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Dismantling consumer protection – a history

Jon Brooks — Mon, 05 Apr 2010 17:38:06 +0000

“Federal regulatory functions all had become dominated by political pressure from the providers of services promulgating ‘free markets’ and ‘lifting the regulatory burden’, greased by millions of dollars of campaign contributions and lobbying.”

One of the sticking points in the Senate in enacting the financial reform bill is the creation of a new consumer financial protection agency, which Republicans have ardently opposed.

This post by former World Bank and Federal Reserve economist Barbara N. Opper, on the financial sector policy blog Finance: Facts and Follies, summarizes the dismantling of consumer protections in the mortgage and credit card industries in the 2000s.

Many of the steps violating unsophisticated consumers’ protections against predatory lending came from a cascade of federal, not state, regulatory actions and legislation.

The financial industry’s influence on Washington, evident in the late 1980s when Alan Greenspan went to Chair the Fed, gained momentum between 2000 and 2008 when the industry ‘captured’ the administration and Congress. Investors sophisticated or not lost protection, as did consumers, especially the unsophisticated. As the famous post-Napoleon expression goes, this was “worse than a crime it was a blunder” because US financial institutions’ ability to attract profitable business worldwide rested on the trust that had been the outcome of our once-effective regulation.

To set the stage, in the 1970s a lot of consumer protection came into place. States enacted “Truth in Lending Laws” and the Fed was to handle consumer protections related to bank lending. By then, 64% of residents owned their homes, financed by self-amortizing home mortgages most of which carried fixed rates. With regulators enforcing strict underwriting standards, delinquency and foreclosure rates were very low. Credit cards were issued only to those with very strong credit records.

So when we started hearing about consumers being lured into very disadvantageous credit card and mortgage loans, it was reasonable to ask how so much predatory lending could prevail against Truth in Lending and other consumer protection in place. The answer is two rulings from the Office of the Comptroller of the Currency (OCC). One in 2003 prohibited states from enforcing their own truth in lending laws. Eliot Spitzer, former NY State Attorney General, said “Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye … all 50 state attorneys general and all 50 state banking superintendents actively fought the new rules.” It took until June 29, 2009 for the U.S. Supreme Court to rule in favor of the states. The other, in 2004, prohibited state bank supervisors from inspecting, supervising and overseeing national banks located in their state.

The impact of this regulatory approach on the examination and supervision functions should not be ignored. Examiners used to look at samplings of loan underwriting that would have caught “liars’ loans”, no-down-payment loans, wishful thinking property valuations, and other abuses of the go-go-mortgage lending years from 2003 to 2008. Instead, they focused more on the way banks handled Bank Secrecy Act and Patriot Act laws monitoring customer transactions.

Between 2000 and 2008, the economy was stagnating. Encouraging consumption with ready access to debt evidently turned into a policy tool to maintain economic growth. Household debt doubled. That growth was fueled not just by mortgages but also by credit card use as federal regulators looked the other way while credit cards were issued to youth and other elements of the population ill-equipped to handle such ‘easy’ credit. By then, states could not effectively offset federal regulators’ inaction because of the OCC rulings and the domination of the banking industry by national banks. Also, interest-sensitive home building with its collateral durable goods purchases is always a standard Fed policy tool. With more-than-accommodative monetary policy and lax underwriting standards, home property values rose at a pace never before seen. This was the kind of bubble the Fed was created to prevent. It was possible to track GDP growth with and without consumption fueled by home-equity draws.

Securitization was once a reasonable approach to improving the marketability of a home mortgage portfolio but it became destructive. One reason is lenders’ eliminating the free prepayment option to improve predictability of the payment stream for the investor. That removed a long-standing valuable right of borrowers, especially those who woke up too late to the predatory terms of their mortgages.

Many criticize the patchwork of overlapping banking regulatory authority involving several federal agencies and the state where a bank did business. But these two OCC rulings show the value of that overlap. Federal regulatory functions all had become dominated by political pressure from the providers of services promulgating ‘free markets’ and ‘lifting the regulatory burden’, greased by millions of dollars of campaign contributions and lobbying. If it had not been for these two OCC rulings, state authorities could have prevented the predatory terms foisted on unwitting borrowers.

The United States system had been designed by people who understood the dangers of concentration of wealth and power, moral hazard, conflict of interest and self dealing. It was a lesson learned from the Pecora hearings, and is the lesson to be relearned by the Angelides Commission.

U.S. debt – follow the numbers

Jon Brooks — Fri, 22 Jan 2010 18:36:28 +0000

I don’t pretend to understand what all the numbers on this US. National Debt Clock mean, but I will give you one impression I have: They don’t look good. Especially when you click on the snapshot below and see the numbers actually moving in one direction: up.

For some perspective, however, look at the following chart,from ZFacts.com. It shows the debt as a percentage of GDP, from about a year ago. Still not good, but only about 2/3 of what it was immediately after WW II.

On the other hand, a lot of the money from those years went toward defeating the Nazis and Imperial Japan. This time, the enemy — who and what it was is still being debated — seemed to come from within.

Maybe when the crisis is officially over, we’ll have a V-G Day. Victory Over Greed.

Now that’s inflation

Jon Brooks — Wed, 06 Jan 2010 00:15:29 +0000

There’s a school of thought out there that holds that the policies of the Fed and the Treasury, while perhaps preventing a full-blown economic depression, are sooner or later going to lead to massive inflation.

Even if that’s true, one would hope the situation won’t spin as out of control as it has in hyperinflationary Zimbabwe. Take, for instance, the country’s $100 Trillion bank note, which it introduced about a year ago.

The bill is available for purchase for $7.99 (or about $25 trillion Zimbabwe dollars, give or take a few trillion) from Capitalistpig Asset Management.

The Crisis of Credit Visualized

Jon Brooks — Thu, 29 Oct 2009 17:24:10 +0000

Here’s an excellent summary of the esoteric concepts and arcane financial instruments that contributed to the near collapse of the entire system last year. Created by designer Jonathan Jarvis as part of his thesis work.

Part 1

Part 2

Who are the Gold Bugs?

Jon Brooks — Tue, 08 Sep 2009 21:58:16 +0000

The price of gold rushed past $1000 per ounce today, sending it within glittering distance of last year’s record high before profit-taking ate into gains. But the breach of the psychological $1000 barrier has put a sparkle into the eyes of those who have been accumulating the precious metal, and has them looking for more profits soon. Why? From Reuters:

Some investors also saw the spike in gold as a warning signal to stock market bulls who have the result of central banks and governments pumping billions of dollars into banking systems to boost growth.

Ah. That single wire-story paragraph stands as the world’s greatest understatement for those dubbed “Gold Bugs.” Investopedia clues us in:

Gold bugs view gold as a safe investment that will protect them from currency fluctuations or downturns in the financial markets. Although gold is widely known as a standard of value, its price – like that of any other precious metal or commodity – fluctuates widely… This is a point frequently brought up by critics, who view gold as a standard of wealth from the past.

However, while there is no consensus, the market does continue to view gold as the traditional “safe harbor” during times of economic crisis. For example, following September 11, 2001, gold prices saw sharp increases as investors sold what they believed were riskier assets.

The core belief of the gold bug: Paper currency — so-called “fiat money” like the dollar or the euro — will eventually prove, unless you’re a paper-eating termite, worthless. From the Safe Haven blog:

A genuine gold bug is a person who is emboldened by knowing that 4,000 years of continuous economic history proves that EVERY fiat currency has failed, as they will always fail, and that gold will rise, just like it always has, because people have always turned to it as a last resort against losing everything that is still denominated in the depreciating currency! It’s a 100% guarantee! How can you NOT be bullish?

From the post “Gold is a currency you can rely on“on Gold Eagle:

Paper money, we all know, is a terrible store of value. The U.S. Dollar has been losing value rapidly ever since we severed our link to a true Gold standard. Let me give you an example of the difference between Gold and paper money over the long haul. Let’s say you had $100 worth of U.S. paper Dollars in 1930 and $100 worth of Gold at 1930 prices. Today, you would still have $100 in nominal U.S. Dollars, but it would buy much, much less in actual goods than it did in 1930. The Gold, however, could be traded in for slightly more than $4800 U.S. Dollars today…

But Gold hasn’t changed over the years, hasn’t grown, hasn’t paid dividends and hasn’t increased in its intrinsic value. Gold essentially has not become more valuable, paper fiat Dollars have become less valuable.

To the Gold Bug, government’s Original Sin occurred when Nixon took the U.S. off the gold standard in 1971, and only a return to that system can redeem the country economically. Only the gold standard can defeat the bankers who pull the strings and wreak financial havoc at the expense of the populace. From a typically prolix Gold Bug post called “Gold Wars: The Return of the Gold Standard“:

The ultimate defeat of the Western banking cabal can only be accomplished by reinstating a precious metals “standard” (or backing) for the global monetary system….While 21st century bankers like to pretend that they are great “innovators”, and claim that they have created a “modern” financial system which is a necessary ingredient of our high-tech society, the reality is that they are playing the exact same game they have been playing for thousands of years.

The modus operandi of the classic bankers’ scam is always the same. First they ingratiate themselves upon the rulers of a particular society by claiming that they provide a useful, if not essential service: they exchange paper “IOU’s” for gold and silver coins, replacing heavy, bulky coins with their near-weightless scraps of paper.

Originally, the scraps of paper are treated strictly as claim-stubs for the gold and silver of the original holders. However, as a society becomes more familiar with these scraps of paper, people begin using the scraps of paper for trade – as proxies for gold and silver.

As this practice increases in popularity, the gold and silver being held by the bankers as custodians is redeemed less and less often, because people simply keep swapping the scraps of paper between themselves….and, for over two thousand years the greed of bankers has caused them to take their “business” a step further: they begin creating more “IOU’s” for gold and silver than what was deposited with them.

Having been lured by the convenience of paper “money”, the people don’t even notice that bankers have begun “creating money out of thin air”. While nothing can dilute the original value of the gold and silver deposited (and hoarded) amongst the bankers, as the number of bankers’ notes in circulation increases – without any underlying increase in the wealth which backs the paper – the value of each note inevitably declines.

This is the true origin of “inflation”: increasing or “inflating” the money-supply devalues the currency, causing the nominal price for goods to increase.

That conspiratorial strain runs through all the Gold Bug literature. From the Safe Haven post:

I also know that there is a concerted, coordinated effort on the part of central banks, the International Monetary Fund, the Bank for International Settlements and many others to restrain the price of gold, as they have actually admitted over and over again, and thus the price of gold is artificially low.

And goldbug Howard S. Katz on the Gold Eagle site, writes:

Pretty much every newspaper, news magazine and TV news show is lying to you…screaming one word at you: “deflation.” Whether they use the words “Great Depression,” “Great Recession,” “economic crisis,” or whatever, the message is the same. Prices are going down…

The Gold Bugs do not believe that prices are going down. They believe that the pumping of so much new money into the economy by the Fed will create rampant inflation, a circumstance that has traditionally caused a flight to gold. Katz:

The only times that prices changed by any significant amount were times that government changed the money supply. When the money supply was increased, prices went up. When the money supply was decreased, prices went down….Through the autumn of 2008, the monetary base increased by a trillion dollars. As this money flows into the private banks, they will get a chance to create additional money on this base, and the regular money supply will increase by even more.

This $1 trillion represents a 70% increase on the money supply over a year ago… Unless there is a radical change in announced policy, the money supply of the U.S. will multiply by 4 times over the next 4-6 years.

What will happen to people who flew to “safety” by buying T-bills and T-bonds in the recent crisis? In 2014, they will be sitting with fixed income investments worth ¼ as much (in buying power) as they are now. What will happen to people who put their assets into gold and gold stocks? They will be ahead of the game as the investing public rushes into gold (as it did in 1979).

To the layman who watched helplessly last year as the banking system appeared to teeter on the verge of collapse, this all sounds quite plausible and impressive. More impressive than Katz’s resume, anyway, which he prominently highlights at the top of his blog:

“Howard S. Katz is a well known gold bug and author of four self-published books on money, the gold standard and politics. He also edits an investment newsletter on gold and gold stocks called The One-handed Economist.”

But that lack of institutional pedigree is no stigma for Gold Bugs, who believe the training of mainstream economists to be poisoned by the Keynesian establishment. From Katz:

This same establishment decided in September 2008 that all prices were going down. They filled the newspapers and the air waves with predictions of a dire “deflation.” …No, the problem is not that prices are going down….The problem is that prices are going up. The problem is that people believe this nonsense from these well-known sources.

Meanwhile a giant increase in commodity prices will gradually unfold, one aspect of which will be a great food shortage which will make spring 2008 look like a picnic…

So what to do? Well, you could buy some, uh…gold. From another editorial by Katz:

…the American public has no concept of how bad things are and what they need to do to protect themselves. This gives you a historical opportunity. You have the chance to buy gold while it is still cheap. People will say to you, “You bought gold under $1000? Boy, I wish I had done that.”

And this from Bob’s Gold Price Column:

Looking at how fast the US government and the Fed are creating fiat tokens (US dollars) out of thin air, it pays to measure your gains with something more related to reality like gold or silver, the classic measuring sticks for the last 5,000 years or so…

The combination of the US Treasury and the Fed have created extra dollars and made payments, extra guarantees and extra future promises of payments of over 13 trillion dollars in less than a year…Eventually, this has baked into the cake roughly 50% future devaluation of the US dollar. And, it looks like this is just for starters.

Not to worry too much (some worry is justified as a really high gold price means some bad things are going to happen on the ground) for those already properly positioned. “There is no rush like a gold rush”. Gold looks like it is a month or two away from heading on up into new high territory.

Sounds pretty simple. But what does a mainstream economist like, say, Paul Krugman think of the Gold Bugs and their theories? Well, in a nutshell, to quote the Nobel Prize winner, “the ideas of our modern gold bugs are completely crazy. Their belief in gold is…not pragmatic but mystical.”

On the other hand, if you bought gold at under $300 ounce in the early years of the decade, maybe you’re not so sure…

Who was Elbridge G. Spaulding?

Jon Brooks — Sat, 05 Sep 2009 01:30:27 +0000

You know the answer to that if you happened to catch Floyd Norris’s column in the New York Times today:

“It was he who, at the end of 1861, figured out that the American government simply needed to print money to pay for the Civil War. It was economic heresy then, but without it this country might not have survived. Such an idea was then dismissed by some as “fiat money,” money that is money not because it is backed by gold or silver, but because some government says it is money.”

While that makes Spaulding a hero to some, it may also render him the moral equivalent of Satan to those who object to the trillions of new dollars the government’s printing presses are working so hard to generate. But for our purposes, the most outstanding thing about Spaulding is that his book relating to that period in history is available for free online. Check out the complete and unpithily titled History of the legal tender paper money issued during the great rebellion, being a loan without interest and a national currency at the Internet Archive or Google Books.

And tell ‘em Ben Bernanke sent you…

With apologies to Elton John

Jon Brooks — Fri, 28 Aug 2009 18:46:05 +0000

B-B-Bernanke & The Fed