most basic legal requirements, like correctly computing the amount a borrower owes on a foreclosed loan or providing proof of holding the mortgage note in question.

“Regulators need to look beyond their current, myopic focus on loan origination and consider how servicers’ calculation and collection practices leave families vulnerable to foreclosure,” said Katherine M. Porter, associate professor of law at the University of Iowa.

In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

On Oct. 9, the Chapter 13 trustee in Pittsburgh asked the court to sanction Countrywide, the nation’s largest loan servicer, saying that the company had lost or destroyed more than $500,000 in checks paid by homeowners in foreclosure from December 2005 to April 2007.

The trustee, Ronda J. Winnecour, said in court filings that she was concerned that even as Countrywide misplaced or destroyed the checks, it levied charges on the borrowers, including late fees and legal costs.

“The integrity of the bankruptcy process is threatened when a single creditor dishonors its obligation to provide a truthful and accurate account of the funds it has received,” Ms. Winnecour said in requesting sanctions.

As you may recall, Countrywide got in a little bit of trouble for inducing some of those homeowners into bad mortgages in the first place. Apparently that's not enough for them, as they now seem to think they're entitled to skim a little bit off the top even as the debtor descends into bankruptcy:

“We’re talking about millions and millions of dollars that mortgage servicers are extracting from debtors that I think are totally unlawful and illegal,” said O. Max Gardner III, a lawyer in Shelby, N.C., specializing in consumer bankruptcies. “Somebody files a Chapter 13 bankruptcy, they make all their payments, get their discharge and then three months later, they get a statement from their servicer for $7,000 in fees and charges incurred in bankruptcy but that were never applied for in court and never approved.”

In bankruptcy proceedings, fees like this MUST be approved by the bankrtupcy court. Debts like this are as uncollectable as discharged debts. But the debtor who doesn't understand the process or doesn't want to have to fork over hundreds or thousands more to a lawyer to contest the debt, are more likely to simply pay up when they get a bill, even after they've been granted a discharge (which incidentally in a Chapter 13, can come as long as five years after filing.) Or, they can simply try to over-bill the debtor, hoping the court won't scrutinize the fees closely and will include them in the Chapter 13 repayment schedule. This won't work in a Chapter 7 where debtors get a discharge and pay little or nothing on most of their debts (unless of course they just send you a bill later, like the credit card lenders in the above article.) But lenders have every incentive to try and game the system, as they often fail to recoup the full value of their loan when they foreclose on a home.

Again, the only recourse for bad behavior like this is to punish lenders severely. Hefty fines, and subordination or avoidance of debt in the bankruptcy proceedings, will help corporate lenders understand that there is a price for illegality. It's absurd that there can be anything but a junk market for suckers in debts that can't be collected. Stories like these are simply unacceptable.

Subprime mortgages in Texas

This from the Dallas Morning News:

Now, Texas ranks third in the nation in the number of foreclosures, according to RealtyTrac. Homes posted for foreclosure in the Dallas-Fort Worth area rose nearly threefold between 2000 and 2006, according to Addison-based Foreclosure Listing Service Inc.

Subprime mortgages, which helped fuel the surge in homeownership by providing loans to those who might not otherwise qualify, are now part of the problem. Such loans usually come with a higher interest rate – typically 3 percentage points higher or more – and often are adjustable, meaning their interest rate can adjust upward as overall rates rise, as is happening now.

In Texas this has meant that a large percentage of subprime mortgages and foreclosures have gone to the Hispanic population.

In Texas, the number of Hispanic homeowners nearly doubled between 1995 and 2005, according to Tim Ready, research director at the University of Notre Dame's Institute for Latino Studies. Hispanics accounted for nearly 65 percent of the state's growth in owner-occupied homes during that period.

Now, Texas ranks third in the nation in the number of foreclosures, according to RealtyTrac. Homes posted for foreclosure in the Dallas-Fort Worth area rose nearly threefold between 2000 and 2006, according to Addison-based Foreclosure Listing Service Inc.

I suggest reading the rest of the article in full. It simply goes to further prove that irresponsible lending has done us all a disservice. Hispanics are more vulnerable given their lower average incomes, but the situation is the same for all those in the lower income brackets.

Fixing the problem will take some work and money, but this story is flying fairly low on the radar right now. It's not something the vast majority of people are reading or hearing about, especially when stories on CNN Money or MSNBC are telling us about record-breaking highs on the stock market. Nobody wants to hear the bad news, except maybe Congress.

I can only say again, this happened because of a lack of regulation in the market (meaning on banks). Hopefully legislation will get passed, but Congress hasn't before even when it was Democrat controlled. We'll see. Let me tell you, if we don't, it'll just happen again.

Housing market slumps, Foreclosures higher

Apropos of my very recent post on the state of the economy, here we have some fresh reports on the state of the housing market and the continuing effects of the massively irresponsible extensions of credit by lenders.

From a report on CNNMoney.com:

Sales of new homes sank to the slowest pace in more than six years in February, with the government's latest reading on the battered real estate market showing the glut of homes on the market reached a 16-year high.

New homes sold at an annual pace of 848,000 in February, according to a Census Bureau report, down about 4 percent from the 882,000 rate in January, which itself was revised lower. The pace of sales tumbled 18.3 percent from February 2006, with all four regions of the country showing sharp declines.

This is surely tied to the fact that so many of the home sales in the past few years have been due to people buying entirely on credit, as lenders gleefully waved wads of cash around telling borrowers the piper never comes to this town. As wages have stalled and even shrunk due to inflation and as the micro-economy for the majority of American has tightened, the time came to pay the piper but they didn't have the money. He's playing his tune and taking all their houses away:

More than 2 million homeowners could lose their houses in the subprime mortgage meltdown, reports CBS News correspondent Anthony Mason. About 300,000 are already in foreclosure and more than 50 lenders are in serious trouble or have gone belly up.

Yes, blame the people for borrowing money they couldn't pay back and taking on house payments they couldn't really afford, but how easy is it to say no the deals they were offering?

Risky lending practices became so lax that in the past two years 40 percent of first-time home buyers put no money down. Now delinquency rates are soaring, adds Mason.

Evidently a lot of people don't find it so easy. Unfortunately, this is the kind of mistake you pay for in a big way. Not only that, but it's the responsibility of these lenders not to extend so much credit to so many people who are virtually guaranteed to default. What to do now? Well, it happens to be in the interest of the United States economy to keep people in their houses and paying on their mortgages instead of letting them declare bankruptcy and leaving millions of empty homes on the market that people won't be able to buy. Hopefully some kind of relief legislation will be passed, because as bad as this already is, we don't want it to get worse and start reaching into the rest of the economy. Two million homes means at least two million homebuyers. That's not the kind of loss our economy, titanic as it is, can absorb with no harm.