The Housing and Economic Recovery Act of 2008: An Analysis by Catherine Austin Fitts
Part V – Where Is the Collateral?
Any government official asked to come up with a workout plan for troubled financial institutions, large portfolios of financial assets and liabilities, and/or places that are financially challenged first must consider all the constituencies involved. No matter what his or her goals, an official must choose from among the options available. Before we judge these individuals harshly, we must consider what we would do if we stood in the same shoes.
The challenge that U.S. Treasury Secretary Hank Paulson faces when working out the problems with Fannie Mae or Freddie Mac is that a significant number of mortgages that serve as collateral for U.S. mortgage-backed securities markets are not real. They do not exist.
The problem is not that the people who bought the house and borrowed the money cannot afford to pay it back or that the house they bought has dropped in value. If these were the problems, we would not be watching the debt the U.S. government is responsible for increase by $5 trillion dollars. We would not be watching the National Bank of Australia announce a 50% loss rate on their mortgage-backed securities.
When my company served as lead financial adviser to the Federal Housing Administration (FHA), we surveyed industry loss rates to compare them to FHA's high rate of 35%. The highest we found in the industry was 25%, and this was at the end of the last housing bubble bust, when loss rates would be expected to be high. As we due diligenced the FHA nonperforming and foreclosed portfolios, trying to understand a 35% loss rate, we started to find symptoms of fraudulent collateral practices. Indeed, we found portfolios with 50% loss rates, and the losses had nothing to do with income levels or housing prices.
Here is a story that I have told many times before:
"In 1994, after the first FHA/HUD financial audit was published, a mortgage banker came to see me. He was a serious engineering type who clearly worked hard and had mastered the details of his business. He was distressed, he said. For decades he had been keeping a tally of total outstanding FHA/HUD mortgage insurance credit. He had brought printouts of his database for me. It turned out that the government’s published financial statements showed the amount outstanding was substantially less than the actual amount outstanding. He was sure. I assumed that the guy was crazy. If what he said were true, then the U.S. Treasury and the Federal Reserve would have to be complicit in significant fraud, including securities fraud."
After I began researching HUD fraud in the late 1990s, I would be contacted by people with experience with HUD fraud. They insisted that the same home was being used to create ten or more mortgages that were placed into different pools. They alleged that Chase as the lead HUD servicer and the other big banks were implementing such systems. This was why we would see the same house default two, three, or four times in a year, they claimed. FHA mortgages had to be churned through multiple defaults to generate the cash to keep all these fraudulent pools afloat. This, they insisted, was all going to finance various secret government operations and private agendas.
This issue of collateral fraud was repeated in other markets. As I started to learn more about precious metals and the commodities markets, I would hear story after story about precious metals arrangements in which what investors really had was a bank credit—there was no bullion behind the arrangement.
I have come to believe that the allegations of mortgage collateral fraud are true—not just for FHA and Ginnie Mae at HUD but across the board throughout the mortgage markets as well.
What this means is that Freddie Mac's and Fannie Mae's obligations must be converted to what is essentially government debt. Such conversion means that investors simply don't care if the mortgages have a lien on anything real or not (at least for the time being). Otherwise, there would need to be a process by which all the defaulted mortgages can be sorted through to determine which of the mortgages are legitimate and which are not.
Creating and managing such a process would indeed crash the global financial system. It is hard for a multi-trillion-dollar financial system to maintain liquidity when contracts and laws are meaningless.
The challenge for Hank Paulson is that by increasing the national debt by $5 trillion—whether collateralized by real estate or by phony paper—he can delay the day of reckoning, but he cannot cancel it.
Only one thing can cancel the day of reckoning, and that is a return to productivity—a reengineering of resources in households and communities; a revitalization of culture, education, and markets; a rebuilding of infrastructure; an integration of new technology and new process; and a shift away from warfare, centralization, financial fraud, and organized crime and those who lead and promote it.
Hank Paulson's hands may be tied, but ours are not. Ultimately, you and I have the power to change this. So . . . who is your banker? Who is your farmer? Where is your money?
Part VI – The Tapeworm Corporation Comes Out of the Closet
President Dwight D. Eisenhower warned us about a military industrial complex. I have read that he had originally included Congress in his speech, referring in a draft to a congressional-military-industrial complex.
What he was describing was the ability of Congress to legislate private profits—to vote dollars for government purposes that would go straight through government agencies into the coffers of private corporations, and through those corporations into the pockets of corporate management and private investors.
Eisenhower must have had an inkling where this was all going when Bechtel proposed to him during his presidency that Bechtel, a private corporation, be permitted to own nuclear weapons. (See the very excellent Friends in High Places: The Bechtel Story by Laton McCartney.) As a soldier, unskilled in manipulating financial markets, I doubt he could fathom all the various methods and schemes that “the complex” has employed since that time to transfer government and household resources to corporate control.
The big mistake, of course, had preceded Eisenhower. That was the creation of the Federal Reserve System in 1913, which was to turbocharge the central banking/warfare model that had defined the Anglo-American Empire for centuries. Central banks print money to pay armies and navies. Armies and navies make sure the money is honored and that profitable markets and cheap resources are accessible. And around and around we go.
Authorizing a group of private bankers to issue our currency, hoard our financial data, and run the federal government accounts—including the Exchange Stabilization Fund, the mother of all slush funds—created a financial system engineered to advantage the large banks and financial centers at the expense of diversified production and markets. The wealth those bankers engineered into private investors' pockets during World World I and World War II institutionalized the American financial addiction to weapons purchases and defense contracts that so deeply frustrated Eisenhower.
Eisenhower was also up against the profit to be had through a second financial mechanism that supported the transfer of vast amounts of public resources into private companies—the black budget. The National Security Act of 1947 and the Central Intelligence Agency (CIA) Act of 1949 together created a way for congressional appropriations to be secretly diverted to nontransparent projects, creating a new flow of real estate, services, and supplies to be procured from private companies.
Long after Eisenhower’s warning, in 1980, an executive order expanded Executive Branch authority to outsource sensitive work to private contractors. With little or no disclosure or congressional oversight, the spigot for corporate armies and intelligence agencies was turned on full blast. Better yet, these mechanisms could be used—behind the protection of national security—to run numerous highly profitable, illegal activities. An additional benefit was technology transfer. To my knowledge, no one has ever priced out the extraordinary benefits to private corporations and investors to be paid on a risk-free basis by the government to learn and manage the most valuable technology in the world. I will bet you $1 it is a larger amount than the U.S. national debt—even after adding another $5 trillion to bail out Fannie Mae and Freddie Mac.
The best, however, was yet to come. Marry the back-door financial mechanisms with the black budget, pour money into this unholy union through federal appropriations and credit, and leverage the schemes with financial tools made possible by advanced, state-of-the-art computers and telecommunications, such as securitization and derivatives, and—voila!—you have the ability to keep thousands of corporations and banks alive, funded, and profitable despite the fact that many of them have absolutely no economic reason to exist.
Increasingly, revenues and share price of the corporations and banks in this military-industrial complex depend on more rules and regulations that guarantee them market share or drive their smaller, more efficient competitors out of business. They have the ability to trade the markets and make strategic decisions with inside information. They can use government money to take them out of their private positions and rescue them from their mistakes. Like the Joy of Cooking cookbook, the recipes for personal profit could fill hundreds of pages.
In Eisenhower’s day, one would have assumed that this state of corruption could not continue forever. At some point, the federal government’s credit would be ruined and the government would lose the ability to borrow more money. If Congress simply votes to borrow more and more money for corporations and banks and various other private interests, and that money is used in ways that are not economic—that is, they do not create the value necessary to pay back the debt—at some point, the game has to stop? Right?
Well, no, not necessarily. With enough weaponry, it can keep going so long as the folks with the weapons want it that way. Dick Cheney gave us the heads-up when he said, “Deficits don’t matter.” We just have to use force to finance more economic waste. As we steal from the healthy to finance the unhealthy, there is more death—of people, healthy enterprises, communities, animal species, and our environment. The more we steal, the more dependent on stealing we become, which means the more we need to steal. The more that success at stealing (as opposed to productivity) defines the winners, the more people and organizations convert to stealing or to investing in those who do. It is the spiral down, not of markets but of life. It is, as one astute commentator on the environmental aspects described, “the death of birth.”
So what has evolved is a corporate and banking model to run the planet that has no connection whatsoever to fundamental economics or business. It is not efficient, it is not transparent, it does not compete, and it is not productive. It has absolutely nothing to do with capitalism or free markets or free enterprise—although it claims these words for branding purposes. It has the economic benefit of fantastic increases in productivity from technology, all of which have been incorporated within its control without helping the model achieve basic productivity or overall sustainability. Technology has made the corporation a more powerful financial vacuum cleaner rather than a source of real wealth. For several years, I have referred to this model as an integral part of Tapeworm economics. So, for easy reference, let's refer to the model as a "Tapeworm corporation."
The Tapeworm corporation works like this: Working alone or with others in a trade group, the Tapeworm corporation arranges for its well-paid lobbyists to write and legislate new government regulations and laws that guarantee it a market or market share. The lobbyist and various beneficiaries of the corporations' largesse fund the campaign contributions that help make the system go. The corporation gets government contracts, often on a no-bid,"cost-plus" basis, which guarantees profits and encourages overspending. The corporation may also make government purchases or receive industry-wide subsidies that also generate revenues or tax exemptions and benefits that shelter income. It uses government credit to attract and command global capital at low cost. The astute participant in this system can even use government enforcement to wipe out its competitors. In the worst cases, honest and ethical people in their way are forced out, harassed, or killed.
Let's say our corporation loses money. If it is a financial institution, it simply has the government or the central bank arrange more borrowings that can be loaned back to the government at a built-in profit or, in the worst instances, bail it out using the "too big to fail" justification. If it is a defense contractor, more contracts and purchases can be arranged. In all cases, our corporation enjoys government intervention to prop up its stock prices and debt in the open market, ensuring it a significantly lower cost of capital. The resulting profits fund rich compensation to hire the best and brightest people, field lots of lobbyists to keep the gravy train going, and pour money into the coffers of foundations, universities, and not-for-profits that provide affirmation of the corporate credibility. Our corporation and its leaders are great philanthropists!
A simple, clear picture of the real workings of this Tapeworm model has been challenging to communicate. The model has been obscured by an enormous amount of legal and operational complexity and financial engineering. A great deal of time and effort, financed by those who most benefited, was spent spinning the illusion that the Tapeworm corporation was efficient and productive. And, in all fairness to those who have served as corporate apologists, some of what was going on was hidden behind the nontransparency of national security law and covert operations and money laundering. For those who want a detailed case study, see “Dillon, Read & Co. Inc. and the Aristocracy of Stock Profits.”
The average person could not believe that the largest, most prestigious Wall Street banks and investment houses were engaged with Washington in managing the largest capital market in the world—the U.S. mortgage markets—on a criminal basis.
That was too much to swallow.
The real model has come out of the closet. Whereas the last year of Wall Street bailouts were making things clearer, the Housing and Economic Recovery Act of 2008 now leaves no room for doubt. The Act could not be more blunt about infinite government subsidy funded with infinite debt benefiting the private few. The Tapeworm corporation is fully engorged.
The American taxpayers are, in essence, guaranteeing $5 trillion of Fannie Mae and Freddie Mac debt. The Federal Reserve stands by to subsidize Fannie's and Freddie's stock in the stock market. Fannie and Freddie continue to pay dividends to their shareholders. All the profit goes to the shareholders and management. The taxpayers get no compensation or payback for saving all of Fannie and Freddie’s equity and essentially guaranteeing their income. The management of Fannie and Freddie get to keep all their compensation and bonuses. They get to spend as much as they want on more lobbyists and law firms. They and their foundations can continue to hand out money to universities and not-for-profits.
This all ensures that Fannie Mae and Freddie Mac can continue to use the federal credit to centralize and control the U.S. mortgage market.
What Fannie Mae and Freddie Mac do get is a new regulator. After reading the scope of work for the new regulator outlined in the Act, it is not clear to me what authority and scope is left for their board of directors. The boards essentially have all liability and no power. The management must do whatever the regulator says, and the regulator has the ability to micromanage no end, checked only by a Congress that can also micromanage no end. We can reasonably expect Fannie Mae's and Freddie Mac's payrolls and partnerships to continue to expand with their market share. A lot of constituencies are likely to get fed from this new back-door spigot.
But perhaps that is only fair. After all, the federal government represents a source of infinite capital that—unlike pesky shareholders—requires no return. The government only requires that you do whatever they say, pay their friends, and send financing and profit wherever they tell you.
The out-of-the-closet Tapeworm corporation is a more powerful, sophisticated version of the old Tapeworm corporations that were common in Washington housing circles—the HUD property management companies that were sometimes referred to as CIA or Department of Justice (DOJ) “proprietaries.” The management would talk as if they were in charge. The investors would talk as if they were in charge. And the folks from the CIA would talk as if they were really in charge. At the mercy of this invisible matrix structure, the old-style HUD property management company lacked clarity on missions or decisions, and the resulting culture was confused and unproductive at best. It all left you scratching your head wondering who “they” really were.
The housing bill has put forward the most explicit description yet of the true corporate model prevailing in America—congressionally legislated businesses with central-bank-determined stock prices.
It is a fascinating combination of friendly fascism and multiple personality disorder. Now that the fundamental nature of the Tapeworm corporation is out of the closet and clear, keeping it afloat will require a mind-numbing combination of global force to maintain financial liquidity, plus global propaganda and payola to preserve its brand.
In 1994, I was deep in conversation with a technologist who managed our server security and firewalls for my investment bank. We started to talk about what would happen as the explosion in information and communications technology increased the learning metabolism within the economy. At one point, he got up to call a physicist he knew at Lawrence Livermore Laboratory to ask him what happened when the learning metabolism rose in a system. After conversing with the physicist, he returned with this warning. "He said, 'When the metabolism rises, the rate of entropy increases.'”
Mapping The Real Deal is a column on Scoop supervised by Catherine Austin Fitts. Ms Fitts is the President of Solari, Inc. http://www.solari.com/. Ms. Fitts is the former Assistant Secretary of Housing-Federal Housing Commissioner during the first Bush Administration, a former managing director and member of the board of directors of Dillon Read & Co. Inc. and President of The Hamilton Securities Group, Inc.