Author Topic: I Saw the Crisis Coming. Why Didn’t the Fed? from the NY Times  (Read 1548 times)

Offline Reginald Hudlin

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I Saw the Crisis Coming. Why Didn’t the Fed?

Published: April 3, 2010
Cupertino, Calif.

ALAN GREENSPAN, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. “Everybody missed it,” he said, “academia, the Federal Reserve, all regulators.”

But that is not how I remember it. Back in 2005 and 2006, I argued as forcefully as I could, in letters to clients of my investment firm, Scion Capital, that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy. My prediction was based on my research into the residential mortgage market and mortgage-backed securities. After studying the regulatory filings related to those securities, I waited for the lenders to offer the most risky mortgages conceivable to the least qualified buyers. I knew that would mark the beginning of the end of the housing bubble; it would mean that prices had risen — with the expansion of easy mortgage lending — as high as they could go.

I had begun to worry about the housing market back in 2003, when lenders first resurrected interest-only mortgages, loosening their credit standards to generate a greater volume of loans. Throughout 2004, I had watched as these mortgages were offered to more and more subprime borrowers — those with the weakest credit. The lenders generally then sold these risky loans to Wall Street to be packaged into mortgage-backed securities, thus passing along most of the risk. Increasingly, lenders concerned themselves more with the quantity of mortgages they sold than with their quality.

Meanwhile, home buyers, convinced by recent history that real estate prices would always rise, readily signed onto whatever mortgage would get them the biggest house. The incentive for fraud was great: the F.B.I. reported that its mortgage fraud caseload increased fivefold from 2001 to 2004.

At the same time, I also watched how ratings agencies vouched for subprime mortgage-backed securities. To me, these agencies seemed not to be paying much attention.

By mid-2005, I had so much confidence in my analysis that I staked my reputation on it. That is, I purchased credit default swaps — a type of insurance — on billions of dollars worth of both subprime mortgage-backed securities and the bonds of many of the financial companies that would be devastated when the real estate bubble burst. As the value of the bonds fell, the value of the credit default swaps would rise. Our swaps covered many of the firms that failed or nearly failed, including the insurer American International Group and the mortgage lenders Fannie Mae and Freddie Mac.

I entered these trades carefully. Suspecting that my Wall Street counterparties might not be able or willing to pay up when the time came, I used six counterparties to minimize my exposure to any one of them. I also specifically avoided using Lehman Brothers and Bear Stearns as counterparties, as I viewed both to be mortally exposed to the crisis I foresaw.

What’s more, I demanded daily collateral settlement — if positions moved in our favor, I wanted cash posted to our account the next day. This was something I knew that Goldman Sachs and other derivatives dealers did not demand of AAA-rated A.I.G.

I believed that the collapse of the subprime mortgage market would ultimately lead to huge failures among the largest financial institutions. But at the time almost no one else thought these trades would work out in my favor.

During 2007, under constant pressure from my investors, I liquidated most of our credit default swaps at a substantial profit. By early 2008, I feared the effects of government intervention and exited all our remaining credit default positions — by auctioning them to the many Wall Street banks that were themselves by then desperate to buy protection against default. This was well in advance of the government bailouts. Because I had been operating in the face of strong opposition from both my investors and the Wall Street community, it took everything I had to see these trades through to completion. Disheartened on many fronts, I shut down Scion Capital in 2008.

Since then, I have often wondered why nobody in Washington showed any interest in hearing exactly how I arrived at my conclusions that the housing bubble would burst when it did and that it could cripple the big financial institutions. A week ago I learned the answer when Al Hunt of Bloomberg Television, who had read Michael Lewis’s book, “The Big Short,” which includes the story of my predictions, asked Mr. Greenspan directly. The former Fed chairman responded that my insights had been a “statistical illusion.” Perhaps, he suggested, I was just a supremely lucky flipper of coins.

Mr. Greenspan said that he sat through innumerable meetings at the Fed with crack economists, and not one of them warned of the problems that were to come. By Mr. Greenspan’s logic, anyone who might have foreseen the housing bubble would have been invited into the ivory tower, so if all those who were there did not hear it, then no one could have said it.

As a nation, we cannot afford to live with Mr. Greenspan’s way of thinking. The truth is, he should have seen what was coming and offered a sober, apolitical warning. Everyone would have listened; when he talked about the economy, the world hung on every single word.

Unfortunately, he did not give good advice. In February 2004, a few months before the Fed formally ended a remarkable streak of interest-rate cuts, Mr. Greenspan told Americans that they would be missing out if they failed to take advantage of cost-saving adjustable-rate mortgages. And he suggested to the banks that “American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.”

Within a year lenders made interest-only adjustable-rate mortgages readily available to subprime borrowers. And within 18 months lenders offered subprime borrowers so-called pay-option adjustable-rate mortgages, which allowed borrowers to make partial monthly payments and have the remainder added to the loan balance (much like payments on a credit card).

Observing these trends in April 2005, Mr. Greenspan trumpeted the expansion of the subprime mortgage market. “Where once more-marginal applicants would simply have been denied credit,” he said, “lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately.”

Yet the tide was about to turn. By December 2005, subprime mortgages that had been issued just six months earlier were already showing atypically high delinquency rates. (It’s worth noting that even though most of these mortgages had a low two-year teaser rate, the borrowers still had early difficulty making payments.)

The market for subprime mortgages and the derivatives thereof would not begin its spectacular collapse until roughly two years after Mr. Greenspan’s speech. But the signs were all there in 2005, when a bursting of the bubble would have had far less dire consequences, and when the government could have acted to minimize the fallout.

Instead, our leaders in Washington either willfully or ignorantly aided and abetted the bubble. And even when the full extent of the financial crisis became painfully clear early in 2007, the Federal Reserve chairman, the Treasury secretary, the president and senior members of Congress repeatedly underestimated the severity of the problem, ultimately leaving themselves with only one policy tool — the epic and unfair taxpayer-financed bailouts. Now, in exchange for that extra year or two of consumer bliss we all enjoyed, our children and our children’s children will suffer terrible financial consequences.

It did not have to be this way. And at this point there is no reason to reflexively dismiss the analysis of those who foresaw the crisis. Mr. Greenspan should use his substantial intellect and unsurpassed knowledge of government to ascertain and explain exactly how he and other officials missed the boat. If the mistakes were properly outlined, that might both inform Congress’s efforts to improve financial regulation and help keep future Fed chairmen from making the same errors again.

Michael J. Burry ran the hedge fund Scion Capital from 2000 until 2008.

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Re: I Saw the Crisis Coming. Why Didn’t the Fed? from the NY Times
« Reply #1 on: January 12, 2020, 08:13:11 am »
Sunday, 12th January 2020 (originally published Wednesday, 5th June 2019)
The Plunder Of Black Wealth In Chicago, Captured On Film
by Bob Chiarito

In just two short  decades — while the post World War II housing boom created the wealth of the white middle class — blacks in Chicago were ripped off to the tune of $4 billion on land sale contracts, a common practice at the time that has been since outlawed but whose damage is still felt.

A recent study from Duke University’s Samuel DuBois Cook Center on Social Equity estimates that  “the total amount expropriated from Chicago’s black community due to land sales contracts is between $3.2 and $4 billion in today’s dollars.

The study, called “The Plunder of Black Wealth in Chicago: New Findings on the Lasting Toll of Predatory Housing Contracts,” is the first report to put a dollar amount on the practice. 

During a time when blacks could not get mortgages because of redlining, buying homes on contract gave the illusion of a mortgage payment without any protection.

Simply put, it was often the only way for black families to buy a home in Chicago during the post-World War II boom.

This practice followed redlining, which began in the 1930s as a New Deal policy that color-coded neighborhoods based on the perceived risk of insuring home loans there.

Neighborhoods with large percentages of non-white residents, particularly African Americans, were colored red, deeming the entire area too risky for lending.

Racial prejudice, both individual and as codified by law, led many whites to leave their neighborhoods by the thousands.

As for contract sales, the average price markup for homes sold through contract was around 84%.

Typically, homes in Chicago “purchased by a speculator for $12,000 would be resold days or weeks later on contract to a black buyer for $22,000,” the report said.

This would often stretch black homeowners so thin that no money was left for maintenance or repairs, and if a black family was late on a single payment, the contract holder would evict them and keep all the equity that had built up.

In fact, until the home was paid off in full, the contract holder held the equity, not the black owner.

In today’s dollars, black contract buyers in Chicago ended up paying an average $71,000 more for their home than they would have paid with a conventional mortgage, according to the study.

It also pointed out that the home sale contracts were offered by “the very banks that turned down black homebuyers,” and along with the banks, contracts were offered to blacks by  “investment syndicates comprised of white Chicago lawyers, doctors, downtown business leaders, and city government officials, all of whom profited handsomely by exploiting a separate and unequal housing market to the profound disadvantage of black families.”

The effects of unequal access to home ownership during the post-war period persist today.

Only 39.1%of black households in the Chicago area own their home, compared with 74.1% of white families, according to an analysis the Washington, D.C.-based Urban Institute released last year.

Along with the study, a five-part film series called “The Shame of Chicago” is in the works by Chicago native Bruce Orenstein, who is also the artist in residence at Duke’s Cook Center.

In the film series, Orenstein talks to surviving victims about the impact it continues to have on their families, shows who was behind it and how some fought back — at one point by joining together and refusing to pay exorbitant rates.

Episode three, the only part that is complete, has been released to the press and additional funding is needed to complete the project.

Orenstein plans to include episodes on restrictive covenants and a deeper dive into redlining and wants the series to be shown in schools everywhere.

Recently, The Chicago Reporter talked to Orenstein about the study and his film series.

What is your background?
I’m from Chicago.

I grew up in Chicago and only have been at Duke for 10 years. Most of my life in Chicago I worked as a community organizer working in low-income areas focusing on economic development, trying to get more jobs and better schools for the community. I was more or less using Saul Alinsky organizing methods. Around 1990, I was working on the South Side of Chicago and headed up the Southeast Chapter of UNO, United Neighborhood Organization. While I was doing that we were working on school reform and started to use video to explain the issues in our own community and one thing led to another and I started The Chicago Video Project. For the next 20 years I made short organizing videos for a lot of different community groups around the city … and then eventually got into making documentaries.

Did you work on the report also or is your work confined to the films?

I worked on the report too.

I oversaw the whole project.

I’m at the Samuel DuBois Cook Center on Social Equity and it has a whole team of social scientists and economists that look at all kinds of issues — racial discrimination, racial disparities in wealth and health and every other measure, so I was overseeing the project and using the resources available.

So your decision to focus on Chicago with the study and the film series was because of your previous work here?

Oh yeah.

I’m Chicago all the way through. This is my city. I’m in North Carolina now and teach at Duke so I don’t have to be here for the winters, but I’ve spent most of my working career and life in Chicago.

Redlining and the scams of buying homes on contract is relatively well known. What new things did your work uncover? I believe your study is the first to put a dollar amount on it, right?


There was an earlier study in a dissertation that someone did on a much smaller scale that tried to estimate how many people were on contract and what the losses were, but this is really the first time something of this scope was done.

I think people do know the term “redlining” but I don’t think they understand the profound impact that it had.

When people think in terms of redlining, they think in terms of, ‘Oh, well, the banks did not invest in communities.’ A lot of people use the term disinvestment in communities of color, and it’s kind of left at that. People who are aware of these issues know it strangled the community in terms of flow of capital into it. It didn’t allow it to economically thrive.

What we are doing with this study is moving it a big step forward and saying that it wasn’t just that the banks did not invest in communities. It was that the whole system, through contract selling, extracted money from the communities so not only do you not have investment, what money you do have in the community with all these aspiring black homeowners who are trying to enter the middle class is being drained of their wealth. That’s where this takes it a big step further. It’s really a plunder.

What we are trying to do with the documentary is to put a human face on it. And as far as people being familiar with contract selling, I don’t think they are. When I talk to friends, many of whom have advanced degrees in all areas and are progressive in their politics, when I talk to them about contracts they don’t know what it is and when I tell them that contracts didn’t build any equity, their eyes open wide. And that equity, that chance to build wealth was denied to a great percentage of black families. So, I think the contracts are going to be new to a lot of people.

You’ve released the third episode which was very powerful. How did you find people that were victimized to interview?

Those are some of the last surviving contract buyers so it was hard. I got the two in the film from [local housing advocate] Jack McNamara, who still keeps in touch with them.

They are the real heroes, as Jack refers to them. What they did by staging a payment strike was really remarkable. I can’t fathom trying to hold together 500, 600 people and telling them to ‘hold out, we aren’t going to pay.’

One thing that was particularly revealing in the episode is the sense of stigma — people did not want to admit they were ripped off. Does that still exist?


Talk to any organizer and they will tell you that one of the challenges in organizing is that people feel because of the larger, wider culture, that they have failed. People who are low-income have a part of themselves that they view as having failed.

So, they incorporate that into the way they think about themselves.

I got the title of the film series, “The Shame of Chicago,” from Elizabeth Wood [the first executive director of the Chicago Housing Authority from 1937 until 1954.].

She’s the one that says it in 1952 when she was talking about the violence that took place at Trumbull Park. Then, as I went through the series it had all types of meanings. Shame on Chicago for what it did. Shame that people held among themselves, believing it was their fault and not seeing the institutional structures.

Do you believe the federal government should be blamed more so than the city of Chicago, because this was something that happened in numerous cities?

I think it’s a blame on everybody, on the institutions.

You can go back to the 1919 race riots [in Chicago].

Realtors decide we are going to divide up the city. They put in restrictive covenants, they organized all those communities and then when the federal legislation came along with FHA to insure the mortgages, the Realtors said this is where investments are good and where they aren’t good [through redlining]. They decided to keep whites and blacks separated and decided that black communities were not worthy of investment.

So that puts in another piece of the scaffolding of segregation, and they did keep the peace in the 1930s.

At the same time, the Great Migration was taking place and Chicago’s black belt was bursting at the seams. By the time restrictive covenants are challenged and fall, most black families wanted to escape the kitchenette apartments they were in only to be taken by these contracts.

So, the whole system that was set up by the real estate agents and by the way, the National Association of Realtors is headquartered in Chicago, so there’s a lot of Chicago connections and inventions of how this whole segregated structure is built. A lot of it originated in Chicago so yeah, the federal government did have this policy and they adopted it by the real estate agents who designed it. It’s kinda like when [Vice President] Dick Cheney met with all the oil executives to decide the energy policy of the United States.

The housing issue goes straight to the core of the American dream. Is there anything else that comes close to explaining the wealth gap between whites and blacks?

Oh yeah, there’s a lot of things but I think it’s one of the central features. I don’t know how to prescribe what percentage goes to what, but you have job discrimination, blacks are being paid lower wages and don’t have the same opportunities to advance. School issues, etc.

So are education and awareness the end goal of the study and film series?


Because I don’t see how we move forward on this issue without that. Unless we know where we’ve come from, I don’t see how we move ahead.

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