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Taking stock of The U.S. real estate crisis
The rise and fall of mortgage lending

[Translated from Gegenstandpunkt: Politische Vierteljahreszeitschrift 4-12, Gegenstandpunkt Verlag, Munich]

Five years after the crash of the housing market in the United States, the crisis has become somewhat permanent. Experts see in the conditions of this sector of the national economy either the worst crisis since the Great Depression or, when prices and sales figures temporarily rise again a bit, the famous light at the end of the tunnel. All the same, the general situation remains as summed up by the chairman of the Federal Reserve at the beginning of last year:

“The state of the housing sector has been a key impediment to a faster recovery. In the typical economic recovery, a resurgent housing sector helps fuel reemployment and rising incomes. But as you know all too well, that scenario has not played out this time… [H]omebuilding remains depressed in most areas, relative both to where it was before the downturn and to where it will need to be to meet the needs of a growing population in the longer term.” (Bernanke, speech to the National Association of Homebuilders, February 10, 2012)

Bernanke’s summary of the devastation that the mortgage crisis has caused homeowners, the financial world, and the U.S. economy in general is sustained by his concern for how long the downturn will continue or whether land is at last again in sight. He is also quite clear about the social and human costs of the crisis, namely, the growing number of those who are homeless or about to join them:

“According to the most recent estimate, about 1-3/4 million homes are currently unoccupied and for sale… Moreover, a very large number of additional homes are poised to come on the owner-occupied market. In each of the past few years, roughly 2 million homes have entered the foreclosure process, and many of these homes have been put up for sale, crowding out much of the need for new building. Looking ahead, the relatively high rate of foreclosures is likely to continue for a while, putting additional homes on the market and dislocating families and disrupting communities in the process.” (ibid.)

This may be bad for society, but necessary: banks must finally clean up their balance sheets and write off the bad loans which impair their willingness and ability to grant new mortgages. On the other hand, the widespread expropriations are economically harmful as well, because the houses put up for sale lead to a “drop in home values of historic proportions.” This hurts the construction industry, indeed the economy in general. After all, over-indebted homeowners show a remarkable aversion to spending money: “While estimates vary, homeowners are believed to spend somewhere between $3 and $5 per year less for every $100 of housing value lost.” This can be projected to a loss of national purchasing power of an immense 375 billion dollars:

“That reduction corresponds to lower living standards for many Americans. And, importantly, lower sales of goods and services also reduce the incentives of firms to invest and hire, thereby slowing the recovery.” (ibid.)

What the country lacks is not just houses and money to live on, but opportunities for business: the impoverishment of evicted and non-evicted homeowners hinders capital from selling them something, and that impairs what the country depends on first and foremost: the prospect of profit; without that, capital can’t use large parts of the working people, make them useful or let them earn something — and so on, in a crisis circle.

Bernanke is also aware of the reasons why the housing market is not getting back in gear again, although its prices must have fallen to an attractive level to buyers by now: everything depends on the banks. In the absence of lending, which previously provided for the growth of this market, nothing happens. The expansive speculation of finance capital on this sector of American economic life has come to this: the supply of the masses with housing stands and falls with the success of financial businesses in constructing and purchasing houses.

The business of home loans and its government support

The nation has accustomed itself to the absurdity of the capitalistic property system, in which massive numbers of houses are for sale or become vacant and go to ruin right alongside a growing number of Americans dwelling in mobile homes, tents, with relatives, or completely without shelter. The reason for this is also not only generally known, but acknowledged: the owners of the houses can no longer make payments on the principal and interest on the loans they have taken out to finance their residence. For this case, the banks have protected themselves with a mortgage on the house; in instances of payment default, they take hold of the collateral. The house is transferred to the bank and the residents land on the street.

According to a widespread view, this situation is at least partly due to the fact that people have borrowed money from the bank at a level they should never have been allowed in view of their low incomes. This denunciation of the breakdown in credit relations as a result of self-indulgent enthusiasts of home ownership and/or irresponsible bankers is revealing in two respects:

— First of all, this view assumes as a matter of course that a residence of one’s own is not possible without help from a financial institution. The elementary need for a place to live can hardly be satisfied in the U.S. (except in big cities) other than by buying a house. However, this is out of reach of the buying power of an ordinary American. He must “finance” the unavoidable purchase, take out a mortgage loan, and serve it from his income over a long time, often a lifetime.

— Secondly, it is taken just as self-evidently that the right to occupancy becomes invalid as soon as payment of the interest due to the lender is not forthcoming. That means, at least, that the right of the bank to the payment on its lent money is so absolute that the need for a place to live must take a back seat as soon as the interests of the two parties come into conflict. If servicing the business concern of the bank, however, is the unavoidable precondition for a person needing a house getting one, then the bank’s concern is the general social purpose someone has to serve if he has no money of his own. The ordinary person gets the loan for the acquisition of this necessity only if the bank finds a way to make a reliable source of money for itself from this limited buying power. The rise and fall of the American real estate market is a nice object lesson in how comprehensively the bank defines the conditions of the act of lending from beginning to end.

At first, banks and savings banks don’t do anything in this sphere of their business other than their usual: they enrich themselves on the deficient ability of their customers to pay by lending them money at interest. To this end, they examine the creditworthiness of customers; in the case of less-well-to-do customers, they assess whether and to what extent their financial resources promise to measure up to the additional burden of interest and repayment. And those who depend on wages face a special charge: loan servicing depends on whether the debtors manage to wring the installments — over a lifetime — from their scarce monthly wages, whose payments are, moreover, unreliable because they depend on the calculations of an employer. The conditions for granting the loan (income statements, information about the applicant’s credit history and other payment obligations) testify to the troubles taken to ensure the suitability of these precarious debtors for the comparatively large credit transaction and to indemnify the bank with higher interest rates for the special risk they represent.

Moreover, the lender secures the mortgage with collateral, namely, seizure rights to the real estate it financed, in case the debtor can’t meet his contractual obligations. The recourse to the value of the seized property is supposed to guarantee that at least the bank’s lent sum survives if the interest payments fail to materialize. This case is admittedly only intended as an exception to the rule that the loan amount is transformed into capital for the bank through the borrower’s interest payment. As an attachable asset, the real estate acquired with the loan performs a second service for the bank: it gives this kind of loan business its special security. The debtor is held accountable for this with his repayment of interest and principal and with his freshly acquired housing property. He must provide the debt payments out of current income to maintain his home ownership. Its monetary value therefore does not help him with that, but nonetheless is no less important: because it plays the role of “equity” for the bank, an equivalent, which justifies the granting of the loan, its amount and eligibility to serve as collateral determines the conditions of the loan.

Hence the owner, who wants to live in his own home and not sell it at all, depends on the market value of his real estate; he has, however, nothing to do with its realization. This is decided by other economic actors among themselves with their businesses and calculations: municipal or private landowners as the suppliers of developable land and construction and/or real estate companies as demanders. They determine the price of land, the other major price component of real estate besides construction costs.

The might of right is the basis and reason for the fact that prices are generally asked and paid for a given piece of nature: the institution of private property permits a person to whom an area belongs to exclude others from using it. This opens the opportunity for the owner to demand money for its use or appropriation by others. He has not produced the land, and in contrast to other commodities, no costs influence his price — land development costs and any buildings are charged extra. The landowner markets nothing but his power of ownership secured by law.

How much money the latter is worth, what price he can demand for the rent or sale of his land, depends on the interestedness and ability of the buyer who wants to use a certain piece of ground to pay for it. In this situation, the home buyer with his need for housing is still not in the game: public and private developers, real estate financiers, and others turn his need for a residence into an investment sphere, i.e., a sector for the investment of capital. For them, the price that the landowner demands for his land is not simply a sum that is paid and therefore gone, but part of a capital advance that has to yield a return. Whether, and at what land price, an investment in a building project yields a profit turns on a multiple comparison: first of all, with the demanded prices for plots of land in similar locations and conditions; secondly, with the prices they can expect to demand from the sale of houses of specific location and amenities; and finally, the comparison to other prices which can be demanded by alternative, possibly commercial uses of the space. To the proposed price of the investors, the seller proposes his own: in order to push through as high a price as possible for his land, he refers to its special location and condition, but also to the economic trend, public development plans, etc. — nothing but the given or expected circumstances that make the use of his piece of land economically interesting.

Speculation on future development thus always enters into the determination of the price of land. What the one side charges and the other side is willing to pay is decided by expectations about how the use of specific plots of land will probably develop. And because the price itself is based purely on supply and demand, its amount has no upward or downward limit. That makes this sphere an ideal object of speculation and investment of credit. Banks climb on board with investors or act on their own as house builders: they pre-finance the development of properties and earn on the growth of the business they initiate with it. And at the same time they become active, as explained, as financiers of the prospective house buyers: they thus ensure that the demand the construction companies count on with their investments materializes. Quite often, one and the same bank is active on both sides of this business; in any case, it’s always the same banking sector, and its yield expectations significantly determine this sphere’s course of business.

The homeowner is thereby the dependent variable on all sides. What he must pay in order to buy a house is the result of bargaining between landowners and investors; what the loan necessary for it costs him results from the calculations of the bank; and what the house he is liable for with the loan is worth is — from the moment it is standing — the result of speculative demand for comparable properties. If the banks make mortgage loans available on a large scale and so ensure a growing demand for real estate, the price of land tends to rise; that increases the market value of the collateral already posted on the banks’ balance sheets, allowing the banks to lend money on the real estate a second time for an additional loan to the home owner and expand their business with it. If the banks reduce their real estate loans, that conversely generates a trend of falling prices, which by itself provides a reason to further restrict the mortgage loan business. In all this, homeowners remain the hopeless figures that, after all, they simply are: rising prices help those who already have a house increase their creditworthiness and at the same time make things more expensive for those who need one; and vice versa. Thus the banks, with their own economic situation, provide the “hardworking American” the creditworthiness they need for their interest-related transaction with him, and then take it from him — and thereby take away a place to stay from the many debtors who can no longer service their debt under harsher conditions.

This is the way it is in normal times; in the “Great Depression” of the 1930s, certainly, like today, the then already significant American mortgage market and housing construction completely collapsed and contributed its part to the contraction of the economy (a forty percent decline of industrial production compared with the pre-crisis level). The government with its “New Deal” discovered not only the provision of the masses with affordable housing as a task of the welfare state, but took on the sphere because of its great consequence for banking and the economy: for President Roosevelt’s exemplary capitalism-compliant version of social policy, the fight against the housing shortage due to the Depression was from the start the same as the rescue of the lending business in the housing market, thus the rescue of the mortgage banks and, beyond that, the whole financial sector. For the poor masses, nothing was to be had other than or better than state aid for the banks, so that their business of making interest on the construction of private homes could succeed again.

In 1934, the Federal Housing Agency (FHA) was founded to insure mortgage loans that met certain quality standards against debtors’ insolvency. For these “conforming loans,” whose size did not exceed a fixed relation to the regular income of the debtors and to the value of the real estate (80%), the state took over the loan risk from the banks for a fee. This hedging of commercial calculations successfully aimed at the willingness of the banks to resume their real estate financing oriented to the mass market, and under conditions which permitted debt servicing from normal wage incomes.

With its founding of the Federal National Mortgage Association (Fannie Mae) in 1938, the federal government actively promoted the ability of the banks to grant mortgage loans. Fannie Mae’s task was:

“…to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.” (Wikipedia)

Fannie Mae still does this today by buying from the banks “conforming loans” insured by the FHA. Banks can transform these claims on mortgage loans at any time into liquid funds by selling them to the government agency, making them available for expanding business as well as for payment obligations. This increases the incentive and ability of private banks to expand this type of lending business. But the full blossoming of this business arises for a different reason.

The career of the home loan as material for the capital market

Fannie Mae does not use government funds to manage the refinancing of the banks’ mortgage lending business; it borrows it. For this, it uses its disposal over the purchased mortgage loans and the interest and repayments accruing from them. It establishes a new credit business on the loans it owns and the inflows that it expects from them by — on the basis of these sources of income — promising investment-seeking money owners future interest yields on the money they are investing. The investors buy for themselves the increase of their invested money effectuated by the issuer, thus transforming it into a piece of money capital.

Like in every other security business, this procedure’s achievement is twofold: it equips the issuer Fannie Mae with the financial means to carry out and expand the purchase of mortgage loans, and at the same time creates new capital assets in the hands of investors. The equation maintained in a security — of speculatively anticipated yields with real, current property — is confirmed in the act of purchase; thus it is based on the investors’ trust in the ability of the issuer to fulfill the given promise of yield, that is to say, in the issuer’s creditworthiness. The role of guaranteeing this befits the latter’s assets, in the given case the pool of mortgage loans bought by Fannie Mae. The state’s guarantee that it will take responsibility for any of the possible obligations of the agency it has created with funds from its budget, however, bestows a decisive new quality to this business: the securities issued by Fannie Mae are regarded — in comparison with competing offers — as exceptionally secure, and so find an abundant demand and allow the agency to expand its refinancing ever more.

This is how the growing securities business fulfilled the political mandate to increase the rate of home ownership. Its success allowed the government to transform Fannie Mae in 1968 and its sister organization Freddie Mac in 1970 into “government-sponsored enterprises” (GSE), privately calculating, partly state-owned corporations. Their special status as initially monopolistic buyers of FHA-insured mortgage loans was able and supposed to be translated by the financial institutions doing business with them into an implicitly continuing state guarantee, without that being formally written down.

The fact that the state no longer explicitly guaranteed the obligations of the GSEs did not detract from their business. They started to take advantage of the other pillar of their creditworthiness, their disposal over a gigantic portfolio of mortgage loans, in a new way by inventing “mortgage backed securities” (MBS) — securities “backed” with claims from mortgage loans. Their special reliability was underpinned by a legally codified relation to an agreed part of the GSE’s mortgage portfolio on which its holder could fall back as security if the issuer should default on interest and principal. The mortgage debts owned by the GSE guaranteed not only in general the ability of the issuer to answer for promised yields; the direct relation to these yields as a legal pledge created the papers’ own creditworthiness, which permitted this creditworthiness to separate from the creditworthiness of their issuer.

The combination of the still-present state background of the GSEs and the stock of mortgage loans —insured and collateralized multiple times against default — that served as collateral for the security of the MBS, earned ratings for the issues of the partly state-owned agencies that were not inferior to virtually failsafe U.S. Treasury Bonds. They thereby met the needs of various participants in the capital markets: institutional investors such as insurance companies and pension funds hedged their long-term payment obligations with MBSs. Banks and other capital market participants bought MBSs as liquid assets that, on account of their security and their great commercial volume, were considered as especially as good as money. Funds invested in such securities in order to market shares, with reference to the purchased source of profit, etc. From their growing business with MBSs, i.e., from the difference between the interest brought in by the mortgages in their possession and what they as absolutely creditworthy institutions had to offer for the marketing of their debts, many billions of dollars were generated for the GSEs.

It was therefore not long before their partners in the securities industry — the banks — no longer operated only as buyers in the MBS market, but also as suppliers. The big investment banks got into the business of securitizing mortgage loans by buying up such loans themselves and issuing their own MBSs on this basis. In the interest of an expanding use of this market, they soon emancipated themselves from the barriers to the business which the GSEs had imposed on themselves to make their securities especially secure, but also low yielding. The banks expanded the range of their securities backed by mortgage loans, from “non-conforming loans” right up to those which later came into disrepute under the name “subprime.” Resourceful financial specialists used this “material” with greater risk of default to construct a new class of securities that they equipped with varying degrees of risk and that they offered to investors according to their appetite for risk or need for security: even unreliable mortgage loans could be transformed into halfway first-class investments by bundling them into a pool that the various tranches of a collateralized debt obligation (CDO) were based on: the low-interest senior tranche incurred the last of possible payment defaults from the pool and was therefore rated AAA, the wide “mezzanine” had to bear incurred losses before that, and even before that — up to their total loss — there was the highly speculative junior tranche, in which primarily hedge funds invested in search of higher yields. In this way, the banks generated “synthetic products” entirely according to their customers’ “demand” for the relation between risk and yield. The speculative risk was provided with a price in the form of conditions and interest rates, thus remaining present at every processing stage. The grouping, linking, and diversification of risks was supposed to mitigate these risks and relativize them to each other; actually, they were distributed and sold to many investors according to the risk they thought they were able to tolerate. This expanded, on the whole, the ability of the financial world to be able to take on risks, and thereby the field of its enrichment possibilities; however, this practice had the downside that the risks were then also generalized and that losses occurring would affect this entire world.

Hedge funds and investment banks used such papers not simply as investments, which they put in their portfolios in anticipation of the promised interest and/or liquidated if necessary: they used their disposal over such papers once again as the basis for a new type of business, for which the German bank for small-to-medium-size companies, IKB, and its special purpose vehicle (“conduit”) Rhineland Funding became noted:

“It is the task of the conduit to buy loans and collateralized securities in the market and to refinance them via issuance of short-term securities (asset backed commercial paper, ABCP). It is clear that IKB has granted it a credit line in order to give Rhineland a good credit rating as an issuer. The profit the conduits make is usually paid via advisory and other fees to the bank that ultimately stands behind the conduit. IKB has estimated the consulting fee of Rhineland at around 54 million euros … According to the IKB spokesman, Rhineland has invested 12.7 billion euros in loans and loan securitizations, thereby also in ‘subprime’ securities.” (Frankfurter Allgemeine Zeitung [FAZ], July 31, 2007)

The papers of such “vehicles” enjoyed the trust of potential investors because a strong bank that provided them a line of credit stood behind them. For the bank, “outsourcing” this business into a “conduit” had an unbeatable advantage: the “conduit” operated completely without the need for its own equity because it financed its procurement of sources of interest entirely by issuing its own debt securities. The funding source cost the bank no advance in equity capital; while yields from zero advance may be limited in absolute numbers, as returns on capital they tend to infinity.

In this way, finance capital organized for itself — and for all investors whom it was in a position to involve in these business dealings — a multiplication of assets that was constantly driven forward. These all derived from securitized debts, which conversely meant: the many wealth instruments were nothing other than the obligations of others; every obligation was guaranteed by the fact that the debtor himself owned others’ debts, i.e., yield-producing claims against an upstream entity. The value sustained by each such financial instrument stood and fell with the trust in the ability of the debtor to assume liabilities, thus depending on the quality of the claims which he could present on his part. The reference back to the original mortgage and its value thereby fulfilled the function of ultimate provider of trust. The original mortgage loan got its prominent role in this fanciful arrangement from the fact that it was the first stage of the structure of claims and obligations referring to each other and piled on top of one another. The assessment of the original mortgage loan was always included in the growth of this gigantic concoction: its interest service, redemption, and failure rate got the new, additional function as an indicator for the functioning of the entire credit superstructure based on it.

As long as the participants were convinced of the evidential value of these indicators, the lucrative marketing of mortgage loans gave rise to the need for more such contractual obligations. The securitization of loans, which began as an instrument for refinancing, became the real purpose of the operation, and the acquisition of mortgage debts the means for it. The need for housing — more exactly, the willingness and ability of citizens to borrow for a home — was now no longer what generated the demand for housing loans; rather, the need for debts as commercial items generated the interest of the banks in ever more mortgage loans. In order to procure material for their credit trade, they enmeshed more and more customers in more and more generous funding and made sure all the necessary sums were available for it. The longer this went on, the more they forewent the applicant’s usual personal contribution in financing housing with new customers, the examination of other collateral became ever more generous, and, in the end, even got by without an agreement on repayment installments.

When bank capital with its credit power plunged into this sphere and provided (almost) everyone who wanted to own a home with the necessary ability to pay for it, that opened new prospects for the housing market and for homeowners at the same time. With the growing number of financed buyers, not only did prices increase for new buildings; the creditworthiness of those who had already purchased a house also improved: on the basis of their self-generated boom, the banks treated their debtors as owners of increasingly valuable properties and again granted further loans against their revalued real estate with home equity loans. They thereby expanded not only their business with their old debtors, enlarged their legal claims to interest payments, and again procured new material for securitizations; they also secured in this way their first mortgage loans by enabling their customers to fulfill payment obligations for old contracts with newly taken-out loans. By this, they made their business more independent of the limits of the debt that had to be served out of the available income of their debtors, which by no means grew along with it. As a byproduct of the credit boom, the average breadwinner temporarily profited by joining the banks in speculating on himself: on credit, he could afford a standard of living and perhaps a college education for his children that was not at all possible on his wages. As long as this worked, no one cared — except for a few know-it-alls who worriedly compared the annually increasing indebtedness ratios of the American consumer in relation to their rather declining wage levels.

During the decades-long upswing in America’s housing market, the full capability of finance capital manifested itself: it not only allowed creditworthy private individuals to go into debt for the purchase of a place to live and of course at interest, and it not only turned good debts into financial products of a higher kind. The interest of finance capital in its own accumulation provided it with the borrowers — indeed created the good borrowers — that it needed by immediately increasing along with its own growth the value of the securities that made these debts good ones. It is not just that the interest payments of customers caused the profitability and growth of the bank’s capital and restricted it at the same time; the other way around, its growth supported — indeed produced — not only the creditworthiness of the borrowers, but also their ability to service their debts; in the interest of their own growth, banks temporarily considered even interest and principal to be expendable.

All this was achieved by marketing the debts that the banks owned. They turned the securities that they sold as investments to money owners around the world into supports for and guarantees of the value quality of their debts. By buying, holding, and using these securities as means of business for financial operations, investors confirmed them as money capital; by using them, they gave the issuers credit, and by purchasing their debts, promoted their creditworthiness. The more business partners involved in the whole concoction, the more durable it became; the more then those who were tarred with the same brush, and who then harmed themselves when they called into question the recoverable value of the tower of debt. The interdependence of obligations provided a stability and security that reduced the first debtor’s reliable payment of interest to an aspect that “the market” sometimes considered important, at other times ignored due to its interest in material for further business in the capital market. But then the same applied the other way around: the more business partners involved in these credit connections, the more credit collapsed when doubts really arose as to its sustainability and investors withdrew en masse from investments, thereby devaluing them. The crisis revealed how global the “socialization” of credit relations had become in the meantime and what the whole world had participated in when believing their money to be safe and invested in durable value: namely, in a chain of obligations that were money capital as long as, but also only as long as, the parties were willing and able to use them for the growth of their assets.[1]

The American government, incidentally, had no objection to this sort of wealth creation; it promoted the boom with all its power — not only with its GSEs. With the might of right, it backed each new scheme for turning legal claims to future yields into current means of business. Every president pursued a “housing policy” — whether under the slogan “Home Ownership Strategy” (Clinton, 1996) or “Blueprint for the American Dream” (Bush, 2002) — with ever new regulations and deregulations, with provisions, authorizations, and subsidies,[2] all in order to increase the attractiveness of the housing business to financial capital. The boom accompanying the private investors’ entry into the MBS market then managed the miracle: in 2004, the proportion of happy homeowners in the United States reached, according to the U.S. Census Bureau, the historic record high of sixty-nine percent of all American families.[3]

The system, and specifically its financial sector, earned a lot of praise for the fact that finance capital helped people get a house of their own that, according to all the standards of the market economy, they did not really deserve. In hindsight, however, the success story was regarded as an improper exaggeration — and indeed one that was no longer revocable:

“Some economists and political leaders argue that Americans over-invested in housing and should learn to live with lower levels of homeownership. But regardless of the merits of this point of view, the nation has committed itself to housing as a major driver of the economy over many decades. Reversing that commitment also would take decades and could inflict damage on individuals and the nation that could last a generation or more.” (Los Angeles Times, September 11, 2011)

The financial crisis and the collapse of the housing market

The crash in the market for securitized mortgage loans came about exactly like its upswing. The banks, which had turned mortgage loans into obligations marketable to vendors, paid attention to all the detailed developments of their underlying business: the failure rate of the mortgages, the price trend of real estate, the interest rate. All factors were taken note of as indicators for the stability of their underlying market, and entered into the pricing of ABSs, MBSs, etc. as “market data.” At the same time, an assessment of how the financial “community” might take and value the data entered into their evaluation — the value of one’s own asset title depended after all on the behavior of others in the capital market. This could mean different things: unsold houses, for instance, are part of the normal course of business, so whether growing vacancy rates were just a glitch in the recovery or the beginning of its end — that’s what needed to be tracked down. On the one hand, it was clear that the market couldn’t continue to grow forever; on the other hand, that didn’t mean that it couldn’t continue to appreciate for another year or maybe more. At what point one got out needed to be carefully considered; best just in time, but in no case too early.

Such doubts had what it took to be generalized. All that sufficed was for a greater number of investors at the same time to take data on the housing market as a reason to sell MBSs and to move into other investments without enough new buyers being found for the securities thrown on the market. When investors wanted to turn debt instruments into money on a large scale, this revealed that these instruments were not money — and that they were only money capital through the investors’ trust in the promise of yields:

“The real estate crisis in America during the past few days has triggered a crisis in the credit markets. In this context, even the recoverable value of AAA securities that are backed by subprime loans is doubtful, which has led to losses … Experts say that it is an open question whether the subprime securities with good credit ratings will in fact suffer capital losses at all. There is a lot to suggest that these papers are actually well shielded against mortgage defaults. In that case, the current markdowns of these securities could be followed by markups and book profits.” (FAZ, July 31, 2007)

It did not come to this, as is well known, and not even because the shielding of the audaciously constructed AAA securities would have failed. Hardly anybody really cared to put it to a test because the depreciated papers had long ago been made the basis for further securities creations, which escalated the mistrust of investors, who then refused to refinance the purchased loan portfolios of the various special purpose vehicles. Due to doubts about the reliability of their asset-backed securities, even the conduits themselves as issuers of debt securities were doubted. “Against this background, it was difficult for Rhineland to find new buyers for their ABSs.” (ibid.) A conduit could no longer pay back its debts because it could no longer procure the money by marketing debts based on these assets. Once the parent bank then became liable for the line of credit that was never really used, but was only supposed to provide a guarantee for the creditworthiness of its conduit, it became overextended itself. Doubts about the soundness of the big banks’ ability to function finally plunged the whole sector into crisis. For it turns out that the capital and reserves of the banks, funds, and insurance companies consisted of nothing other than these and similar debt securities.

The crash of the capital market also had a marked effect backwards on the real estate financing and housing prices it had previously spurred on. Distrust in the stability of the MBS market weakened the ability of financial institutions to expand their mortgage business, as well as their interest in doing so. For business professionals, the expectation of impeded real estate financing translated directly into the expectation of falling, or at least stagnating, housing prices; the caution in granting loans, growing all the more for that reason, made that expectation a self-fulfilling prophecy: prices fell across the board. Massive numbers of homeowners were consequently over-indebted because the value of their real estate fell below the amount they owed on the mortgage. Banking customers, only yesterday owners of respectable collateral, became again poor people whose debt was disproportionate to their income. As a first step, the banks therefore refused to continue refinancing their debts and insisted on interest and principal. More than a few homeowners promptly proved unable to make payments on their outstanding loans because they could previously only do so through new borrowing.

Mortgage loans thereby changed from the banks’ functioning means of business into unredeemable claims. The banks’ measure of halting credit relationships with defaulting debtors across the board, foreclosing on them to at least recoup the remaining value of their real estate, did the rest: carrying out massive numbers of foreclosures threw more and more homes on the market and brought to light the fact that their values, intended as collateral, were the result of speculation on their growth, and thus were destroyed by the attempt to realize them. The further decline in housing prices put even more mortgage debtors “underwater,” leading to worse credit terms, a strict insistence by the bank on punctual debt service, and, in the event of default, led to more foreclosures and an even worse decline in housing prices, and so on. Not a few banks, most recently Bank of America, arrived at the decision to sell off or liquidate their entire mortgage department. In this way, the collapse of the speculative superstructure reached those whose debts and homes had functioned as the base for a whole epoch of credit growth. They paid the price for finance capital coming to appreciate that their debts could serve as its means of growth: first in their own home that they really could not afford, then in the form of dispossession and homelessness.

The state’s crisis management

The social disaster — a case for the rule of law

The devastating effects of the credit crisis on the lives of millions called the state into action — in its capacity as rule of law. In the “land of the free,” the loss of a home is a private matter, bad luck, tough times that must be coped with privately. At most, an aggrieved person could expect consideration for the basic need for housing when he could demonstrate that the bank which dispossessed him was not allowed to and broke the law. Those affected grasped at this straw and went to court en masse. Under the heading “foreclosure-gate,”[4] the American nation was outraged about everything that the courts and the media found to be illegal or even only unfair in the conduct of the banks that resulted in homelessness. These proceedings affected a lot; only — not the main issue.

The seizure of over-indebted homes was fought by dispossessed residents with the claim that, in view of the unlawful resale of their loans by the mortgage bank and their use in a pool of hundreds and thousands of other debt agreements as collateral for securities derivatives (MBSs, ABSs, CDOs), it was no longer at all clear to whom the debtor was now actually indebted and who was thus entitled to the lien on his real estate. The holders of defaulted real-estate derivatives saw this the other way around, demanding the right guaranteed them to the property of the last borrower, even if the security they owned — perhaps in the second and third processing stage — only represented a lien on perhaps a thousandth of the value of a particular house. The matter is not simple: apparently, when asset-backed securities were being constructed, no one had considered how a right to assert a claim on collaterals that were mixed, chopped to pieces, and split up among countless securities would be sorted out again if the derivative’s issuer went bankrupt; the unwinding of the tangle of loans up to the bitter end was not foreseen. The case will keep the courts busy for a while.

There is another scandal that is easier to sort out. The banks, which no longer cancelled just one or another nonperforming mortgage but cut back or dissolved their entire home-financing departments, made use of the same form of automatic business transactions they had been practicing in the boom. Back then, this was in the interest of the applicant and not complained about. However, the mortgage law now required careful examination of the circumstances and creditworthiness of the individual case and consideration of alternatives to eviction. The banks avoided the costly efforts needed for this by deploying assistants as human “robo-signers” of eviction notices. Many critical Americans could be outraged about this because it confirmed their view that the whole crisis was only attributable to the illegal practices of greedy bankers. And the latter actually are legally vulnerable. Lawyers share with local and state advising centers and mediation boards the market arising for legal aid in which those facing eviction can get free help and advice. Civil servants take pains to produce something like a level playing field between the banks and their helpless customers so that people are not unduly taken to the cleaners.[5] Foreclosures should only happen when they are legally flawless, and those affected should — if at all — be ruined no more than necessary.

The great demand, in view of the catastrophic collision of the banks’ property rights with their poor customers’ need for housing, was generally justice in the sense of American fair play. So a practice of underwater homeowners that was legal in some states and illegal in others[6] found growing social acceptance. It is popularly called “walkaway” or “jingle mail “ — “strategic default” in legalese — and consists in the debtor defaulting on his loan and simply leaving his house to the bank. He quits making payments before he runs completely out of money and preempts the foreclosure. A legal professor from Arizona, Brent White, made a national name for himself with an article recommending this tactic to homeowners and based it on its legal, but above all moral, admissibility.

“The housing collapse left 10.7 million families owing more than their homes are worth. So some of them are making a calculated decision to hang onto their money and let their homes go. Is this irresponsible? President Obama has urged that homeowners follow the “responsible” course. Indeed, HUD-approved housing counselors are supposed to counsel people against foreclosure. In many cases, this means counseling people to throw away money… There are two reasons why so-called strategic defaults have been considered antisocial and perhaps amoral. One is that foreclosures depress the neighborhood and drive down prices. But in a market society, since when are people responsible for the economic effects of their actions? Every oil speculator helps to drive up gasoline prices. Every hedge fund that speculated against a bank by purchasing credit-default swaps on its bonds signaled skepticism about the bank’s creditworthiness and helped to make it more costly for the bank to borrow, and thus to issue loans. The government should encourage borrowers to default when it’s in their economic interest. This would correct a prevailing imbalance: homeowners operate under a “powerful moral constraint” while lenders are busily trying to maximize profits. More important, it might get the system unstuck. If lenders feared an avalanche of strategic defaults, they would have an incentive to renegotiate loan terms. In theory, this could produce a wave of loan modifications — the very goal the Treasury has been pursuing to end the crisis.” (New York Times, January 7, 2010)

The plea for justice and a nationally useful ‘equality of arms’ with greedy bankers — a level playing field — is in a class of its own: vacating the house is recommended as liberation! Freedom — just another word for nothing left to lose!

The government’s struggle to rescue and renew mortgage loans

The American state, meanwhile, had more serious problems. It had to save the collapsing national financial system in general and mortgage financing in particular. The recovery of this sector was widely regarded as the key to overcoming the entire economic crisis.

The government made full use of — what else? — its monetary power. On behalf of the government and with new state loans, Freddie Mac and Fannie Mae bought up bad mortgage loans from the banks to prevent their bankruptcy and stop the ongoing collapse of the real estate market. The guarantees of the GSEs were used on a broad scale; the rescued banks nevertheless did not go back to financing real estate as they previously had. The funds of the state agencies did not function as they formerly did — as the basis for a growing private business — but as a lifeline and substitute for its failure. The fact that banks did not return to a more generous granting of mortgage loans nicely shows the interest they had in this business during the upswing. They could use the business well as a foundation for their credit securitizations. Now that the business depended on the demand of customers who could carry out and afford the building of a house in the recession, it remained paltry. The takeover by the GSEs of rotten mortgages ensured some cleanup of the banks’ balance sheets but at the price that the agencies accumulated losses in their budgets. In the course of 2008, it became known that their market interventions entailed enormous capital requirements for which no financiers were to be found on the capital markets.[7] However, because the GSEs absolutely had to remain solvent guarantors for the U.S. housing market and the ABS market, the state took over management of the two companies and responsibility for their payment obligations.[8] This burdened its budget with totals in the hundreds of billions through 2011 alone.

Because all this did not stop the collapse of the housing market, the government then also designed programs to assist homeowners facing the threat of termination of their loans. HARP (Home Affordable Refinance Program) and HAMP (Home Affordable Modification Program) provided support for some of those who were insolvent. At a certain level of their over-indebtedness, the government sorted them into bad debtors and good ones who were somehow financially impeded and offered to relieve the latter of their debt payments or subsidize banks that were willing to modify contracts. Neither the right to participate in the program nor the duty of the banks to offer participation to their borrowers was provided for. Both programs were to a negligible extent taken advantage of; and the multiple amendments to their terms changed little. The banks charged such high fees for participation that the programs were unattractive to the debtors. They demonstrated for a second time that they were not interested in this segment of the loan business for the time being.

The Obama administration was miffed about that. The banks were happy to help themselves to government aid to unload their bad loans, but refused to assume their responsibilities as lenders and grant relief to their overextended customers, and instead continued their practice of foreclosures. The government was now focusing on the nonperforming, systemically too-big-to-fail financial industry as an obstacle to crisis management and even as a law breaker. With the help of the law, it intended to force the banks to at least limit the damage they caused. Taken to court by the partly nationalized agencies Freddie Mac and Fannie Mae, the banks were required to take back mortgages they sold to agencies too expensively, meaning with a falsely declared quality. A similarly justified, much larger lawsuit was filed by the federal government against a variety of American, as well as international, banks.

On the issue of foreclosures, however, the Obama administration brought the legal dispute with the banks over the distribution of the costs of the crisis to a certain conclusion. In February, 2012, it reached a foreclosure settlement with the largest institutions in the country:

“This round of relief will reach about two million former and current homeowners. Under the agreement, banks will grant some $10 billion worth of principal reduction, $3 billion in refinancings and $7 billion in other mortgage relief, like forbearance for unemployed borrowers, covering roughly one million borrowers in total. Another $1.5 billion will be cash payments of about $2,000 to some 750,000 borrowers who were treated unfairly in foreclosures from 2008 through 2011. And $3.5 billion will go to state and federal governments for what has been described as resources for legal aid and other counseling for borrowers facing foreclosure… What do banks get in exchange for the relief? The answer, in short, is a sweet deal. The banks did not get the blanket release they originally sought from legal liability for all manner of mortgage misconduct. But the settlement still shields them from state and federal civil lawsuits for most foreclosure abuses, including the wrongful denial of loan modifications, excessive late fees that enriched the banks but could make it impossible for borrowers to catch up on late payments, and conflicts of interest that led banks to favor foreclosures over modifications. Going forward, the banks will have to adhere to tougher standards for servicing loans and executing foreclosures. But past sins in servicing and foreclosure are largely absolved.” (New York Times, February 11, 2012)

The government praised the agreement as a long overdue admission of guilt by the banks that they had ruined millions of “responsible homeowners” (Obama) with their irresponsible business conduct. It hoped that in practice the credit relief agreement would lead to more mortgages being continued rather than terminated. For the generous concession by the banks to give up on claims that were unredeemable anyway and to initiate a way to continue business with their impoverished customers — how many will ultimately benefit from the offer remains to be seen — the government spared them from civil suits for their illegal practices. Prosecution by the Securities and Exchange Commission of breaches of law remained unaffected.

The Fed intends to buy the entire U.S. economy out of the recession with mortgage loans

During the whole back and forth between the state and the banks, the real estate and general crisis has entered its sixth year. All the government’s measures have failed to achieve at least one thing: the economy as a whole did not come out of the recession. In September, 2012, the Federal Reserve decided on an “unprecedented step”:

“To support a stronger economic recovery …the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.” (Fed Press Release, Sept. 2012)

The Fed has identified the pile of illiquid real estate loans in the banks’ balance sheets, still counted in the trillions, as the cause of the persistent crisis. And precisely because there is so much capital in this segment of the credit system, and so much of it is ruined, it also sees this as the starting point for managing the general crisis: it wants to buy up the whole scrap heap step by step and indeed as long as it takes to achieve what it calls a valid measure of a growing economy: jobs, a decline in unemployment to normal levels.

The Fed is faced with the effects of the overaccumulation of capital: illiquid mortgage markets, unsalable homes, falling house prices, the depressed housing market as an important part of the economy and its stagnation — too much credit has been given in this sector and everywhere else; too much capital has been invested than would still be profitable. The Fed regards the crisis as a lack of capital and a lack of willingness to invest, which it wants to heal by both increasing credit and reducing its cost; it is fighting the overaccumulation of capital with more of it. And if the government’s and the Fed’s own measures to rescue the real estate sector have so far only led the banks, which sit on devalued assets and are threatened by bankruptcy, to get rid of their bad debts and remain halfway solvent, but not to expand their lending and bring about growth, then — the Fed concludes — its substitute measures for the defaulting and shriveling private loans were just not big and persistent enough. It is determined to force the qualitative change of bad, non-recoverable debts into new, profit-yielding money capital and thereby sticks to its basic dogma: banks and citizens would take up credit and use money for something profitable if they could get enough of it in their hands cheaply enough. The ongoing crisis shows it that the price for disposal over capital, the interest rate, must be too high. The less profit that can be made with capital investment, the more it is determined to do whatever it can to lower the interest rate in order to nonetheless ensure a difference between costs and yields of capital investments.

Since the Fed has already been holding the money market rate that it charges private banks for central bank money at close to zero for half a decade, and still not as many want to borrow from it as it considers necessary, it is using the current program as a way to depress the interest rate in the capital market without the banks.

“By buying mortgage-linked debt, the Fed hopes to press mortgage rates lower, helping the housing market and also encouraging investors in MBS to switch into other assets, lowering their yields as well. Those lower borrowing costs should spur more lending and foster faster economic growth, officials believe.” (Reuters)>

The Fed’s sustained demand for the highly speculative and illiquid MBS securities is supposed to raise their price again and allow returns bought with high risk to decline. This, in turn, should drive investors out of the market to other fields of investment, so that interest rates also decline there and the economy as a whole is more cheaply financed. The circumstance that hedge funds and others venture into MBS transactions because they do not find less speculative or higher yielding investments is interpreted again by the Fed entirely according to its concept: namely, as being a consequence of interest rates elsewhere remaining too low, which is why the interest rates in the MBS area must therefore be too high for investors to consider alternatives.

The Fed’s contradictory fight against the overaccumulation of money capital through more money capital can’t be bothered by failure; its struggle is surely not a questionable experiment: the central bank has rather used its power as mandated, a power which derives from its sovereignty over the national money. It can prevent the overdue devaluation of mountains of debt by political credit creation and ensure they remain intact as assets and available as investment funds — as long as the further political increase of money does not cause investors to lose confidence in the national currency. In this respect, the Fed can give the all-clear: inflating the dollar is not hurting it, at least so far and in relation to the alternative, equally questionable European world currency.

Notes

1 Hence the horror when Lehman Brothers crashed: no one ever took the legally proper note in small print — that securities become worthless in the event of the issuer’s insolvency — as a warning for a case that could ever really occur.

2 The Tax Reform Act of 1986, for instance, allowed debtors to deduct their repayment installments from their income tax.

3 See “Subprime crisis impact timeline,” Wikipedia.

4 Ever since Richard Nixon’s illegal bugging of the Democrats’ election headquarters in Washington’s Watergate Hotel in 1972, everything in the United States that smells of scandal is a gate.

5 Some states oblige their banks to participate in such mediation talks; others just try to coax them. All in all, the activity reports of the mediation boards offer nothing but a picture of the misery that over-indebted homeowners are exposed to by outrageous banking practices.

6 These eleven states have so-called “non-recourse debt,” a form of credit that only allows the creditor recourse to the real estate financed with it; even in the case that the outstanding debt exceeds the real estate’s value, access to the debtor’s other assets is excluded.

7 “As recently as late March, Washington viewed the companies as saviors of the housing market and the economy… Instead of requiring Fannie and Freddie to scale back, regulators gave them a green light to buy and guarantee more and bigger mortgages. …As the housing crisis continued to widen and deepen, confidence in the companies began to evaporate. Rumors spread that Fannie and Freddie were not fully reflecting losses from rising foreclosures on mortgages they held. The stocks of both companies fell more than 60 percent during the second week of July… and the cost of borrowing money rose for both, reflecting anxiety over growing risk.” (New York Times, September 7, 2008)

8 “The government would place the two companies under ‘conservatorship,’ a legal status akin to Chapter 11 bankruptcy. Their boards and chief executives would be fired and a government agency, the Federal Housing Finance Agency, would appoint new chief executives.” (Washington Post, September 7, 2008)