It’s Time to Bring Our Mortgages Home

The Administration is now proposing the transfer of significant defaulted mortgages and foreclosed properties held by Fannie Mae, Freddie Mac and the Federal Housing Administration (“FHA”) to large national institutional investors.

A Huge Housing Bargain — but Not for You
The Street (18 Aug 11)

White House Seeks Ideas to Shrink Foreclosure Glut
Catherine, News & Commentary (11 Aug 11)

Enterprise/FHA REO Asset Disposition (PDF)
RFIFinal (10 Aug 11)

Such a transfer is not economic — other than for the large investors and to serve a wider agenda of social control and engineering, including gentrification of numerous areas whose former residents were fraudulently induced and evicted with the use of these mortgages.

I served as FHA Commissioner (See: Austin Fitts Better be Good With Hammer and Nails) during the first Bush Administration and then, several years later, my company, Hamilton Securities Group, served as the lead financial advisor to FHA, providing portfolio strategy advice with respect to $400 billion of financial liabilities and assets, including over 50,000 of foreclosed properties held by the government as the result of mortgage insurance claims for defaulted FHA-insured mortgages.

Hamilton’s job as FHA’s financial advisor also included designing and implementing the disposition of $10 billion of the $12 billion of defaulted mortgages then held in the FHA portfolio, a feat we achieved through the sale of the mortgages in the institutional markets. As the direct result of our efforts, the government saved $2.2 billion for the FHA Fund. Indeed, GAO reported that the $2.2 billion savings number was understated and GAO’s audit showed that the impact on communities of the loan sales was positive. (See Hamilton Securities)

In the process of managing the FHA portfolio myself as FHA Commissioner and then later assisting FHA as lead financial advisor, I learned a lot about the management of mortgages and properties by the federal government and the economic impacts to homeowners, communities and the taxpayers of servicing or transferring them to the private sector in various ways. I also got a significant education in who makes money on that process being managed to generate “fees for friends” instead of on an economic basis.

In 1989, as FHA Commissioner, I was reviewing lists of defaulted mortgages and foreclosed properties that were multiplying as a result of the bursting of the housing bubble that took place during the “S&L crisis.” My staff had identified one community in New Mexico where 70% of the housing stock, or the related defaulted mortgages, were owned by Fannie, Freddie or FHA. I suggested that we have the local town or municipality buy them. Clearly, the townspeople needed to reinvent their economy. I believed that the way to do that was to convert local debt — including mortgage debt, but it could also include many other forms of municipal and household debt – to equity, thus creating the financial conditions and incentives to rebuild. Equity funds, particularly those that could be made liquid through a local stock exchange or a community venture fund, offer tremendous opportunity for building new family wealth in America.

My staff protested that the town had no money. I explained that they did not need money. They could create a trust structure or some other type of corporate vehicle with which to achieve the goal of local ownership, much like a leveraged buy-out in the investment banking world. We could swap the mortgages with the government or government-sponsored entity (i.e., Freddie or Fannie) for an equity interest or common or preferred stock in the new vehicle, which could take the form of a trust, corporation or partnership, depending on legal considerations. In other words, the government or GSE would transfer the mortgages into the investment entity in exchange for a percentage equity interest in that entity, with control and the remaining equity interests being vested in the town or locally controlled enterprise. My staff’s reaction to this proposal was not positive – this kind of securitization was still new to Washington, although the disposition of the S&L defaulted mortgages through the Resolution Trust Corporation would change that over the next few years.

When Hamilton Securities became the lead financial advisor to HUD, we developed a loan sale auction process using state-of-the-art software and Internet capabilities to afford interested bidders low-cost access to information about the portfolio for purposes of evaluating the mortgages and to optimize bid results. The result was that a variety of market players, including both modestly capitalized real estate professionals and wholesale institutions, could self-stratify the portfolio. In other words, instead of selling a huge portfolio of mortgages to a single high bidder, which would have allowed only huge institutional investors like GE Capital to bid, using our software, we allowed the likes of GE and Goldman Sachs to bid against smaller bidders who wanted or could afford a much smaller number of mortgage loans. The process was quite successful, improving the HUD recovery rate on defaulted mortgages from 35% to 70-90% and significantly shifting the pricing in distressed mortgage markets.

Two Innovations that the Feds Refused to Implement

There were two innovations we consistently pushed HUD to implement that were bitterly resisted. In hindsight, I now believe the reason was that these solutions would have illuminated and/or prevented the extraordinary mortgage fraud that was ongoing in the FHA and HUD portfolios.

First, Hamilton Securities Group consistently recommended that bidders be allowed to bid for a single mortgage, including allowing homeowners to bid in the open auction process for their own mortgages. HUD was adamant that the minimum bid had to be for a pool of $1MM. Their reasoning was that closing single loans would require increased expenditures for servicing contracts. That, however, made little sense if netted against the economic benefits of doing so. I now believe that the government was protecting ongoing fraud in the portfolio and wanted to ensure that only large investors could participate.

It is critical to note that there is absolutely no reason for the government not to sell current FHA, Fannie Mae and Freddie Mac mortgage portfolios using an eBay-type auction system of mortgage and real estate market-making. Indeed, the transparency and access of such a system would stimulate the local real estate markets and allow many American homeowners to finally achieve timely and economic workouts on their under-water mortgages – in a way would even save money for taxpayers.

The only reasons I can think of to dump the whole pile of defaulted and under-water home mortgages into the large institutions and banks (as is, apparently, the Administration’s current plan) are to:

(1) facilitate the shredding of mortgage files and thereby keep the extent of past rampant mortgage fraud in the mortgage-backed securities market a secret (see MERS/MBS/Foreclosure Goes RICO for examples as alleged in a recent lawsuit and Mortgage Robosigning: Must Watch Deposition regarding “robo-signing” problems);
(2) feed more profits to the very large banks and other institutions that were responsible for creating the housing and national and international economic crisis in the first place and that failed to “trickle down” the benefits of the TARP and other rescue packages previously financed at taxpayer expense;
(3) prevent local communities from having a hand in dealing with the thousands of empty foreclosed properties abandoned by far-away institutional lenders, further pulling down neighborhood property values; and
(4) facilitate central planning of the next round of gentrification in American cities and towns, with the attendant poverty, unemployment and social problems.

Oh, and, of course, leaving the ownership of home mortgages in the hands of existing financial institution owners might allow them to sweep the “MERS problem” under the rug, prevent local counties from recovering millions of dollars of unpaid recording fees and prevent defrauded homeowners and communities from recovering damages they have suffered as a result of lender mortgage fraud. (See A Comment on Catherine’s Interview on the Keiser Report and Citigroup, Ally Sued for Racketeering Over Database; Lawsuit Alleges that MERS Owes California $60-120 Billion in Land-Recording Fees; and Does MERS Make the US a “BBB” Credit? for information about and potential ramifications of the “MERS problem.”)

The notion that it is too difficult logistically to do for non-performing mortgages what eBay does every day for thousands of different assets is complete poppycock. The notion that instituting auctions to large institutional investors is a way to generate better prices is also poppycock. Please don’t listen to it.

Second, Hamilton Securities’ experience documented why it made sense to allow the securities, mortgage and real estate buyers to stratify their interests in mortgages by place. For example, rather than auction all of the apartment mortgages on properties located in the Southeast, or all the single family mortgages nationwide, why not allow a bidder to bid on foreclosed properties or non-performing mortgages on properties located in just Atlanta or Lewis County or a particular town? For that matter, why not provide data on ALL defaulted mortgages and foreclosed properties and assets government-wide and permit the creation of local place-based ownership entities to own the mortgages in the form of a partnership or joint venture between local institutions and investors and the federal government? Such an enterprise [I used to call it a "Rouse Trust" in honor of developer Jim Rouse] could even approach the banks and private institutions and swap stock or equity interests for their defaulted financial assets and paper.

With a critical mass of this type of local enterprise in place, there would exist a widely-understood “template” for use as an investment vehicle that has a vested interest in improving the well-being of any place. A “Rouse Trust” also could be used to:

(1) facilitate equity investment in local small business;
(2) encourage student internships and entrepreneurial education in partnership with local high schools, community colleges and universities;
(3) help to reposition local real estate, including improvements in energy efficiency;
(4) introduce new energy technology into older the housing stock and small business facilities;
(5) facilitate local food production; and
(6) serve as a positive force for reengineering government spending and credit policies to those that would increase income, decrease expenses and enhance local productivity.

Imagine how quickly jobs could be stimulated and communities could be revived with the proliferation of “Rouse Trusts” if local and state governments were to enact laws, policies and procedures to cut existing red-tape and curb institutional interference with such initiatives. See,
for example, how a local European alternative energy venture succeeded (German Village Proves: Local Leadership + Engineers + Local Investment Works) and a similar US effort failed (Response to “What a Small Town, Some Engineers and Local Investment Can do…”) due to the absence of facilitating mechanisms to achieve this very end.

Hamilton’s 1990s Efforts to Prototype A New Equity Model

As a result of its experiences doing portfolio strategy for $400 billion of residential real estate and mortgages and building relational databases to simulate investment by place, Hamilton was seeing significant investment opportunities available on a place-based basis. New information technology meant that we could create rich databases that would allow taxpayers to identify the sources and uses of all federal government investments, spending and other activities in their place. Significant reengineering opportunities were available. Numerous neighborhoods had foreclosed properties that could be purchased and fixed up for $50-75,000, and yet the federal government was instead financing the construction of public housing for as much as $250,000 per unit.

Local investment vehicles we were proposing also would have meant that functions that typically had been performed at the state or federal level could be delegated back down to the local level, where locally-relevant decision making could take place. Data servicing needs were exploding in both the public and private sector. As federal subsidies diminished, we thought, why not ship the work to be done to counties throughout the country where the cost of unemployment, foods stamps and housing subsidies were rising? Yes, the individual pieces of work could be done cheaper in Asia, but not when the cost of paying millions of people not to work was taken into consideration. To prove this point, we prototyped a partially tenant-owned data servicing center (called Edgewood Technology Services) located in a Section 8 housing project not far from our offices in Washington where we subcontracted FHA data servicing work under our financial advisory contract.

In the hopes of achieving successful place-based resolutions for local optimization of housing values, as an alternative to feeding billions of dollars into Wall Street coffers, we prototyped state housing finance agency – negotiated transactions (in which local housing finance agencies assumed both ownership benefits and ownership responsibilities of HUD-owned low-income housing project mortgages from HUD) and the first sale by auction of equity interests in a structured mortgage trust that had as assets mortgages on Section 8 and other affordable housing projects. In both cases, special servicing requirements in the form of tenant initiatives, assumption of regulatory agreement responsibilities and other public policy requirements were incorporated into the terms of sale. These transactions were designed and consummated more than eleven years ago, when many currently-available software innovations and hand-held devices did not even exist. Yet, in each transaction, much of the legal and financial engineering work that would need to go into the creation of a “Rouse Trust” today was already accomplished.

The next step in the reengineering efforts led by Secretary Cisneros in 1992 – 1996, our attempt at the first place-based equity vehicle, was cancelled when Andrew Cuomo took over at the helm of HUD on the heels of a conveniently engineered mistress scandal that resulted in Cisneros’s resignation. Cuomo (who was rumored to have been the only candidate for HUD Secretary that Alfonse D’Amato would allow to be confirmed by the Senate) was intent on creating a politically fashionable excuse for canceling the HUD loan sales and engineering a housing bubble that would further his political career (see “Unanswered Questions about Andrew Cuomo”).

For more on these efforts at Hamilton Securities Group, see, Hamilton Securities Group and “The Story of Edgewood Technology Services.”

I shared this vision at one point in 1997 with a group of excellent pension fund leaders who shared our concerns that without significant change, America and its pension funds would not be able to fund the baby boomers’ retirements. I described the experience in Dillon Read & the Aristocracy of Stock Profits:

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Excerpt:

“The Hamilton Securities Group had a subsidiary charged with taking our data as it developed on individual transactions and portfolio strategy assignments and using it to develop a new approach to investment. We sought to help investors understand the impact of their investments on people and places and on a wider society as a strategy to identify opportunities to lower risks and enhance investment returns. This included understanding how to reduce the dependencies of municipalities and small business and farming on debt and increase their ability to finance with equity. Indeed, easy, subsidized access to equity financing is one of the reasons that large companies have grown so powerful and taken over so much market share from small businesses. Access to equity investment for small business and farms would result in a much healthier economy and much more broad-based support for democratic institutions.

We were blessed with an advisory board of very capable and committed pension fund leaders. In April 1997, we had an advisory board meeting at Safeguard Scientifics where the board chair led a venture capital effort. I gave a presentation on the extraordinary waste in the federal budget. As an example, we demonstrated why we estimated that the prior year’s federal investment in the Philadelphia, Pennsylvania area had a negative return on investment. It was, however, possible to finance places with private equity and then reengineer the government investment to a positive return and, as a result, generate significant capital gains. Hence, it was possible to use U.S. pension funds to increase retirees’ retirement security significantly by investing in American communities, small business and farms — all in a manner that would reduce debt and improve skills and job creation. This was important as one of the chief financial concerns in America at that time was ensuring that our retirement plans performed financially to a standard that would meet the needs of beneficiaries and retirees. It was also critical to reduce debt and create new jobs as we continued to move manufacturing and other employment abroad. If not, we would be using our workforce’s retirement savings to finance moving their jobs and their children’s jobs abroad.

The response from the pension fund investors was quite positive until the President of the CalPers pension fund — the largest in the country — said, “You don’t understand. It’s too late. They have given up on the country. They are moving all the money out in the fall (of 1997). They are moving it to Asia.” He did not say who “they” were but did indicate that it was urgent that I see Nick Brady — as if our data that indicated that there was hope for the country might make a difference. I thought at the time that he meant that the pension funds and other institutional investors would be shifting a much higher portion of their investment portfolios to emerging markets. I was naive. He was referring to something much more significant.”

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I bring up the pension funds because any transfer of mortgages from Fannie, Freddie and FHA will have a profound impact on the pension funds. The US pension funds have very significant holdings of mortgage-backed securities as well as Treasury bonds and other fixed income securities whose credit and valuation depends on a healthy US economy. They have a vested interest in the American economy getting back on its feet. Another pump and dump of the US residential real estate market will have a devastating impact on their portfolios that further enriches and emboldens the institutions that have brought us to this place.

What is called for is a resurgence of local private and liquid equity investment at a local level. We have been so used to sending our capital to Washington and Wall Street, it is hard for many of us to envision a world in which we circulate our capital locally and prosper in doing so. However, step one is for thousands of local municipalities and counties to imagine creating local venture and trust structures that can both attract local capital and facilitate local workouts and renengineering that can return our local real estate markets and economies to a sound footing.

If you are a local municipal official or developer or work in a local or regional economic development agency, here are some of the posts from the Solari archives and related links about place-based development that may help you think about creating a local fund that can swap stock or partnership interests to the federal government and large financial institutions in exchange for the mortgages and assets in you area. Ideally, such a fund would create a platform to help you do a series of things that will strengthen your local human and financial capital.

It’s time to bring our mortgages and foreclosed properties home.

• The Popsicle Index
• Popsicle Culture: A Backcasting as a Report to Shareholders—1998
• A Design Book for Solari Stock Corporations—1998
• Solari & the Rise of the Rule of Law
• A Solari Report: Can Our Communities Serve as Financial Safe Havens In Troubled Times
• Positioning Your Assets
• Positioning Your Assets: Is Your Community Waving Goodbye to $3.3 Billion?
• The Essence of Solari
• Real Deal: Economic Resurrection for My Neighbors
• The Community Wizard of Sebastopol – Part 1
• Community Databanks
• UnAnswered Questions About Rawesome Food
• Restoring Freedom In Tennessee
• The Politics and Economics of Food
• The Experience of the Participative Budget in Porto Alegre Brazil, MOST Clearing House Best Practices Database

Catherine Austin Fitts is the president of Solari, Inc. and managing member of Solari Investment Advisory Services, LLC and Sea Lane Advisory, LLC. Carolyn Betts is an attorney in private practice in Ohio who serves as general counsel to Solari, Inc. and Solari Investment Advisory Services. LLC.

Catherine served as managing director and member of the board of Dillon, Read & Co. Inc. and as Assistant Secretary of Housing/Federal Housing Commissioner in the first Bush Administration, before founding the Hamilton Securities Group.

Carolyn served as a senior banker at Hamilton following a legal career as an associate and then principal of a Washington, DC-based law firm that served as outside counsel to RTC, VA and the Farmers Home Administration in connection with their non-performing mortgage loan sales, the precursors to the FHA loan sales led by Hamilton Securities Group.

ENDS

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