The SF Chronicle's Atrocious Mortgage Conspiracy Theorizing

Editor's note: In December 2007, Felix Salmon described an opinion piece written by Sean Olender as “grossly irresponsible” for the author’s views about the nation’s mortgage meltdown and his dim view of then-Treasury Secretary Henry Paulson. In May 2011, Salmon issued an apology to Olender after the Columbia Journalism Review suggested he do so following an audit of the case.

“With the benefit of hindsight, I went too far in my post,” Salmon wrote in a May 31, 2011, post in his Reuters blog. “I said that there was nothing to Olender’s accusations of fraud, when in fact there was a lot of fraud in the mortgage-origination process, even if there wasn’t a criminal conspiracy reaching up to the Treasury secretary to cover it up….

“So: well done, Sean, for being very early to the problem of putbacks. You were much more right than I gave you any credit for, or than I thought possible at the time, and you certainly didn’t deserve to be lumped in with Ben Stein. Sorry.”

Olender contacted Portfolio.com in June 2011 to ask us to place an editor’s note on Salmon’s original post updating our readers about the apology. He said he’s been continually frustrated by seeing the 2007 post rank as a top search result for his name on Google. “It drives me quite crazy not least because I’m not really a “player” in this area. My day job focuses on completely different things and I wrote on the mortgage crisis for a while because it made me so angry how it was playing out. But my job has nothing to do with it,” Olender said.

But Olender also said he wasn’t asking for the original post to be deleted. “I don’t like censorship,” he said. “It is what it is.”

To read Salmon’s apology in Reuters, click here. To read the Columbia Journalism Report analysis, click here. And for the original post, just keep reading.

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The San Francisco Chronicle published on Sunday a grossly irresponsible opinion piece from one Sean Olender, headlined "Interest rate 'freeze' - the real story is fraud". I would dearly like to hold someone at the Chronicle to account for printing this incendiary and meretricious column: it sheds much more heat than light on the issue, and spreads a lot of misinformation and outright falsehoods in the process. Mark Thoma today says that "I don't know if there's anything to these accusations or not": let me assure him (and Tyler Cowen, for that matter) that there isn't.

Olender sets the tone for his piece right at the beginning:

New proposals to ease our great mortgage meltdown keep rolling in. First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth.

This simply isn't true. The MLEC, for that is the only thing he can be referring to here, was specifically designed to buy only high-quality assets: the whole point of it was that it would not buy any risky mortgage bonds at all. In any event, the point was not to buy bonds for more than they were worth: the point was to provide liquidity to a market which was suffering from a major liquidity shortage.

Olender continues:

Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the bill.

I have no idea which idea Olender thinks he's talking about here. Fannie and Freddie buying private-label subprime mortgages on the secondary market? I don't recall any plan like that, certainly not anything which was embraced by anybody in government.

Olender then says that the mortgage-freeze plan is just as bad, if not worse: "the "freeze" is just another fraud," he writes. Yes, fraud: he's saying it's illegal.

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.

It's worth noting the "foreigners" hiding out in this sentence: it's a good indication that Olender is rather out to lunch. Why on earth would the nationality of bondholders make any difference either way? But in any case, we're beginning to see what Olender's thesis is here. Apparently he thinks that (a) US banks might be forced to buy back subprime mortgages at par; and that (b) the mortgage-freeze plan will somehow prevent that from happening. Neither of these things is true.

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

The real problem here is that Olender never makes the crucial distinction between subprime mortgage originators, on the one hand, most of whom were not banks at all, and the investment banks, on the other hand, who pooled and tranched and sold off the subprime mortgages to bond investors. The originators are required to buy back fraudulent loans, but most of them have gone out of business at this point. The investment banks are just middlemen: they are not required to buy back anything.

Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?

Er, no, nobody thinks that, Sean. In fact, you're the only person who thinks the deal was even designed to prevent such lawsuits in the first place. But never mind, you're about to wax apocalyptic:

The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.

Olender uses the term "originators" here, rather than "banks", originally, but immediately elides that into "banks". The fact is that "the largest U.S. banks combined" really didn't originate much in the way of fraudulent subprime loans. Most of that origination happened at companies like Ameriquest, which have long since closed their doors. The US banking system simply doesn't bear the liability that Olender thinks it does. And I think that Olender is saying that not only the originators but also the investment banks have criminal liability here:

What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back.

It seems as though he's talking about investment banks here, not about originators. But investment banks were just the middlemen, funneling subprime mortgages from originators to investors who were desperate for yield. I don't see how they should suddenly be forced to buy back all those mortgages at par, and I'm quite sure that they have no legal obligation to do so. But Olender isn't finished yet:

The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"

The key is to refinance borrowers whose current loans involved fraud in the origination process.

This is where Olender reveals that he's really living in cloud-cuckoo land: he simply doesn't grok the difference between a loan modification – which is the centerpiece of the mortgage-freeze plan – and a refinance. The whole point of the mortgage freeze is that it does not involve refinancing any loan – the loan is simply modified, and the bondholders retain all their legal rights.

But wait – Olender isn't done yet. No column as crazy as this one would be complete without taking a page from Ben Stein's book and drawing out the Paulson-Goldman connection:

Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time.

As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006...

If a mortgage bond investor sues Goldman Sachs to force the institution to buy back loans, could Paulson be forced to testify as to whether Goldman Sachs knew or had reason to know about fraud in the origination process of the loans it was bundling?

At this point it's clear that Olender is operating under the delusion that investment banks, rather than originators, can be forced to buy back loans. After all, Goldman never originated any subprime mortgages itself. In any case, Olender finishes with a flourish:

We're talking about criminal fraud here. We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.

I honestly think that Olender is accusing Hank Paulson of criminal fraud. And I'm really unclear as to what Olender thinks should be done to ensure "the continued existence of the US banking system" – should we force banks to buy back subprime mortgage bonds at par, or not?

The whole piece suffers from an acute case of conspiracytheoryitis, shot through with some very damaging misunderstandings about where legal liability lies in the securitization process. It's the kind of thing which would be easily ignorable on a blog somewhere, and I'm not surprised that something along these lines has been written. But I am extremely surprised that the editors of the San Francisco Chronicle, whose job is to filter out the nutcases, somehow let this one through and printed it on the front page of the C section on Sunday. Shame on them.

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