Down the Up Escalator (14 page)

I’m afraid I’m going to have to define a couple of financial terms in order to explain what Dizard found so surprising.

People who buy bonds normally insure them against default. The credit-default swap, CDS, or simply “swap,” that Dizard is surprised to see trading again is a special form of insurance.

An insurance company like AIG says to an investor, perhaps a pension fund, “You pay us $7,000 a month, and if you fail to receive the full interest on that mortgage-backed bond for, say two months, then we’ll buy the whole bond from you for the $200 million you paid for it.”

They couch it in those terms instead of writing a straight insurance policy because insurance is regulated. When AIG sells insurance, it’s required to put aside a small amount in reserve in case any of the hazards it insured against occur. But this is a private, custom-written agreement to “swap” a worthless bond for money in case of default.

The first thing bugging the columnist John Dizard is that the U.S. Treasury, under Timothy Geithner, decided to make good on these unregulated non-insurance policies even though AIG had been flouting insurance regulation. The costs of covering these swap obligations were potentially enormous because they involved most of the mortgages in the United States.

But here’s something even more shocking. You don’t have to own the mortgage bonds to buy the swap/insurance on them.

Any “investor” can go to AIG and say, “You know that Merrill asset-backed bond number 123456? I
too
will pay you $7,000 a month, and if the bond defaults, you’ll owe
me
$200 million also.”

It’s as if any number of people could buy life insurance on the same individual.

If our government was merely going to cover the policies on the original mortgage-backed securities, the maximum payout, though large, was at least calculable. If 80 percent of the mortgages in the United States have been securitized and if a quarter of them eventually default, that’s a vast but finite loss.

But any number of people could have bought swaps on the same bonds, related distantly to the same mortgages. So the swap payouts could be many times the value of the real houses. How many times reality will it eventually come to? Two times, ten times, a hundred times? We don’t know, because swap trading was (and still is) unregulated. There’s no derivatives exchange that, like a stock exchange, keeps track of transactions. (Regulation of this trade is still “pending.”)

Not only are swap losses potentially humongous, but the “investment” has nothing to do with anything in the real world. Neither party to these “me too” swaps owns, builds, or finances housing or anything else. Both parties are simply betting on whether a certain group of people will pay their mortgage bills. And, of course, a life insurance policy beneficiary with no relation to the individual insured has an interest in finding the sickest individuals and shortening the life span of those who linger too long. Some of these people were also in a position to create the most unhealthy mortgages and mortgage bonds.

It’s the ultimate example of Phil Angelides’s “money making money” or Russell Wynn’s “spinning stuff.” That’s why Dizard called it “vampiric.” It’s something dead feeding on the blood of the living economy.

And according to Dizard, speculators are actively trading these
and other debt derivatives again. So my missing unemployed man isn’t just cleaning up old messes. He’s busy making new ones!

But why are rich people reviving this market and fighting any attempt to regulate it? Aren’t they scared of it too? Let me quote Dizard’s column once more:

“No
demand for the products of real capital spending
.” That means you can’t invest your money in a productive business because there aren’t enough buyers for the additional products or services they’d make. That doesn’t mean there isn’t enough need or desire. In economics “demand” means desire backed with money. There’s insufficient demand when people aren’t earning enough to buy back what they produce.

But in the absence of action in the real world, folks with money have to put it somewhere. The last time a big bookie, AIG, went broke, the U.S. Treasury decided to make good on all its uninsured, unregulated markers. So of course everyone is returning to the track on the assumption that it will do so again. By strengthening the assumption that there’s no real risk, the government is fostering what is called moral hazard.

The lawyer representing those Lehman Brothers traders wasn’t lying to me. The guys who lost jobs at one off-track betting parlor
were immediately snapped up by another. My mysteriously missing unemployed man has been sitting at a trading desk all this time.

Way up on a high floor he’s still spinning old asset-backed securities, new securities made of bundles of the defaulted old bonds, swaps to insure them, bets on the swaps, and ever higher, more “derived” financial products.

Meanwhile, many levels of abstraction below, we can make out tiny houses with ant-sized people at the windows and barely visible “For Sale” signs on the lawns. Those are the “assets” these asset-backed securities are ultimately backed by. As we get closer, we can see that the ants are agitated. For though the highest-level lenders were relieved of their risks, the ground-level borrowers still owe as much as ever. In many cases it’s more than they can pay.

When I contacted people who faced recession-related home loss, I found that I could understand the mortgage crisis best by arranging their stories in order of their escalating difficulties. So we’ll start with someone who merely fell behind and work our way up (or down) to foreclosure and eviction.

Buying Them Time

At the start of the Great Recession, I heard that you could stop an eviction by demanding to see the mortgage. The notion gained currency because of the way that mortgages passed from owner to owner until they were bundled by the tens or even hundreds of thousands into mortgage-backed securities. Some investors collected only the principal payments from these mortgages, others only the interest payments. So who holds the mortgages themselves?

According to instant urban lore, the original mortgages were often misfiled, physically lost, or impossible to tie to particular investors. So when they knock on the door to evict you, you say, “Howdy, Sheriff. I’m a law-abiding citizen, but I don’t think those people own this house. I’ll leave as soon as you
show me the mortgage
.”

I’d heard it from community organizers; I’d heard it from lawyers; I’d even heard a congresswoman instruct her constituents, on network television, to demand to see the mortgage when they come to take your house. I hadn’t heard of anyone who succeeded. As a matter of fact, I hadn’t located anyone who actually tried it. That remained true even after the robo-signing scandal of 2010 exposed
the fact that clerks at mortgage companies signed hundreds of foreclosure papers a day without checking the original mortgage documents whose existence and terms they swore to. But way before that scandal I heard about a judge who seemed to be saying something similar to “show me the mortgage” in his courtroom.

The housing bust was relatively mild in New York City, but from its beginning the Brooklyn judge Arthur M. Schack developed a reputation for standing up to banks and thwarting foreclosures. In his 2007 decision in
Deutsche Bank National Trust Company v. Castellanos
, he quoted George Bailey (Jimmy Stewart) confronting the evil banker Mr. Potter (Lionel Barrymore) of
It’s a Wonderful Life:

Schack had been a lawyer for the Baseball Players Association—“I represented millionaires against billionaires”—before he became a Kings County Supreme Court judge. At five feet five inches and two hundred pounds, he looked, on the bench, like one of those Russian stacking dolls. “The third or fourth doll in,” I thought as I followed behind him into his chambers.

By the time I met him in 2009, more than thirty of Judge Schack’s decisions were linked to on a Web site called the Home Equity Theft Reporter. So I was ready to hear some radical talk about reversing that theft. But the most Judge Schack would say
to me about his judicial philosophy was “I try to buy the little guy some time.”

Here’s how he did that.

In Florida the legislature set up special “rocket docket” foreclosure courts, hiring retired judges to get through the backlog. At the time, courts in Fort Myers, Florida, were handling a thousand foreclosure actions a day. Most of them received as much judicial time as it took to apply a stamp or a signature where the bank needed it. (Fewer than half the states in the Union even require a judicial signature to foreclose. New York and Florida are among the states that do.)

When homeowners actually appeared in court, one Fort Myers judge permitted them to answer only two questions: “Are you living in the home?” “Are you current on your mortgage?”

Brooklyn’s housing caseload wasn’t nearly as high. Still, foreclosures accounted for about 30 percent of the Kings County Supreme Court’s docket. That didn’t stop the judge from applying an unusual procedure. When Judge Schack gets a foreclosure application, he betrays his bias toward the little guy by actually reading it. If it’s full of errors, he denies the foreclosure until the papers are cleaned up.

The chubby judge swiveled toward the teetering piles of documents on his windowsill and pulled out three examples while somehow leaving the stacks standing.

“This one …” He handed me papers on a ghetto walk-up that had been foreclosed. “But no one from the bank told the tenants, so the former landlord kept showing up for over a year to collect the rent.”

The most recent tenant had found her apartment on Craigslist, the judge told me. “She paid $3,000—one month’s rent and a
month’s security—to a scam artist.” For the tenants’ sake, Judge Schack delayed clearing the building for ninety days.

The second case Judge Schack pulled out concerned a man named Jonas Earl who lived on a block of single-family houses near my old high school, James Madison in Flatbush. The neighborhood was now black and Russian and still solidly middle-middle class. In 2006, Earl had taken out a $375,000 loan against his house with Contour Mortgage Corporation, which sold his note to a loan company called Option One. (Hold on to that name.)

Option One passed Earl’s debt along to other financial institutions until it finally became part of the asset-backed certificate 2006-OPT
₄
, managed by Deutsche Bank. But Judge Schack (remember, he actually reads these papers) noticed that the first transfer in the chain occurred
a day before
Earl signed for his loan. “Nonexistent mortgages and notes are incapable of assignment,” the judge said, throwing the case out “with prejudice.”

“Does that mean he gets to keep the house,” I asked, “and they’d just be out that cash?”

Judge Schack laughed, perhaps at the way I’d suddenly reversed sides at the idea of a real “little guy” walking away with 375,000 real dollars. But all the judge would say about his decision was “I bought him some time.”

“But what if Contour and Option One can’t find the correctly dated paperwork?” And I told him about the myth I still cherished: “The sheriff comes to Earl’s door, and he says, ‘Of course, sir, but first show me the note I signed.’ ”

“Like the silent movies,” the judge said, kidding me. “
Perils of Pauline
. The guy with the black mustache forecloses on the mortgage and ties her to the railroad track, but our hero comes along and …”

“Yes,” I had to admit. That’s what I’d hoped was going on in his courtroom.

Judge Schack had never heard of any case where they “lost” the mortgage. He explained that all mortgages are registered immediately by the block and lot. “Things may get messy as the debt passes from brokers to banks to investor trusts and back to the bank or some mortgage servicer to handle. Then you might sometimes find that bank X doesn’t own it but bank Y does. It can get murky, that’s the word you should use, ‘murky.’ But in New York you need a judge to approve a foreclosure, so they have to establish who owns it
before
the sheriff comes to your door.”

Judge Schack’s “little guy” decisions merely required that the banks establish things properly.

“Here’s a good one …” The final decision Schack showed me opened with a quotation from Gretchen Morgenson in the
New York Times
Sunday business section:

Schack had extended Morgenson’s “show” metaphor in the foreclosure action against Susana Elsemeer: