Callahan’s Cleveland Diary

Last night we learned that the Chairman of the Federal Reserve and the Secretary of the Treasury want to create a new Resolution Trust Corporation to take billions and billions of dollars worth of “illiquid mortage-related assets” off the hands of the banking industry. They’re going to “work through the weekend” to have the whole plan on Congress’ desk Monday morning.

Today we learn that the bailout they have in mind is going to cost at least “hundreds of billions”, or maybe $500 billion to a trillion, or maybe “an $800 billion fund to purchase so-called failed assets and a separate $400 billion pool at the Federal Deposit Insurance Corporation to insure investors in money-market funds.” And we learned that the Treasury Secretary has started calling it a “troubled asset recovery program”, or TARP, rather than an RTC… which is appropriate, as Calculated Risk points out, because “the TARP is intended to cover all of Wall Street’s sins.”

Outrageous as it sounds, it seems clear that this is going to happen. (Now that it’s been proposed and the Treasury and Fed have said it’s urgently needed, can you imagine the financial-market bloodbath that will ensue if it doesn’t? Not to mention this nonsense.) So communities on the ass end of this crisis, like Cleveland, had better act quickly to make sure the TARP is designed to help recover our troubled assets, too.

Train’s leaving. Everybody on board.

One predictable demand from liberal and urban Dems is money: “We’re going to spend hundreds of billions bailing out big corporations and wealthy investors, so why not demand more billions for green energy / unemployment extension / state Medicare costs / the Cities?“  (Case in point, Yglesias.)

The other predictable demand is some minor regulatory reform: “How can we bail these sleazeballs out and not fix the system that allowed them to create this mess?”

Now if we had a shot at rebudgeting an extra $100 billion toward impacted cities, or reinstating the Glass-Steagall Act (new and improved for the era of loan securitization and derivatives), I might support this kind of thinking. But we don’t. Major progressive change of any kind is going to take more than a week or two of bargaining over something your own leaders want to pass anyway. It’s going to take winning the election, for starters. Until that happens, whatever money or new regulation liberals can pry out of this situation will be symbolic.

What urban representatives and progressives (and others who care about cities and poor people) need to focus on is the deal itself. Specifically, we need to focus on what the banks must give in order to get the TARP to take over their problems, and on what the TARP will be able and required to do with the real-world assets (i.e. houses) at the heart of this transaction.

Jim Rokakis is fond of pointing out that nobody cared when financial blood was running in the streets of Cleveland, but now that blood is running in Wall Street it’s a national crisis. The deal that stops the bleeding on Wall Street and gives the banks a new start must do the same for the streets of Cleveland, Detroit, Cincinnati and Chicago.

So here’s what I have on my bargaining agenda. Sherrod and Dennis, this is for you (and you, too, George).

1. To start with, everything must be on the table. If you’re a bank or investment house that dug yourself into a hole through reckless and often predatory business practices, and now you want the taxpayers to put up billions to buy you out of that hole, we have a right to ask for virtually anything in return. If you don’t like the price, don’t take the bailout. Simple as that.

2. If a bank wants TARP intervention, its foreclosures must stop now. If it’s in court, withdraw the case; if it’s waiting for the sheriff’s sale, cancel it. When we know who’s going to end up owning that mortgage — the bank or the TARP — then that party can decide what to do about it. Till then, full stop.

3. If a bank wants TARP intervention, its bulk sales and auctions of foreclosed properties to speculators must stop now.  A house that’s worth a thousand dollars to the bank may be worth a lot more to the TARP and the community.  We should require the bank to preserve that asset.

4. In managing any mortgage-related assets it acquires, the TARP’s guiding principles (laid out explicitly in the law) should be:

• avoidance of foreclosures on owner-occupied homes;
• fair renegotiation of mortgages as needed to preserve both home ownership and equity;
• keeping current residents, including tenants, in their homes even when foreclosure is necessary;
• managing and disposing of foreclosed properties in a manner consistent with community preservation.

5. To make sure it’s in a position to act on those principles, the TARP should refuse to take over any mortgage-related asset unless the terms of acquisition give it full management control of the underlying mortgage(s). This seems obvious, but in reality it’s not obvious at all. Here’s why:

There are two basic categories of “illiquid mortgage-related assets” that the TARP might agree to acquire. The first is actual mortgages held by the institutions in their own portfolios. The second category — probably much bigger and more problematic — is mortgage-based securities (MBS).

It’s easy to see how the TARP could take over the management, workout and disposition of regular unsecuritized mortgages, just as the original RTC did. But those unsecuritized mortgages aren’t a very big factor in the foreclosure crisis.

It’s much harder to see how the TARP will manage the institutions’ mortgage-based securities in order to minimize foreclosures, keep people in their homes, etc. That’s because the owner of an MBS doesn’t actually own any of the underlying mortgages — only an equity share in a security issued by a pooling entity (e.g. a trust) for which “control” is divided among various contract players, i.e. the trustee, the master servicer, etc. So just taking control of a bank’s nonperforming MBSes won’t give the TARP any real management authority over the mortgages (and homes) they represent.

So Congress must make this crystal clear: If Morgan Stanley comes to the TARP with a few billion dollars work of junk mortgage-based securities it wants to dump, it must also bring all the necessary agreements from other investors and partners in the investment pool to let the TARP take full control of the underlying mortgages. (This is normally the role of the pool’s “master servicer”.) Otherwise, no sale.

6. The TARP should get no Federal-agency exemption from local housing codes. Foreclosed properties now controlled by Federal agencies (HUD, VA) are exempt from municipal enforcement of building and housing codes. This creates a huge problem for Cleveland and other cities that have to deal with  hundreds of vacant HUD houses. Acquisition of thousands of foreclosed properties by a Federal TARP could make this problem twice as huge. The Congress should make sure the TARP, as a property owner, is subject to all applicable state and local laws and regulations.

I’m not suggesting these should be the only things our legislators seek in return for the biggest corporate bailout in history.  But they’re very important things for Cleveland, Cuyahoga County and other areas that have taken the losses from the subprime securitization racket for many years, while the banks and investment houses piled up the gains. A Troubled Asset Recovery Program that used its bailout leverage to bring foreclosures to a halt, restructure mortgages, keep residents in their houses, preserve foreclosed houses from the “bottom feeder” aftermarket and help get them into community-friendly markets — that kind of TARP could be an important new strategic partner for our city and county.

Of course a big hit of that bailout money would help a lot, too.

This entry was posted on Friday, September 19th, 2008 at 10:39 pm and is filed under Economics, Foreclosure crisis, Poor Cleveland. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.