In the article, I wrote that while the banks have insisted for the past several years that the robo-mortgage violations represented minor technical issues, which harmed no one. Recently, a far more grave explanation has emerged: The possibility that the scandal was the back-end of activities that appear to represent tax evasion, the failure to comply with basic rules in securitizing mortgages, and massive fraud on the purchasers of the securitized mortgage bonds.

Now, I have received numerous requests to clarify this extraordinary alternative explanation.

It’s complex, but here goes: First, as Yves Smith at Naked Capitalism explains, it appears the specific mortgages which were the assets comprising the securitized bonds were never actually transferred to the bonds, within the required time period (90 days under New York law).

By way of background: remember that the big concern about the release was that it would go beyond robosigning and waive other types of liability. The ones observers were most concerned about were what we called chain of title issues, namely that the parties that had put mortgage securitizations together had failed on a widespread basis to take the steps stipulated in their own contracts to transfer the notes (and in lien theory states, to assign the lien) properly.

The securitization agreements were rigid, requiring that the transfers through multiple parties be completed by a date certain, typically 90 days after the closing of the trust. Most deals elected New York law as the governing law for the trusts, and New York law allows them to operate only as stipulated. Since the notes were supposed to be transferred in by a particular date, trying to move them in later is a “void act” having no legal effect. That makes attempts to make transfers legally at this juncture a non-starter.

Having realized somewhat late in the game that their failure to do what they promised could interfere with trusts’ ability to foreclose and create tons of liability, servicers and their various agents have relied on not just robosiging, but widespread document fabrication and forgeries to fix their transfer problem when judges have taken notice. Anyone who has been on this beat knows of numerous cases where foreclosure documents are challenged, say for being too late, not having the right transfers, etc, that new versions of supposedly original documents that tell the right story miraculously show up in court.

Second, Ellen Brown, the President of The Public Banking Institute, explains the implications of this failure to abide by the 90 day deadline:

Since 1986, mortgage-backed securities have been issued to investors through SPVs [Special Purpose Vehicles] called REMICs (Real Estate Mortgage Investment Conduits). REMICs are designed as tax shelters; but to qualify for that status, they must be “static.” Mortgages can’t be transferred in and out once the closing date has occurred. The REMIC Pooling and Servicing Agreement typically states that any transfer significantly after the closing date is invalid. Yet the newly robo-signed documents, which are required to begin foreclosure proceedings, are almost always executed long after the trust’s closing date.

Third, as Brown also notes, the liabilities associated with a failure to transfer the documents on time came to head when:

Fannie Mae sent out a memo telling servicers that in order to be reimbursed under HAMP–a government loan modification program designed to help at-risk homeowners meet their mortgage payments–the servicers would have to produce the paperwork showing the loan had been assigned to the trust.

Brown believes that, as a result,

The hasty solution was a rash of assignments signed by an army of “robosigners,” to be filed in the public records…

This explains why, as noted by Brown above, “the newly filed robo-signed documents” are “almost always executed long after the trusts closing date.”

All of this is undoubtedly highly complex. And, I am not in a position to investigate whether it is true. However, the implications of these assertions are grave. If the mortgages were knowingly assigned to the REMICS after the closing date, then the tax benefits of the REMICS appear to be invalid. If so, these transfers (as I understand the law) represent tax evasion by the banks. As part of an ongoing scheme, they also constitute, in all likelihood, conspiracy and fraud on the bond purchasers.

With regard to the bond purchasers, as Yves Smith notes above, the failure to adequately establish the trusts created “tons of liability” for the banks to these purchasers; since the banks then effectively misrepresented the nature of the bonds they were selling.

At the moment, the important question here is not whether these allegations are true. What’s important is that their appears to be enough evidence to warrant at least a minimal investigation of these astounding assertions: The possibility that for years the banks have been knowingly misleading the public and the government on the extent to which robo-mortgage scandal activities were merely technical violations versus the back-end of potentially serious criminal activities and an attempt to evade enormous liabilities.

If we are a nation where justice is blind, should we not investigate this possibility before we give the offending financial institutions another free pass?

The essence of an effective capitalist system is rules and accountability. For markets, and our larger economy to work, important players cannot be permitted to make up their own rules. In all likelihood, a settlement next week means these serious questions will never be answered.

Tomorrow is the deadline for state attorneys general to sign on to a joint federal and multi-state $25 billion settlement of the robo-mortgage scandal. The settlement will involve Ally Financial Inc. (formerly GMAC), Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co., and Wells Fargo & Co. The details of the proposed settlement have not been released. However, one thing is clear: This settlement puts the nation at further risk of another systematic financial crisis and runs counter to any notion that the actions of the Obama administration will reflect the president’s newly energized populist rhetoric.

As a nation, we need to ask several questions. As a participatory democracy, we also have the right to the answers before any settlement is inked:

1. In his State of the Union Address, President Obama announced a new financial crimes taskforce, yet the administration is rushing to finalize this settlement before the taskforce begins its work. Why?

2. What is the public interest in releasing banks that have openly admitted they broke the law by signing false affidavits in tens of thousands of separate instances from liability?

3. The bank narrative has been that the robo-mortgage scandal reflected technical issues which harmed no one. Recently, new allegations have emerged that suggest these activities were actually the back-end of even greater malfeasance involving tax evasion, the failure to comply with basic rules in securitizing mortgages, and an attempt to avoid high liabilities on the part of the banks to the purchasers of the mortgage bonds.

These allegations operate as follows. First, as Yves Smith at Naked Capitalism explains, it appears the specific mortgages which were the assets comprising the securitized bonds were never actually transferred to the bonds, within the required time period (90 days under New York law).

By way of background: remember that the big concern about the release was that it would go beyond robosigning and waive other types of liability. The ones observers were most concerned about were what we called chain of title issues, namely that the parties that had put mortgage securitizations together had failed on a widespread basis to take the steps stipulated in their own contracts to transfer the notes (and in lien theory states, to assign the lien) properly.

The securitization agreements were rigid, requiring that the transfers through multiple parties be completed by a date certain, typically 90 days after the closing of the trust. Most deals elected New York law as the governing law for the trusts, and New York law allows them to operate only as stipulated. Since the notes were supposed to be transferred in by a particular date, trying to move them in later is a “void act” having no legal effect. That makes attempts to make transfers legally at this juncture a non-starter.

Having realized somewhat late in the game that their failure to do what they promised could interfere with trusts’ ability to foreclose and create tons of liability, servicers and their various agents have relied on not just robosiging, but widespread document fabrication and forgeries to fix their transfer problem when judges have taken notice. Anyone who has been on this beat knows of numerous cases where foreclosure documents are challenged, say for being too late, not having the right transfers, etc, that new versions of supposedly original documents that tell the right story miraculously show up in court.

Second, Ellen Brown, the President of The Public Banking Institute, explains the implications of this failure to abide by the 90 day deadline:

Since 1986, mortgage-backed securities have been issued to investors through SPVs [Special Purpose Vehicles] called REMICs (Real Estate Mortgage Investment Conduits). REMICs are designed as tax shelters; but to qualify for that status, they must be “static.” Mortgages can’t be transferred in and out once the closing date has occurred. The REMIC Pooling and Servicing Agreement typically states that any transfer significantly after the closing date is invalid. Yet the newly robo-signed documents, which are required to begin foreclosure proceedings, are almost always executed long after the trust’s closing date.

Third, as Brown also notes, the liabilities associated with a failure to transfer the documents on time came to head when:

Fannie Mae sent out a memo telling servicers that in order to be reimbursed under HAMP–a government loan modification program designed to help at-risk homeowners meet their mortgage payments–the servicers would have to produce the paperwork showing the loan had been assigned to the trust.

Brown believes that, as a result,

The hasty solution was a rash of assignments signed by an army of “robosigners,” to be filed in the public records

This explains why, as noted by Brown above, “the newly filed robo-signed documents” are “almost always executed long after the trusts closing date.”

All of this is undoubtedly highly complex. And, I am not in a position to investigate whether it is true. However, the implications of these assertions are grave. If the mortgages were knowingly assigned to the REMICS after the closing date, then the tax benefits of the REMICS appear to be invalid. If so, these transfers appear to represent tax evasion by the banks. As part of an ongoing scheme, they also constitute, in all likelihood, conspiracy and fraud on the bond purchasers.

With regard to the bond purchasers, as Yves Smith notes above, the failure to adequately establish the trusts created “tons of liability” for the banks to these purchasers; since the banks then effectively misrepresented the nature of the bonds they were selling.

At the moment, the important question here is not whether these allegations are true. What’s important is that their appears to be enough evidence to warrant at least a minimal investigation of these astounding assertions–which suggests that a large part of the robo-mortgage scandal was the back-end of potentially serious criminal activities and an attempt to evade enormous liabilities.

In all likelihood, tomorrow’s settlement means these serious questions will never be answered.

If we are a nation where justice is blind, should we not investigate the full truth before we give the offending financial institutions another free pass?

4. Why are the terms of this settlement secret? Prosecutorial negotiations are normally secret in order to prevent the disclosure of evidence that might or might not be relevant to a later trial if the negotiations collapse. This concern does not apply here.

5. This settlement has far more of the characteristics of legislation than of prosecutorial activities. The offending banks have destroyed the wealth, livelihood, and dreams of millions of Americans. Shouldn’t the public at least have two weeks to view the proposed terms of the settlement and make their views known to their state’s attorney general? And at a time when trust in government is at historic lows, isn’t secrecy for this type of activity the wrong way to build the much-needed confidence of the American people?

6. The press also has a constitutionally guaranteed role in our system of governance. In these unusual circumstances, isn’t this precisely the type of situation where the nation would benefit from careful scrutiny of the intended settlement by the press?

7. Officials have indicated that the settlement will require banks to write down the principal on homeowner loans. Unfortunately, a portion of the $25 billion allocated for this purpose is far too little, spread across a large number of homeowners, for any write-downs to make an effective difference. So either these statements are effectively meaningless, or the settlement is based on promises of future activities by banks. To date, the nation has witnessed repeated and egregious failures by the banks to live up to promises of future behavior, with no subsequent penalties for such failures. For any release from liabilities to be effective, shouldn’t it be contingent on the banks actually delivering on these promises?

Since the start of the economic crisis, none of the administration’s housing policies have succeeded. Each policy initiative has been fatally flawed. As a consequence, there’s no reason to believe that the policy pursued in the current settlement will aid, rather than hurt, the housing market. Meanwhile, the secrecy surrounding this policy initiative makes its potential positive contribution to the crisis even more suspect.

A month ago, I wrote that we were a nation in denial with regard to housing prices and the impact of ongoing foreclosures. Despite a favorable rent to buy ratio, ultra-low interest rates and an “all time low cost of owning a home,” housing prices are continuing downward. There is a simple explanation. With foreclosures and the so-called shadow inventory of homes, our housing supply will overshadow demand for many years to come.

With 29 percent of homeowners already underwater, this creates a massive risk for the economy. Some analysts predict that home prices will drop another 10 to 20 percent, which will put many borrowers deeply underwater. With additional price declines, underwater homeowners may start to simply walk away in droves. This will create havoc for our economy, the mortgage securities markets, and it will destroy solvency of the banks as they are forced to write-down their portfolios. The nation will be plunged into another economic crisis.

Unfortunately, all indications over the past several weeks are that this risk is continuing to grow. Indeed, the most recent reports on housing prices showed larger than expected declines in November. This reflected the third month in a row of declines. “The trend is down and there are few, if any, signs in the numbers that a turning point is close at hand,” said David M. Blitzer, chairman of the S&P’s home price index committee.

In his State of the Union speech, President Obama stressed assistance for “responsible homeowners.” Yet the current definition of a responsible homeowner is someone with a job. (Although yesterday the president did say, “We’re working to make sure people don’t lose their homes just because they lost their job.” ) So, at least for the moment, continued unemployment woes will keep this vicious cycle going.

Here’s how this relates to the proposed settlement: All of the activities covered by the settlement took place after the crisis began. They were not unforeseen effects of once-in-a-lifetime systematic risk. They reflected willful and knowing disrespect for the rule of law. To date, documents provided by the banks to the Courts, as well as accompanying testimony, demonstrate that laws were broken on a massive scale. The essence of capitalism is responsibility and accountability. The settlement ignores both. (See the letter below from a Michigan County official asking the Michigan Attorney General to “refuse” to join the settlement)

In 2010, Richard Cordray, then Ohio Attorney General, sued GMAC seeking a $25,000 fine for each false affidavit filed. Now, the open question is what is the potential liability of the banks, absent a settlement, for the robo-mortgage activities. The banks desire to settle at $25 billion is one indicator that their actual liability is probably far higher. My suspicion is that the total liability, including all punitive damages for criminal and civil malfeasance, would be sufficient to make the banks insolvent. This means that, because of the banks’ malfeasance and greed, the nation has the leverage to bargain for a massive write-down of mortgages — thereby preventing an economic catastrophe. I am not advocating this option, nor am I saying it is good policy. But I do believe it would be a scandal to limit whatever leverage we have to save our economy by once again permitting gross malfeasance.

In late May, my eldest daughter will graduate from college and join the labor force. Will there be jobs for her and her classmates? Will she come of age in a decade of limited employment opportunities, the collapse of the middle class, and unequal justice while a privileged few live lives of abundance because they have corrupted our democracy? As someone who reveres our system of justice, what is the advice I should give her about working hard and playing by the rules? There is still a chance that we can turn all of this around. But rushing to settle with law-breaking banks is certainly not the way to solve the issue of inequality — which President Obama called the defining issue of our time. It is also the antithesis of capitalism, which is based on adherence to law, a fair bargain, and accountability.

This article originally appeared as part of the Restoring Capitalism series, of the New Deal 2.0 blog, a project of the Roosevelt Institute.

In early December, the Justice Department confirmed that it was investigating the pricing of e-books and the related activities of major publishers and online retailers, such as Amazon.com and Apple. As a print and digital author, participant in the publishing industry, and graduate of the Yale Law School, this naturally caught my eye. It also led me to start thinking about the assumptions that underlie existing antitrust laws.

Democracy is the basis of our form of government. Capitalism is the basis of our economic system. They are distinct systems, and (at least in theory) it’s possible to have one without the other. But will the antitrust rules developed to foster capitalism in the previous century inadvertently weaken our democracy in this century? In addition, do pre-digital era antitrust doctrines hinder the development of a fair, robust capitalism in our age? The current Justice Department investigation is a case study for examining these issues.

Lengthy, reasoned arguments (i.e. books) have historically played a central role in the marketplace of ideas. Important books have changed the way we look at our society, altered our political beliefs, changed foreign policy, and moved the nation in myriad ways. In the digital era, we benefit from many new forms of disseminating information, such as blogs and online news sources, all of which add to the marketplace of ideas. Nonetheless, none of these new sources of information has replaced the essential nature of a book (in physical or digital form): a lengthy effort, researched and written over a long period of time, which reflects the author’s most thoughtful analysis and reflections on the subject in question.

The research and creation of many significant, important works are funded by advances from book companies. The book company grants the money up front on the basis of a proposal, which allows the author to pursue the project while earning a living. Hypothetically, if publishers stopped offering advances, many important works would never be created. Authors (who are not always academics or paid foundation researchers with a guaranteed salary) simply could not afford to undertake the work. This capitalist, for-profit motive plays an important role in funding important contributions to the marketplace of ideas.

Today, the book industry is struggling to adapt to the digital transformation. At its core, digital information has a tough time establishing value in the eyes of the consumer. If the book industry declines, some authors will undoubtedly self-publish, and it’s possible new financing vehicles, for the equivalent of today’s advances, will evolve. In essence, a weaker book industry means our society loses a source of funding for important, time-consuming, and extensive research and analysis.

The Justice Department has not revealed the precise nature of the investigation. But it’s my understanding that when the Kindle was first released, Amazon.com priced e-books at less than the wholesale cost it was paying publishers. In effect, to boost Kindle sales and the idea of e-reading in general, Amazon was often taking a loss on sales.

A long-held tenant of antitrust law is that vertical price fixing (an agreement between the manufacturer and the retailer to sell a product at a specific price) is often illegal. These restrictions are why manufacturers offer products with a “manufacturer’s suggested retail price” (”the MSRP”). The manufacturer is not permitted to formally agree with retailers on the prices consumers pay for products. The retailer is free to set the price offered to consumers, thereby enabling discounts from the MSRP. (Note: In recent years, the Supreme Court has adopted a moreflexible approach to the issue or vertical price fixing, adopting a “rule of reason” test, but it remains a central area of antitrust policy.) In addition, competitors cannot work together to restrain price competition in some way (horizontal price fixing).

As the e-book business started to develop, publishers were concerned that Amazon’s pricing approach was devaluing their products and (I assume) threatening to destroy hardcover sales at bookstores. In response, publishers developed what is known in the industry as “the agency model.” Under this model, the publisher sets the price the consumer pays. In this model the digital retailer is not buying the product at a wholesale price, but acting as a sort of sales agent for the publisher. As the sales agent, the retailer receives a commission on each sale. In effect, digital book purchases become like insurance policy purchases, with Amazon and Apple as the brokers. From the perspective of antitrust law, the actual seller is the publisher, which sells through an agent and no agreement in restraint of trade exists. My assumption is that the Justice Department is investigating whether this agency pricing model violates restrictions on vertical price fixing and whether the way it was deployed by multiple publishers reflects some form of horizontal price fixing.

It’s easy to have a knee-jerk negative reaction to the higher e-book prices that publishers have set under the agency model. But here’s where this all gets interesting. As the (now barely existent) music industry and suffering newspaper industry have learned, it’s incredibly hard to establish value for digital content. This reflects the competitive marketplace that may make content available for free, consumer perceptions of what they should pay for digital goods, the availability of other revenues streams (such as advertising), and a host of other factors.

One undeniable effect is that the Internet inherently drives the value of digital goods down. Instant price comparisons, easy access to lower-priced alternative options for digital information and entertainment, and illegal file sharing all contribute to this phenomenon. Traditional publishers also face challenges in making the digital transition. Importantly, a host of new competitors that help authors create digital books have arisen, and authors can also publish on their own. So the competitive dynamic for digital books, with far easier access to low-priced and free alternatives as well as all kinds of new types of publishers and distribution models, is very different than the dynamic that existed when vertical pricing restrictions were first developed.

There is a second, more fundamental issue at work here. The digital world makes the bundling (whether explicit or implicit) of intellectual property far easier than the physical world. Companies can make their profit in one place and break even or lose money on other products to support this activity. The problem is that this kind of activity destroys the perceived value among consumers of the bundled products. Amazon, for example, may be making money on the Kindle and not the e-books, but still profit in the long run.

The basic point here is that in the digital world it’s possible to imagine instances where it’s profitable for retailers to destroy the perceived consumer value of e-books and the associated hard copy titles.

Our society is best served by a robust e-book industry. As e-book prices declines, fewer and fewer authors are able to make a living expressing their ideas, whether they are political, socially insightful, or a form of entertainment.

With so much new competition emerging, and so many unknowns for the publishing industry itself, my strong bias is not to stretch interpretations of antitrust laws developed for a different era-and to allow the industry to do what it feels is best for its long-term survival. If the violations of the laws are clear-cut, then perhaps the Justice Department should seek to have the laws changed before beginning an enforcement action. If no violations are clear cut, then the Justice Department should have the wisdom to leave well enough alone. The worst possible outcome would be for the Department to attempt to extend the doctrines of the antitrust laws to cover the agency model, working from the mistaken belief that this would benefit our society.

Here are two takeaways:

First, the creation of information in our society has always been recognized as playing a central role in building a healthy democracy, with the attendant benefits of the best aspects of capitalism. This recognition is embodied in the first amendment. As we move to a digital era, there is increasingly less ability for information creators to profitably fund the creation of “expensive” information (i.e. books requiring extensive research and interviews, investigative journalism, and the like). Our democracy, and ultimately the operations of a robust, fair capitalist system — based on the best possible information — are poorer for this loss. To the extent that any of our existing laws inadvertently destroy the remaining infrastructure that profitably supports the creation of such information, they must be reexamined.

Second, the ability for retailers to make money on one product (such as the Kindle or the iPad), while cutting prices on digital products, is something new to our era. We need to stop and think about how the distribution of products that spread ideas may be affected by antitrust laws. We must ensure that our laws are not furthering the destruction of a robust marketplace for ideas.

Full Disclosure: I have published books with several publishing houses and worked as a paid consultant to several book and magazine companies.

All of the above is a unfortunate commentary on the state of values in America, and the expectations our citizenry has for its leadership. Sadly, we have come to expect the worst, rather than the best, in the people that lead our society. If we hope to regain the sense among our citizens that we are a great nation, and a force throughout the world for moral good, all of this is unacceptable.

But, despite the ongoing stream of disheartening news, today’s revelation is just over the top. As an optimistic cynic, I am shocked that Mitt Romney maintains a portfolio of investments headquartered in the Cayman Islands. As detailed by ABC News:

Although it is not apparent on his financial disclosure form, Mitt Romney has millions of dollars of his personal wealth in investment funds set up in the Cayman Islands, a notorious Caribbean tax haven.

There are a host of issues associated with these activities, and none of them are positive:

First, the Romney campaign contends that this is irrelevant. According to ABC News:

A spokesperson for the Romney campaign says Romney follows all tax laws and he would pay the same in taxes regardless of where the funds are based.

But, as experts quoted in the ABC News article noted:

Tax experts agree that Romney remains subject to American taxes. But they say the offshore accounts have provided him — and Bain — with other potential financial benefits, such as higher management fees and greater foreign interest, all at the expense of the U.S. Treasury. Rebecca J. Wilkins, a tax policy expert with Citizens for Tax Justice, said the federal government loses an estimated $100 billion a year because of tax havens.

Blum, the D.C. tax lawyer, said working through an offshore investment vehicle allows the investor to “avoid a whole series of small traps in the tax code that ordinary people would face if they paid tax on an onshore basis.”

Wilkins agreed, saying the “primary advantage to setting those funds up in an offshore jurisdiction like the Cayman Islands or Bermuda is it helps the investors avoid tax.”

FYI: I predict that, despite the statements of his campaign, we will ultimately find substantial tax savings for the Romney family through these tax havens.

Second, it is almost impossible for me to believe that any candidate running for President is foolish enough to think the American people don’t care.

There is nothing patriotic about parking money earned by “creating jobs” in offshore funds. It is fundamentally an unpatriotic act. You are knowingly taking your activities outside of the jurisdiction of the United States. How can Romney possibly defend this action?

Third, it seems clear that Romney has indeed been hiding something about his finances.

It is one thing to say I am a predatory–but honest–capitalist. And Romney’s year’s at Bain have sparked a healthy debate on the role of private equity firms in our nation’s economy.

It is another for a Presidential candidate, who has been working for years for this moment, to show such obvious disdain for the American system of Justice, that he removes his assets from it.

Moreover, there is the distinct feeling that the combination of Romney’s refusal to release his tax returns and the lack of disclosure of such accounts in his public filings (although within the law) indicate that Romney knows this is unpatriotic, reprehensible behavior and somehow believed he could be elected President without this coming to light.

Fourth, do we want a President that seems to believe he can successfully hide basic information like this from the American people. We have learned from the The Washington Post that at Bain Romeny’s word was not his bond. So, his honesty is already in question. Now, we are forced to wonder about his basic intelligence, and the intelligence of his advisers (if they knew about this).

In an earlier era, a revelation of this type would have forced Romney to resign from the race. The consequences in our age are, as yet, unknown. However, there is simply no acceptable reason  for a Presidential candidate to have his or her money managed in a jurisdiction purposely designed to avoid the laws and reporting requirements of the United States.

We are a better nation than this.

Last week, a number of important events occurred in Washington, including important recess appointments by President Obama. However, the most noteworthy event did not make front page news: the  Federal  Reserve’s  (apparently) unsolicited memo to the committees of Congress that oversee financial services warning of the dangers the current housing market poses for the economy.

This represents an extraordinary action and underscores both the seriousness of the continuing crisis and the absence of meaningful discussion of the problem in Washington. Bernanke’s memo reviewed federal actions to date and effectively concluded that they were unlikely to solve this national tragedy. The memo concluded, in part:

“The challenges faced by the U.S. housing market today reflect, in part…a persistent excess supply of homes on the market; and losses arising from an often costly and inefficient foreclosure process (and from problems in the current servicing model more generally)… Absent any policies to help bridge this gap, the adjustment process will take longer…pushing house prices lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.”

This memo is notable for several reasons. First, it’s important to remember that when the Fed speaks, it does so in sober, limited terms. So an unprompted Fed warning suggesting “a persistent excess of supply” and a “resultant drag on the economy” is comparable to the Secretary of Homeland Security holding a press conference to warn of the risk of an imminent national emergency. Second, an unprompted memo from Bernanke to the House means that he is so deeply worried he felt the need to speak out in as strong a voice as his position permits. Third, the Fed rarely speaks on issues unrelated to its direct activities. Indeed, The Wall Street Journal subsequently wrote that, “For an institution that jealously guards its independence, the Federal Reserve is wading into treacherous political waters.” This further underscores the severity of the risks the Fed foresees.

Finally, a further indicator of the depth of the Fed’s concerns is what may be an apparently unprecedented set of coordinated speeches by three top Fed officials. On Friday, the presidents of the New York and Boston Fed banks, and Betsy Duke, a Fed Governor, all gave speeches detailing the need for aggressive action to spur a housing recovery. For example, William Dudley, president of the New York Fed,  told a group that, “The ongoing weakness in housing has made it more difficult to achieve a vigorous economic recovery.”

There are a multitude of other indicators that our current treatment of the housing sector will at minimum prevent an economic recovery and at worst have disastrous consequences for the stability of the financial sector as well as the health of the middle class. (For the record, my analysis leans toward the latter of these two viewpoints.) These include the reportedly poor health of our financial institutions (zombie banks), the administration’s  seeming efforts to cover this fact up, and the inevitable failure of federal homeowner assistance programs that rely on the cooperation of financial institutions whose profit incentives are in the reverse direction.

Consumer spending represents 70 percent of the nation’s economy and is central to any economic recovery. To achieve sufficient  aggregate demand (i.e. total spending on goods and services), this will require  spending by middle-income individuals in addition to what we now call the 1%. The Fed report suggests that the housing crisis makes such a recovery unlikely.

The report  found that, in the aggregate, more than $7 trillion in home equity–more than half of the aggregate home equity that existed in early 2006—has now been lost, noting, “This substantial blow to household wealth has significantly weakened household spending and consumer confidence.” Moreover, “Middle-income households, as a group, have been particularly hard hit hit because home equity is a larger share of their wealth in the aggregate than it is for low-income households (who are less likely to be homeowners) or upper-income households (who own other forms of wealth such as financial assets and businesses).” These households have seen their home equity decline by an estimated 66 percent.

Moreover, the fear of a continuing loss of wealth (which is a cushion against job loss or other economic emergencies), the fear of job loss itself, the negative effects of underwater homes, lack of forbearance for unemployment (a point the Fed particularly emphasizes), and consumers struggling to meet mortgage payments in a far more difficult environment are all dragging the economy down.

There is also a far worse possibility. Today, an estimated  29 percent of all homes with mortgages are underwater. In addition, at least one respected analyst estimates that a total of 14 million homes will be foreclosed on from 2007 to the end of the crisis. This represents a hard-to-imagine one in every four mortgages. With foreclosures increasing, there is now such a looming imbalance of supply and demand that, as the Fed notes, further decreases in home prices are likely. Some believe home price reductions of another 20 percent are likely. This would, in all likelihood, have disastrous consequences on at least three fronts—and ripple effects that are impossible to predict.

First, many homeowners would be so far underwater that massive walkaways would be likely. The negative impact on consumer spending of such price declines would almost certainly lead to a vicious cycle of more job losses, leading to further walkaways by struggling consumers.

Second, the mortgage securities market would be in chaos. Nonperforming loans would lead to the forced recognition that bank capital (based on the value of mortgages in bank portfolios) is weak or insufficient.

Third, it is almost impossible to imagine foreclosures on the massive scale anticipated without dire social consequences or even some form of social unrest. As Peggy Noonan has observed, the real meaning of Occupy Wall Street is that this is just the  beginning of the protests we are likely to see. “OWS is an expression of American discontent, and others will follow,” she predicts. Protests and social unrest are particularly likely if people feel they are unfairly losing their homes to support irresponsible, law- breaking institutions that have successfully disregarded the fundamental rules of capitalism and good citizenship. Mechanisms to avoid this possibility are one of the central issues I address in my

forthcoming book, Making Capitalism Work for the 99%: A Manifesto.

What is shocking is the almost total lack of attention the administration has paid to suffering homeowners. It’s hard for me (and apparently Chairman Bernanke) to understand how the administration can possibly hope to revitalize the economy without seriously addressing the overhang of consumer housing debt. Moreover, the failure to address the risk this poses for a broader economic catastrophe borders on the inexcusable.

If President Obama is serious about saving the middle class and  reducing income inequality, the administration needs to be far more aggressive in developing policies to keep homeowners as homeowners. As I have written before, this was one of FDR’s c entral go als in the New Deal. Detailed proposals for addressing this extraordinary risk  do exist. However, they will require a determined effort. There are solutions, but they are not simple.

What is most important right now is that we recognize we are in a lifeboat that will not reach land. We need to focus on implementing a meaningful solution to the problem. A clock is ticking and Washington needs to acknowledge that a witching hour is approaching.

This article originally appeared as part of the Restoring Capitalism series of the New Deal 2.0 blog, a project of the Roosevelt Institute.

At the time, I referenced the SEC case against Citigroup and criticized the relatively small fine the SEC had imposed, suggesting it was evidence of a broader problem related to meaningful enforcement of the laws by the agency. As background, SEC settlements must be ratified by the court, and a central aspect of these SEC settlements is that defendants “neither admit nor deny the allegations.” Rarely does the court fail to endorse an agreement proposed by the SEC, since it’s the prosecuting party.

Subsequently, the proposed Citigroup agreement has received considerable attention, as U.S. District Judge Jed S. Rakoff rejected the settlement, calling it “neither reasonable, nor fair, nor adequate, nor in the public interest.” He both criticized the typical SEC “neither admit nor deny” form of settlement and called the SEC negotiated fine “pocket change” for Citigroup. Today, The Wall Street Journal indicated that the SEC enforcement division is expected to recommend to SEC commissioners that the Judge’s decision be appealed.

These recent events beg a deeper look at the system of SEC enforcement. Why has the SEC apparently pursued such minimal settlements? The answers are surprising in that they reflect a wide discrepancy of views.

I found three very different explanations. There is probably some truth in each of them. But they all indicate that we have a broken system that must be fixed so that capitalism can operate properly.

First, the SEC enforcement division is underfunded and therefore lacks the resources to pursue a large number of complex trials. Critics say this reflects a deliberate effort by Congress, influenced by large financial institutions, to prevent punishment for malfeasance. This suggests yet another example of how our largest financial institutions are preventing actual capitalism from functioning, often in ways that are not obvious.

Second, without the no admission of guilt clause, defendants would open themselves up to a stream of well-funded plaintiff actions based on admitted guilt and even risk bankruptcy. In essence, the proponents of this explanation suggest SEC fines are considered a cost of doing business, but if injured customers have an adequate chance of redress then the punishment will more closely relate to the injuries caused by the illegal actions involved and this worries the banks. Judge Rakoff’s opinion sharply criticized the settlement in this regard, indicating it “depriv[ed] the pubic of ever knowing the truth in a matter of obvious public importance.”

Third, it can be explained by the revolving door, where former SEC enforcement officials are “going to work for the very same firms they used to police.” Top SEC enforcement officials represent some the clearest examples of people who move out of government to high paying jobs in the private sector. This has a chilling effect on the efficacy of SEC efforts related to the largest, most powerful institutions. Clearly, we need to find a fair system that will both attract talent to the SEC but prevent this phenomenon.

There are several implications to these different explanations for what is clearly a broken system. Without the deterrent effect of the credible threat of law enforcement, the financial services industry will continue its malfeasance. The additional deterrent effect of successful private lawsuits based on a pre-existing admission of guilt is lost when the SEC uses the no admission of guilt standard. This raises a central question: Is the SEC’s role in our society to punish and deter malfeasance, or is it to help victims more easily recover losses resulting from misconduct? If it is the latter, then finding the actual truth of guilt or innocence would serve a strong societal interest.

Additionally, the knowledge that the SEC always settles suits will inevitably start to enter into the thinking of potential bad actors. Here again the deterrent effect is minimized. It becomes easy to imagine bad actors discussing an issue and saying, “What’s the worst that could happen? We will settle with the SEC for far less than we will make on this deal and the details will never become public.” Meanwhile, malfeasance by the financial sector has caused millions of people to suffer.

Clear solutions to these problems exist. The Obama administration must insist on far more extensive funding for SEC enforcement. Then we need to remember the famous words of Justice Brandeis, who said, “We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can’t have both.” Perhaps, as recently discussed by The New York Times, it’s time to reconsider the maximum size and concentration of power in our financial institutions, which seem to consistently interfere with the fair operation of capitalism.

This post originally appeared as part of the New Deal 2.0 project of the Roosevelt Institute.

The financial crisis effectively started with the housing crisis, and it will not end until we find a way to resolve the housing crisis.

Economists who have repeatedly forecast a healing economy have misjudged the need for a healthy housing market as a central component for any type of economic recovery. The administration’s current plans for preventing foreclosures are woefully inadequate, some experts believe housing prices will decline as much as 20 percent this year, and our nation’s cycle of economic misery will continue.

Since mortgage meltdown begin in 2007, six  million homes have been lost  to foreclosure.  At present, another four million homes are at some stage of the foreclosure process.  As the New York Times reported recently, one of the nation’s leading housing analysts anticipates that a “staggering” total of more than 10 million of the nation’s existing 55 million mortgages are “reasonably likely to default.” Another recent article noted that, “If the U.S. foreclosure crisis were a baseball game, we’d probably be in the bottom of the fourth inning.” This national tragedy is a long way from over.

The housing and foreclosure crisis represents a conundrum with plenty of blame to go around: banks that violated lending standards in a search for easy profits; the creation of complex mortgage-backed securities whose risks were not fully understood; borrowers who took on far more debt than they could afford; the list goes on.

What the Occupy protesters recognize, either explicitly or implicitly, is that since the start of the housing crisis, government actions have by and large penalized suffering homeowners while rewarding banks that should have failed because of poor business decisions. The government has not adequately enforced the laws associated with ensuring foreclosures are valid, appears to have no concerns when banks wrongfully take possession of homes  (which, I believe, used to be called “criminal trespass” and  “breaking and entering”). On the flip side, all of the administration’s plans associated with helping homeowners facing foreclosure have failed miserably.

All of this is bad economics, violates the rules of accountability and equal justice that are essential to a viable capitalist economy, and undermines our democracy.  The Salon article also reports that the Occupy protesters plan to “disrupt” foreclosure auctions. These actions are strikingly familiar to the “penny auctions” that took place during the Depression era. As detailed in my 2009 book, It Could Happen Here, which focused on the danger of growing income inequality to our nation:

“Civil disobedience can emerge, even among the most conservative and normally upright citizens. During the Great Depression, foreclosed farms were auctioned on local courthouse steps. As the situation worsened, farmers took matters into their own hands. In what became known as “penny auctions,” neighbors of bankrupt farmers would gather for an auction, physically prevent people from bidding on foreclosed farms, and then bid a token amount for the farms with the goal of returning the homesteads to their original foreclosed owners.”

What is striking is the lack of creativity or sense of urgency that has been applied to the housing crisis. Here is a guiding principle for action: Homeowners must remain homeowners. Yes, this may not be an idea that is universally supported. And yes, it may be unfair to those who acted more responsibly. But the bailouts of the banks were also grossly unfair and I suspect hundreds of other significant, unfair government actions biased toward financial institutions and not consumers have taken place since the start of the crisis.

As a nation, we no longer have the luxury of concerning ourselves with fairness. Our economy is on life-support, unemployment is far above the 6% to 7% level which then-candidate Obama called an “immediate economic emergency” when running for office in October 2008, and further declines in housing prices will send the economy into a greater tailspin.

We have adopted a dangerous complacency around the housing crisis that must be abandoned. If our economy and social fabric are to heal, a sense of urgency is desperately needed.

One rarely remarked upon but dramatic aspect of the New Deal were the many innovations associated with ensuring continued homeownership. This was a central focus of FDR’s effort to heal the nation. In 1933, Congress created the Homeowners Loan Corporation (HOLC), which bought up one in every five mortgages in the U.S. and reissued longer term, lower monthly payment mortgages. In 1934, Congress created the Federal Housing Authority to insure long-term mortgages in a manner similar to the way the FDIC insures deposits, which ultimately made private lenders comfortable with 30-year mortgages. Most of us don’t realize that the 30-year mortgage was effectively invented in the era of the New Deal and that previously mortgages ran for periods as short as five years.

A recent study estimated that 29 percent of all homeowners with mortgages are underwater, and it’s likely that a sizeable portion of this total is more than 25 percent underwater, which is generally agreed upon as the point where even solvent homeowners simply abandon their properties (also known as jingle-mail, since the former homeowners send the house keys to the mortgage lender). As housing prices continue to drop, and I strongly believe they will, these numbers will continue to accelerate.

I do not have a specific policy proposal for fixing the housing crisis, but I have no doubt that with sufficient determination and creativity, this mess can be solved and we can move forward. The solution is likely to involve some pain on both sides — losses for financial institutions and homeowners perhaps trading a portion of their equity (under the auspices of some new type of government agency) for a substantially lower mortgage principle.  Or, any number of completely different solutions. But both sides made mistakes and so shared pain is not a bad thing.

But what is a bad thing will be to do nothing. We simply cannot allow the impact of additional foreclosures to to further destroy our economy or allow our social fabric to disintegrate as more and more people conclude that they were cheated out of their homes.

In the era of the New Deal, increasing farm foreclosures also led to riots and widespread violence in the Midwest, something we disregard today at our peril. In It Could Happen Here, I wrote:

“These generally conservative farmers viewed their rebellion within the context of American principles.  Arthur Schlesinger, Jr., who published the three volume study The Age Of Roosevelt, wrote, “Theirs, as they saw it was the way not of rebellion but of patriotism.…

I have no doubt that these [rioting] farmers would have explained their actions as a combination of anger and righteousness that would be echoed in our modern era: A corrupt system of home loans, combined with an economic system that was run for the benefit of a privileged few, unfairly destroyed their lives.”

The housing crisis emerged and has been exacerbated by a violation of the fundamental principles that make both capitalism and democracy work: accountability, bankruptcy for bad business decisions, enforcement of our laws, and equal justice.

I have written elsewhere that the Occupy movement would not simply disappear into the night. It is the flashpoint for the deep anger and sense of unfairness that pervades our society, with millions of people who feel their lives and dreams have been unfairly destroyed, while those who played a central role in causing their misery continue to profit.  The transition of the Occupy movement to a focus on foreclosures was inevitable; this is the epicenter of our national tragedy.

The movement’s focus on foreclosures will shine a necessary, even brighter light on our failure to address this central aspect of the financial crisis. These actions are an important and necessary wake-up call to our society about what is happening throughout the nation on a daily basis.

We can, of course, dismiss this latest act of protests. But if we do nothing, I wonder how far we stand from the violence of the New Deal era or worse.  At the time, FDR said, “The West is seething with unrest.” Where are we?

]]> http://itcouldhappenhere.com/blog/the-daily-dish/feed/ 0 http://itcouldhappenhere.com/blog/why-atlas-shrugged/ http://itcouldhappenhere.com/blog/why-atlas-shrugged/#comments Fri, 18 Nov 2011 19:33:05 +0000 Bruce Judson http://itcouldhappenhere.com/blog/?p=927 As the dysfunctional nature of our economy becomes increasingly apparent, the media is appropriately focusing on the whether the ideas of economic thinkers from earlier eras can help to solve today’s problems.  Recently, NPR devoted a segment to the thinking of Ayn Rand.

The NPR segment quoted from an extensive television interview with her conducted by Mike Wallace in 1959, and now available on YouTube.  As the segment noted, Rand is a hero to many Washington  politicians who advocate free markets. In the Wallace interview, Rand said, “I am opposed to all forms of control. I am for an absolute, laissez-faire, free, unregulated economy.”

The Washington establishment has, in fact, misinterpreted what Rand valued and what she would advocate today.

At this moment, what’s relevant to our nation is not  the laissez-faire policies Ayn Rand advocated in the late 1950s as an outgrowth of the philosophical system she called “Objectivism,” but what the philosophy itself considered important, how these principles should be applied to our modern economy, and whether we believe implementing these ideas would aid the economy.

The central statement Ayn Rand makes in her interview with Wallace which she stressed repeatedly  is that entrepreneurs and businessmen are the producers who create the goods and services that make our economy run. They deserve their wealth, are her heroes, and no one including the government has the right to take their property. As NPR notes, “In Atlas Shrugged, which Rand considered her masterpiece, the wealthy corporate producers are the engines of the American economy.” In this fictional tale, the economy starts to stagnate when these producers go into hiding, leaving behind what she calls “the moochers.”

In effect, an important aspect of Rand’s philosophy supports the central tenet of a functioning capitalist economy: Those who create the greatest societal wealth should be the most highly compensated.

This is a fundamental notion in any capitalist economy. It underlies one aspect of the American Dream and also explains the historic admiration of the American people for rich people.  In general (and before the Occupy Wall Street movement), the prevailing ethos in America has been that rich people deserve their wealth because they have created societal value for all of us. Indeed, I suspect the vast majority of the American people do not begrudge the wealth earned by successful, risk-taking innovators like Michael Dell, Jeff Bezos, the late Steve Jobs, or Ross Perot.

In effect, Rand’s philosophy is only anti-regulation because it is ultra-supportive of the capitalist ideal: The people who create the most societal wealth should receive the benefits of this contribution.

From this perspective, Rand’s philosophy points out that real capitalism is no longer enforced in America; not because of welfare programs, taxes, the social safety net, or government regulations, but for a very different reason: The highest paid people in America today create no real wealth for the society.

The financial industry, comprised of traders, hedge funds who exploit arbitrage opportunities, and “quants” who develop mathematical models to take advantage of minute inefficiencies in trading markets (for stocks, derivative securities of all types, commodities, and more) are now earning seemingly inestimable sums. Hedge fund owners earn billions of dollars annually while traders who earn less than several million dollars a year are not, by Wall Street standards, real successes. Yet they are all gambling in “a heads I win, tails you lose” game. The outcome of all their efforts are high profits, but little, if any, new societal wealth.

Real societal wealth is anything that enhances the lives of those in our society, starting with basics such as food, shelter and medicine, but also including almost any property a person can own or anything a person can experience, such as entertainment or greater convenience. Real wealth can be eaten, used, shared, or experienced.

Profits cannot be eaten and they do not provide shelter. As a consequence, it’s essential to recognize that the creation of profits is often confused with the creation of real societal wealth. They are different. Profits are an accounting proxy we use for indicating whether wealth is created. But like all proxies, this one sometimes falls short. With regard to the financial industry, this proxy has failed the nation spectacularly.

The current issue of Foreign Affairs describes how a Wall Street firm spent $300 million to construct a fiber-optic cable connecting the Chicago Mercantile Exchange and the New York Stock Exchange to shave “three milliseconds off high-speed, high-volume automated trades—a big competitive advantage.” And huge sums are now being spent to use technology to earn these profits. High frequency (i.e. computer-driven) trading is now estimated to account for 75 percent of all buying and selling of U.S. equities. Does any of this add to our societal wealth?

Some Economists openly wonder whether our financial services sector actually destroys, instead of creating, societal wealth. In December 2008, Paul Krugman wrote in The New York Times (emphasis added):

“The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s not just a matter of money: the vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole….

We’re talking about a lot of money here. In recent years the finance sector accounted for 8 percent of America’s G.D.P., up from less than 5 percent a generation earlier. If that extra 3 percent was money for nothing — and it probably was — we’re talking about $400 billion a year in waste, fraud and abuse.”

By late 2009, Krugman noted, that this view is now widely shared:

“after the debacle of the past two years, there’s broad agreement — I’m tempted to say, agreement on the part of almost everyone not on the financial industry’s payroll — with Mr. Turner’s assertion that a lot of what Wall Street and the City [of London] do is “socially useless.”’

Yes, many financial economists have concluded that high speed trading and hedge fund arbitrage add to the efficiency of these markets. But I wonder if they have quantified the value to our society of these benefits and compared them to the very real costs. As far as I know, they have not.  It’s my understanding that they have only looked at the isolated impact of these activities on markets—not their overall impact on our society.

This system, with the highest rewards going to those who create nothing, is antithetical to a capitalist economy. We have turned the underlying premise behind our entire economic system on its head. Now, those who create little, if any, societal wealth receive the most wealth in return.

Moreover, the wealth now inappropriately channeled to Wall Street is harming our society in a myriad of ways: First, money inevitably leads to political power through donations, lobbying, access, and more. Inevitably, trading-related money is now further distorting our capitalist economy by influencing legislation for its own anti-capitalist benefits.

Second, in a society where success is often defined by income (for better or worse) the talent the nation desperately needs to create real wealth is instead sucked up by the financial system and dedicated to arbitrage and other zero-sum activities.

Third, the speculative investments of hedge funds and other trading entities can have a dangerous destabilizing impact on markets and the prices of essential commodities (such as food and energy), and create systematic risk for the economy as a whole.  In February of this year, Bloomberg reported on the findings of a federal government report, stating:

“Hedge funds and insurers might threaten U.S. economic stability in a time of crisis, according to a report aimed at helping regulators decide which non-bank financial companies warrant Federal Reserve supervision.”

Fourth, it’s likely that billions of dollars of our nation’s limited resources are spent each year on infrastructure with no real societal value, all of which could instead be spent for productive uses.

Fifth, pay scales throughout the society are thrown out of whack as other elites start to question whether they should be earning similar amounts.

Finally, the notion that all profits are good—whether they create real societal wealth or not—is consistently reinforced through the highly publicized example of Wall Street earnings and applied with the same harmful effects in other industries throughout the nation.

Ayn Rand would, I believe, argue that this absolute failure to enforce capitalist principles is exactly what she most feared: The emergence of a powerful group that produces nothing, yet manages to takes a large share of the societal wealth created by others. In her view, this inevitably leads a society to implode and self-destruct.

(Yes, Rand did not believe in altruism or any type of social safety net, and I am not addressing this aspect of her “Objectivist” philosophy here. But it is worth noting that she opposed these programs for the same reason I am certain she would be horrified by the current channeling of wealth to financial firms: She believed that they were allocating the benefits of production away from the rightful beneficiaries. Whether we agree or not with these assertions, they are irrelevant to this discussion.)

I do, however, feel comfortable asserting that if she returned today, Rand would consider eliminating the transfer of un-earned wealth to the financial sector to be a far greater and far more urgent priority than addressing her beliefs related to the social safety net.

Unless we address the destructive effects caused by making speculators and traders the highest earning class in our capitalist society, the economy will remain dysfunctional.  In effect, the nightmare that Rand’s philosophy anticipated for our economy is increasingly real, but because of the financial industry, not the social safety net or taxes.

Here’s a final thought: In Rand’s Atlas Shrugged, the industrialists who create the real wealth of the society start to disappear as they go into hiding. The trains that make the society work, both literally and metaphorically, stop.

So I have developed what we can call the Ayn Rand test of value: If securities traders and quants at investment firms and hedge funds started to disappear in large numbers tomorrow, would the trains that comprise our economy and society run better or worse?

Sadly, each of the stages of dysfunction and misery for millions (in lost jobs, foreclosures and disappearing dreams) predicted in the book have been occurring like dominoes falling. I take no pleasure in correctly anticipating such misery. Indeed,  the book was written as a warning, not a prediction, to say this is what is most likely if our public and private institutions don’t take steps to stop growing economic inequality. Unfortunately, no one acted.

Now, with the spread of the Occupy Wall Street movement, I have received a stream of requests asking:

—What it means

—Is the country in imminent serious danger?

—How do we fix the nation’s economy and social fabric?

In response to these events, and the seemingly high public interest in my analysis, I will be releasing an ebook in the next two weeks that answers these questions. The book is titled: Making Capitalism Work for the 99%: A Manifesto.

If you would like to receive a note when the book is available, please sign up below: