There's a tendency, in the endless discussions about the economic
crisis, to think of the entire financial industry as a single,
ultra-powerful actor. Big commercial banks, nimble hedge funds,
even the odd insurance company all get lumped together under the
heading "Wall Street," with its sinister, Death-Star connotations.
In a recent story about relations between the financial world and
Obamaland, no less a populist organ than The Wall Street Journal
offered up such a conflation, noting that the administration,
"after months of criticizing Wall Street, has been scrambling to
woo top bankers and financiers to back its latest bailout plan."In fact, there are real differences among these species of moneymen.
Top executives at large commercial banks tend to be a little older,
a little stodgier, a little more politically conservative than
their counterparts at hedge funds and other money-management firms.
Traditionally, the bankers have also been far more sophisticated
about navigating Capitol Hill. That's especially relevant in the
current crisis, when the interests of the two groups increasingly
diverge and Washington is being forced to adjudicate. And perhaps
no episode better illustrates the gap in political savvy than the
battle over housing legislation now boiling over in the Senate.
Ever since 2007, Congress has been grappling with a way to ease the
millions of foreclosures piling up in the wake of the housing bust.
Any solution needs to accommodate the fact that banks don't keep
most of the loans they originate. Instead, they sell them off for
repackaging as securities, which investors buy. But the banks
continue to service the mortgages--collecting payments from
homeowners each month--and it falls to them to work out a
modification. Which is to say, while the banks have the authority
to modify a loan, they often don't have a strong financial interest
in doing so, since they no longer have a stake in the mortgages.
Worse, the banks actually face a huge disincentive: investors irate
that they lowered their returns.
Among the Democrats' preferred solutions to this problem is
something called "cram-down"--that is, allowing bankruptcy judges
to modify a mortgage and unilaterally impose the new terms. When
Obama unveiled his own housing plan in February, he asked Congress
to revive the cram-down idea as part of a carrot- and-stick
approach to helping borrowers. The carrot would be cash
incentives--a series of $1,000 payments--for banks to perform
modifications. Cram-down would serve as the stick.
Almost immediately, investors and banks joined forces to snap that
stick like a twig. Investors hated the cram-down idea because they
worried judges would force them to accept, say, lower interest
payments for the sake of distressed borrowers. The big banks had
similar worries for the mortgages they keep. Many also hold on to
second liens (basically, second mortgages) after they sell off the
first and worried that judges would wipe those out entirely. And
both groups generally feared the arbitrary ways judges might wield
their power.
But a funny thing happened while the big banks and investors were
uniting against the cram-down push: The banks cut their own deal.
Top executives at four large banks--Citigroup, Bank of America,
J.P. Morgan, and Wells Fargo-- descended on Congress to proclaim
they'd love nothing more than to modify mortgages, just like the
president wants. It's just that, with all those greedy investors
out there, you never know who's going to sue. The solution, they
argued, was a "safe harbor" provision: Give us legal immunity, and
we'll modify all the loans you send us. "They said it's necessary
to protect them from lawsuits," recalls one House Democratic aide.
"Our position was, to the extent there are barriers to
modifications, let's erase those barriers." (Spokesmen for J.P.
Morgan and Wells Fargo declined to comment; the other banks did not
return calls.)
From the banks' perspective, the beauty of legal immunity was that
it would give them a free hand to modify mortgages owned by
investors while collecting cash incentives from the government and
protecting their second liens--a proposition potentially worth
billions. From the investors' perspective, it meant the cost of
modifications would come entirely out of their pockets. If the
fight in Congress was essentially over who would eat hundreds of
billions of dollars in housing market losses, the genius of the
banks was to realize early on that, given the political
environment, it wasn't going to be homeowners. That left them
duking it out with investors, even if the latter weren't aware of
it.
And so, while the investors droned on to glassy-eyed congressmen
about the sanctity of their contracts, the banks waxed expansive
about all they wanted to do for the man on the street. "The
investors don't make a sympathetic case. The banks positioned
themselves as happy to help modify the loans," says one neutral
finance industry lobbyist. "By essentially throwing investors under
the bus, they created a glide path for loan modifications."
When the House passed its bill in early March, the investors were
stunned to see that it contained the safe harbor provision they
feared and loathed. They'd hardly realized it was even on the table
and had made no attempt to fight it. Their only consolation was the
belief that safe harbor was joined at the hip to the cram-down
measure, so the banks would work with them to defeat the entire
package in the Senate. But it soon became clear that Senator Dick
Durbin, who was spearheading the cram-down legislation, had no
intention of letting it torpedo the overall bill--which, in
addition to safe harbor, also included a larger credit line for the
fdic. (Durbin eventually decided to slice off cram- down for a
separate vote.)
The investors realized they'd been had. They quickly pulled out of
the broader lobbying effort and formed their own group--called the
Mortgage Investors Coalition--which spent most of April frantically
pleading their case. They argued that, even without safe harbor,
the lenders had all the legal protection they needed. They insisted
the only thing safe harbor would accomplish is to protect banks who
made fraudulent loans, which they'd essentially be able to launder
through modification.
The investors also finally adopted the universal language of
Washington lobbying: the fight for the little guy--in this case,
homeowners. "The borrower and investor have aligned interests
here," Micah Green, head of the Mortgage Investors Coalition,
recently told me. "The goal of this whole process should be to get
the homeowner in a position where they not only can stay in homes,
if at all possible, but where they want to stay in their home."
True, a modification might lower monthly payments, Green conceded.
But he said it wouldn't change the fact that many mortgages are
underwater--that is, the borrower owes more on the mortgage than
the house is worth--a scenario that leads people to walk away.
(Administration officials disagree, citing extensive research
showing that when modifications actually lower payments, people
living in homes they own tend to stay put even if they're
underwater.)
Alas, it may be too little, too late. Pressed by the big banks, the
Senate just defeated cram-down and is on the verge of passing safe
harbor in early May. (J.P. Morgan CEO Jamie Dimon was spotted in
the chamber on Wednesday.) "We're trying to cram six-to-eight
months of education into three-to-four week period, " bleats one
beleaguered investor lobbyist.
In the end, the problem for investors was largely sociological.
Banking is a heavily regulated industry; in order to succeed, a
bank's top executives must be as deft at navigating Washington as
they are at lending money. But, with a few important exceptions,
most hedge funds live by a meritocratic credo: You make money by
having the more sophisticated computer model or arbitrage strategy.
"Traditionally, investors aren't lobbyists, they don't have an eye
toward Washington," says the finance industry lobbyist. "They have
an eye on deal-making." That helps explain the irony that, even
though Obama himself is closer to more hedge fund managers than
bank executives, the banks look to have won this fight. (The
administration did finally work out a compromise between investors
and banks on the second-lien issue, though.)
From the public's perspective, it's not a bad thing that private
investment firms are belatedly emerging as a separate interest
group on K Street. Yes, the investor arguments about the dangers of
mortgage modifications are self-serving. And, other things being
equal, it's hard to see why the average person should care whether
banks or hedge funds end up shouldering a bigger share of housing-
market losses.
But, given the banks' central role in causing the financial crisis
and their outsize influence in Congress, investors could serve as a
needed counterweight. For example, it's far from clear that banks
won't abuse the safe-harbor provision they've lobbied for; if it
passes, the investors could push to prevent them from using it as a
shield against liability for peddling fraudulent mortgages.
Investors could also play a constructive role on other issues, such
as the attempt by banks to return their bailout money quickly in
order to wriggle free of pay restrictions. Investors who own the
banks' bonds aren't likely to be keen on this, because the bailout
money insulates them from potential losses. Think of the new
dynamic as a kind of Iran-Iraq war come to Capitol Hill: Where
there are no obvious good guys, the next best thing may be two
powerful rivals beating each other to a pulp.
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