Asking if Paulson is a liar is a bit harsh, but it is not without justification and from what I've seen from some of the buzz online, even those that are for the bailout feel that Treasury Secretary Henry Paulson is not being honest. Federal Reserve Chairman seems to be spared some of the harsher criticisms, likely because Paulson is the one that would be in charge of the bailout as well as being a former Wall Street CEO. He left his post at Goldman Sachs before coming to work for Joe Taxpayer.

"Losers Keepers" was part of Stephen Colbert's "The Word" segment this past week, where he discussed the proposed plan to give $700 billion to Paulson to bail out Wall Street. Those two words, in my opinion, sum everything up nicely.

I've discussed why I feel that is the case in previous posts including a recent one discussing who is to blame for the housing bubble, homeowners or lenders. So I'll just give a quick summary here. The big guys on Wall Street took advantage of deregulation, which they lobbied for, along with federal programs to increase homeownership, to fuel the housing market. So that prices would keep rising, banks kept giving home buyers more and more money. When the housing market was booming, they threw as much money into it becuase they thought they had created a perpetial-motion-esque money machine. As even Paulson and Bernanke are saying, the root of the problem is the housing market. What they're not saying is, that is the case because Wall Street leveraged themselves up to their eyeballs based on the housing market. Why wouldn't they? As I discussed, they had the most control over it. If you thought you could fix NBA games, you'd beg, borrow and steal to bet on them.

The title is a bit unfair but it seems to be how the media outlets are selling their stories.

I watched Peter Orszag, Director of the Congressional Budget Office, testify before the House Budget Committee. Forget the hearings with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. Orszag's testimony, in my opinion, is the most clear and honest opinion I've heard on the proposed $700 billion bailout. He thoroughly described what the problems are in the financial markets. How it affects individuals, banks, big and small businesses, homeowners, the housing market, the dollar, exchange rates, inflation, interest rates.

Every question you may have he addresses. Though his answers are clear and thorough they are not what most people want to hear. By that I mean, most people want to ask a question and hear a pretty definative answer. What time is it? It's 5:54am. Nice, simple and direct. Many people can even settle for hearing that it's almost 6 in the morning. This is a complicated situation and he doesn't try and minimize that fact. What he does give is a lot of scenarios on what could happen with a lot of detail, in a fairly easy to understand manner.

Bloomberg is reporting on an FBI probe into 26 companies including Fannie Mae, Freddie Mac, AIG, Lehman Brothers, IndyMac Bancorp, Inc. and Countrywide Financial Corp. for possible accounting misstatements surrounding the collapse of the subprime mortgage market.

The US Securities and Exchange Commision is launching their on investigation into the companies for civil violations.

The FBI has come under pressure to hold companies responsible as the loan crisis rocked Wall Street and led to the biggest housing slump since the Depression. Financial companies worldwide have reported more than $500 billion in losses and writedowns stemming from the subprime collapse.

Housing lenders Freddie Mac and Fannie Mae, as well as insurer AIG, were all taken over by the government earlier this month. Lehman filed for bankruptcy. The crisis has led the Bush administration to ask Congress to approve a $700 billion bailout for the financial industry.

...

FBI Director Robert Mueller, testifying in Congress last week, pledged to ``pursue these cases as far up the corporate chain as necessary to ensure those responsible receive the justice they deserve.''

Hopefully this isn't just for show.

This weekend Congress is working on a new Wall St bailout proposed by Treasury Secretary Paulson and Federal Reserve Chairman Bernanke. Apparently the hundreds of billions of dollars pumped into the market wasn't enough and the plan is to allow the Treasury Sercretary to use $700 billion dollars, that will be added to the public debt, to buy bad debt from troubled lenders to keep them from failing. The NYT released a leaked draft of the bailout proposal. You can also read Paul Krugman's opinion on it.

This meeting of course is being rushed because the help is needed urgently. You see, the people that have been trying to "stabilize the market" have just now, in the past few days, realized what a giant mess there is and how much trouble it will cause if something isn't done about it, even though it's been years since the bubble was identified and started to deflate. It's not like there were any warnings. Oh except in 2006 when NYU economics professor Nouriel Roubini warned economists at the International Monetary Fund or back in August of this year when it was reported that people were skeptical of his predictions until they started happening. Or further back in 2005 when Warren Buffet warns about the "residential real estate "bubble," the destabilizing effect of hedge funds on the financial markets". Why would anyone listen to him? Hmm... What about listening to states that in 2001 and 2002 were passing legislation to put an end to predatory lending that was increasing foreclosures and causing other problems? How about in 2001 when Bank of America announced it will no longer originate subprime mortgages? (Unfortunately they didn't completely get out of the subprime game and suffered some losses.) Or what about The Federal Reserve duty to prevent asset bubbles?

Each Federal reserve bank shall keep itself informed of the general character and amount of the loans and investments of its member banks with a view to ascertaining whether undue use is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities, or for any other purpose inconsistent with the maintenance of sound credit conditions; and, in determining whether to grant or refuse advances, rediscounts, or other credit accommodations, the Federal reserve bank shall give consideration to such information. The chairman of the Federal reserve bank shall report to the Board of Governors of the Federal Reserve System any such undue use of bank credit by any member bank, together with his recommendation. Whenever, in the judgment of the Board of Governors of the Federal Reserve System, any member bank is making such undue use of bank credit, the Board may, in its discretion, after reasonable notice and an opportunity for a hearing, suspend such bank from the use of the credit facilities of the Federal Reserve System and may terminate such suspension or may renew it from time to time.

...

Whoever knowingly makes any false statement or report, or willfully overvalues any land, property or security, for the purpose of influencing in any way...shall be fined not more than $1,000,000 or imprisoned not more than 30 years, or both.

No. Nobody saw that this was going to be a big problem and now Congress has to rush to get this legislation passed or the financial markets are going to collapse!

Back in early June, I posted an entry about how NJ community banks were still doing well compared with some larger banks, because they chose to stick to more conservative lending practices when their bigger counterparts were running around giving loans to anyone with a pulse to continue to create mortgage based investments to sell on Wall St.

A news story out today though discusses how Hudson City Bancorp's President and CEO, Ronald Hermance is frustrated with his companies stock performance as Wall St has lumped all financials into the same bin. Even though Hudson City Bancorp "has never made a subprime loan. His bank doesn't keep risky mortgage securities on the books, and is headed toward another record year of profits."

Nonetheless, Hermance's Paramus, N.J.-based savings bank finds itself cast alongside embattled institutions like Citigroup Inc. and Washington Mutual Inc. as the credit crisis continues. For executives at small regional and community banks around the country, selling their story to Wall Street is proving difficult amid all the negativity.

"We get lumped in with all the other financials," said Hermance, chairman and chief executive of Hudson City, which operates 125 branches in New Jersey, New York and Connecticut. "I'm going to have another record year, but who is going to know? We suffer from the company we keep."

The Federal Reserves discount rate has dropped to 2.25 from it's value of 5.75 compared to last year. The discount rate is the rate at which the Federal Reserve lends funds to banks whos reserves dip below requirements. The money comes from banks with healthy reserves. Could it be that the banks that didn't lose their head, or as President Bush said "got drunk", now have to lend their funds out at a huge discount to help prop up banks whose misguided financial judgment caused them to sit on unstable reserve positions?

Is this why Wall St isn't hot on banks right now? Do they want and wait and see if the Federal Reserve's policies are going to help fix the problems or are they now just throwing more good money after bad? I'll have more information and opinions on this matter in a subsequent post.

Personally, HCBK's share price doesn't look too bad right now considering the overall market. It's not like it tanked and it's actually about 9% higher than it was when I first wrote about them, even though it's down a bit from their recent high. So I'm not sure what the concern is about. When you compare how their stock price to other banks in the past year or more, it doesn't look like they should worry too much. I'm really not sure what the story about HCBK's stock price is all about? I mean, they apparently avoided the subprime mess by focussing more on long term financial strength rather than the short term hot markets. Why even worry about why the stock hasn't taken off during a time where there is unsurety in the market?

As of September 1st, Freddie Mac and Fannie Mae will no longer be purchasing subprime mortgages in NY due to legislation that is aimed at helping troubled borrowers but also puts more restrictions on those who purchase mortgages to guard against predatory lending practices.

...because of the "potential for heightened legal and business risk exposures." In its decision, Fannie Mae restated its policy by saying "it will not purchase or securitize certain mortgage loans that meet the definition of 'high-cost' or 'high-risk' home loans."

This sounds similar to some of the legislation that states enacted back in 2001 and 2002 that would make entities that purchase subprime mortgages responsible for predatory lending practices involved in the origination of the mortgage. Unfortunately the Treasury Department stepped in on behalf of the banks.

Banks generally give out more in loans than they have on deposit. They can do this by selling off some of their loans to investors. The securitization of subprime loans was a big contributor to the housing bubble. Towards the end of the bubble, the number of conforming loans dropped while subprime and Alt-A loans rose. In addition most of the non-prime loans were securitized which was a large departure from the past. Up until 2002 Fannie Mae and Freddie Mac didn't even deal in subprime. These two companies hold or guarnatee about half of the mortgage debt in the US.

If the GSE's don't buy these mortgages that's a lot of money that won't go back to replenish bank's reserves to allow them to write more loans. In my opinion, this is a good thing. The amount of credit that was issued which caused the bubble caused a lot of problems for borrowers, lenders investors and the economy in general. We need to start returning to a more normal pace of lending and bring housing prices back in line with incomes. 

"New York and the nation got into this crisis in the first place because Fannie Mae and Freddie Mac turned a blind eye to the abuses of loan originators," said Bertha Lewis, executive director of New York Acorn, an advocacy group.

The law also sets in place requirements for lenders in foreclosure proceedings and makes it a crime to write mortgages for borrowers knowing they cannot repay them.

Now that last part is a bit of a shock. You'd think it wouldn't be in a bank's best interest to lend to people they know can't possibly pay them back. But that happened over and over during the bubble. The banks didn't care because they just wanted to have new mortgages to sell on Wall St. It's pretty sad that they had to make a law that essentially keeps banks from shooting themselves in the foot. Kinda have to wonder what all those bonuses were for. My theory was to cash out as much as possible before the crap hit the fan.

With subprime mortgages being harder to sell in the NYC along with other aspects of the legislation, lenders will have less incentives to write bad loans. Without being to write loans to people that can't afford them, they'll have to write loans that people can afford. Since the marjority of the people in the NYC area can only afford a tiny fraction of the housing stock available, house prices are going to need to come down if sellers expect to sell. Otherwise properties will sit on the market for years.

The strange thing is that the law doesn't preclude the anyone from purchasing subprime loans in NY, Fannie Mae and Freddie Mac included. What it does from my understanding, is what previous state legislations tried to do. Put responsibility for predatory lending also on those who purchase these loans so that they would have an incentive to make sure these high risk, high cost loans do not fall into the realm of predatory lending.

Sounds like Freddie Mac and Fannie Mae are afraid to touch NY subprime loans because they might fall under the predatory lending laws. Probably a good idea for the GSE's but what does it say about the companies originating and servicing these loans? Maybe the NY metro area can fall back out of the least affordable housing market spot.