Mortgage Servicing Fraud
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Wall Street Embraces Government to Avoid Recession (Update1)

By Kathleen M. Howley

Feb. 1 (Bloomberg) -- With U.S. mortgage foreclosures set to top 1 million this year and home prices falling at the fastest pace since the Great Depression, Lehman Brothers Holdings Inc. Vice Chairman Thomas Russo says the government must take action to prevent a recession.

``The direction we are heading in isn't a good one,'' Russo said in an interview. ``We need significant fiscal and monetary intervention.''

The worst drop in new home sales on record has turned financial leaders into champions of big government with everyone from Russo to executives at Citigroup Inc. and JPMorgan Chase & Co. supporting public measures to keep the housing market from sinking the economy. It's a change from Wall Street's usual stance that markets work best without government interference.

``Sentiment can change when there's money on the line, even in an industry that up to now has been doctrinally opposed to government having a role in the markets,'' said Thomas Schelling, a Nobel laureate in economics who taught at Harvard University for 30 years.

Wall Street fueled the growth of subprime lending by packaging home loans into securities and marketing them as low- risk investments. As demand rose, lending standards dropped, driving the homeownership rate to an all-time high of 69.2 percent in 2004. The median U.S. home price reached a record $230,200 in July 2006. Last month it was $208,400.

Countrywide's Loss

Now, many of the same people who profited by putting buyers into properties they couldn't afford are advocating federal help to manage the bust.

Their demands were answered this week when the House and the Senate Finance Committee approved economic stimulus plans worth $146 billion to $157 billion. The Senate version includes a tax break for banks and lenders. Losses from investments in subprime mortgages may total as much as $400 billion worldwide, Deutsche Bank AG said in November.

Angelo Mozilo, chief executive officer of Countrywide Financial Corp., supports the government's Hope Now program, a coalition of mortgage companies aimed at preventing foreclosures by freezing adjustable rates or refinancing loans of subprime borrowers.

That type of loan increased Countrywide's net income to almost $2.7 billion in 2006 when it was the biggest U.S. subprime lender. Mozilo earned $48 million that year. Countrywide reported a net loss of $703.5 million in 2007, dragged down by loans to people with bad credit, and the Calabasas, California-based company agreed Jan. 11 to be acquired by Charlotte, North Carolina-based Bank of America Corp. for about $4 billion.

`Amazing Hit'

Hope Now is being pushed by Treasury Secretary Henry Paulson, former chairman of Goldman Sachs Group Inc., and backed by firms such as New York-based Citigroup, led by Chief Executive Officer Vikram Pandit, and JPMorgan, headed by CEO Jamie Dimon.

In addition, the government expanded Federal Housing Administration mortgage funding in August to help subprime borrowers and President George W. Bush has proposed using tax- exempt bonds to refinance mortgages. Those programs won't help homeowners who have seen their property values drop below their loan balances.

The measures aren't enough, Russo said.

``The whole financial system has taken an amazing hit already and the bulk of the mortgage rate resets are still to come,'' Russo, 64, said.

Without additional government action, declining home values will prompt people to snap their wallets shut, choking the 70 percent of the economy that's driven by consumer spending, Russo said in a paper he presented at the World Economic Forum in Davos, Switzerland, last week. Russo said the paper reflected his own views and analysis, not those of New York-based Lehman, the fourth-biggest U.S. securities firm by market value.

Russo's Proposals

About $550 billion of subprime loans will reset before 2009, Russo said. Most of those borrowers will have no option except to walk away from their properties because the drop in home prices and an increase in lending standards will prevent them from refinancing or selling, he said.

Russo, in the paper originally written for the Group of Thirty, a research group led by former Federal Reserve Chairman Paul Volcker, proposes giving government-backed loans to homeowners with adjustable-rate mortgages, whether prime or subprime, in danger of default. He also supports a tax credit for people who buy homes in 2008 that would roughly triple the current tax benefits given to mortgage holders.

In addition, the Federal Reserve needs to cut its benchmark rate to 2 percent, reduce the discount rate to match it, and ``broaden access'' to the discount window where banks get government-subsidized temporary loans, he said. The Fed lowered the benchmark interest rate to 3 percent on Jan. 30, the second cut in nine days.

Quick Action

Those measures surpass the Hope Now program and the stimulus plans that passed this week. A provision in the House measure would temporarily increase in the size of loans that can be bought by Fannie Mae and Freddie Mac, the largest U.S. mortgage-finance companies.

``To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so,'' Fed Chairman Ben Bernanke said in Jan. 17 testimony to Congress.

In backing government action, Bernanke broke from the creed of Milton Friedman, the free-market champion who said such programs don't work. Bernanke described Friedman in a 2002 speech as the man who inspired his interest in monetary policy when he was a college student.

While top regulators and executives are demanding help, some of their colleagues are shaking their heads in disbelief.

Mark Kiesel of Pacific Investment Management Co., the world's largest bond fund manager, said rescuing borrowers will worsen the economic misery for everyone. Kiesel helps oversee more than $700 billion of fixed-income investments at Pimco.

`Blunt Instrument'

``Keeping the market from correcting itself only prolongs the problem,'' he said. ``It helps a couple hundred thousand people stay in their homes a little longer, but it also may have the unintended consequence of lifting mortgage rates for everyone because if you're going to be changing the rules, investors will need to be compensated for that risk.''

David Henderson, an economist at the Hoover Institution at Stanford University in Stanford, California, agrees.

``Government intervention is a blunt instrument aimed at a particular problem that ends up hitting all of us,'' Henderson said. ``Let the housing problem work itself out.''

The camp that favors government action is growing.

Growing Group

``We look forward to continuing our work with the administration, Congress, state and local officials'' to limit the number of foreclosures, Washington Mutual's Schneider said in a statement last month in support of the Hope Now program. The Seattle-based company, the largest U.S. savings and loan, on Jan. 17 reported a fourth-quarter loss of $1.87 billion after writing down the value of its home mortgage unit.

Alex Pollock, former president of the Federal Home Loan Bank of Chicago, urges the creation of a federal lending agency based on the Home Owners Loan Corp., or HOLC, created by Congress during the Great Depression.

Robert Kuttner, co-founder of the Washington-based Economic Policy Institute, Senate Banking Committee Chairman Christopher Dodd and others have proposed similar ideas.

Many who are calling for action point to the 1930s, the last time the U.S. national median home price fell, as an example of what government should do.

Great Depression

During the worst economic slump of the 20th century, HOLC issued tax-exempt bonds and used the proceeds for below-market- rate mortgages. It refinanced one-fifth of U.S. homes between 1933 and 1936 after negotiating with the original lenders to accept less than the amount owed on the defaulted mortgage.

Former Treasury Secretary Edward Carter Glass opposed President Franklin D. Roosevelt's expansion of government after the 1929 stock market crash. Senator Robert Taft, a critic, said it was socialism. Most Americans supported Roosevelt and his ``New Deal'' plan. He won every state except Maine and Vermont when he ran for re-election in 1936.

In the 1930s, lenders were seizing homes at an average rate of 3,000 a day, adjusted for today's housing stock size. In the fourth quarter of 2007, new foreclosures averaged 2,939 a day, double the pace of a year earlier, according to RealtyTrac Inc., an Irvine, California-based real estate data company.

Statistics like these are managing to change even the most ardent opponents of big government. William McCarthy, a mortgage broker in Parker, Colorado, said he has been against federal intervention his entire life. Now 62 and facing eviction Feb. 11 after his lender foreclosed on his $199,200 mortgage, he said the government has to take action.

Suicides and Bankruptcy

``This has reached the point of being catastrophic,'' said McCarthy, who declared bankruptcy in July when his business failed after 18 years. ``I had a client who called me sobbing because his wife committed suicide rather than face eviction. Something's got to be done to help people.''

McCarthy said he took an interest-only adjustable-rate mortgage in 2005 when he and his wife, Janna, bought a 1,680- square-foot, ranch-style retirement home in Littleton, Colorado. His wife has a heart condition and needs a home without stairs, McCarthy said. They planned to sell their primary residence and refinance the ranch's interest-only loan before it reset, he said.

Risk Taking

They didn't act fast enough. In March 2006, U.S. home sales began the biggest decline in 26 years, according to data compiled by the Chicago-based National Association of Realtors. The house didn't sell. Now, they are losing both properties.

``My wife goes to bed crying every night, and there's nothing I can do,'' McCarthy said. ``The bank won't even return my calls.''

Bailing out borrowers who take risks creates a ``moral hazard'' that leads to riskier behavior as people assume the government will step in to save them, said Kiesel. In March 2006 Kiesel sold his house near Pimco's headquarters in Newport Beach, California, and rented a home in anticipation of the housing slump.

``The housing market will find its own bottom, without a government bailout,'' Kiesel said.

To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net .

Last Updated: February 1, 2008 10:25 EST
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It's not bailing out borrowers I am one of those most ardent anti-government intervention people. The loans were designed to fail and have the taxpayers pick up the pieces.

The sub-prime crises is the greatest property theft scam in the history of the earth the governmetn aided the Banking criminals evey step of the way.

Am I saying everone in the lending industry was crook no many may have though they were just cashing in on a housing and lending boom that's the whole point of freee market capitalism to be aboe to profit and benefit from good market conditions. That is not at all the situation here we have an engineered specualtive boom to use the mortgaes as backing for securites and pump up Wall street and set up an Enron times million money laundering scheme.

The government does not need to manipulate the market they need to investigate the crime and create moritorium on foreclosures until there is a Supreme court rulling on property siezure though fraudulent loans and loans designed to fail.

I would like to know as well were these investors got permision to create their own money by borrowing our mortgages and placing them at risk.
Effectively the government, lenders and investors created there own monetary system virtually unregulated outside of the Federal reserve fractioanal reserve methos of created loans 8x deposits which many inclusie of myself feel is UnConstitutional and illegal and was tolerated due to war time emergency and never corrected.

Outside those debatable pints it's not debatable whether a lender or servicer can foreclose on a home where the borrower has fulfilled all terms of the contract and the payments have been made on time. That is certainly outright property theft outside the argument of where they got the money from and what they did with it.

It's absurd use the term government intervention in the sub-prime crises becuase the money was lend and created though the Fed and the loans were funded by the GSE's Fannie and Freddie. It's not a private lending system it's a government backed and sponsered lending system these homes are being stolen and foreclosed though the Federal government.

The whole lending system is government private hybrid.

The whole sub-prime crises and ms fraud could never have happened with out massive government assistance and support evey step of the way.
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