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U.S. policymakers just dealt struggling homeowners another devastating financial blow by helping Wall Street banks cook the books on their mortgages.
The real outrage, however, is that federal policymakers know the strategy they're adopting screws borrowers: they did the same thing in the 1980s to save banks from overwhelming losses on loans they'd made to developing nations, with horrific consequences for the global economy.
Under intense pressure from Congress and the banking lobby, regulators have approved a new accounting rule that allows banks leeway to value troubled mortgages and debt-backed securities at inflated prices. Banks typically have to value these assets at market prices: the amount investors might pay for them.
But with the U.S. economy fighting for life under a mountain of foreclosures, investors have figured out that these loans -- and the byzantine securities into which they were "sliced and diced" -- are not actually worth very much. As a result, nobody is buying them; their "market" has disappeared.
So the banks now insist that hundreds of billions of dollars in debt-backed securities are not really worthless predatory garbage but merely assets being unfairly scorned by the trading markets. Their bargain-basement prices are artificially low.
So Big Finance has persuaded Congress and regulators to allow them to use secret proprietary "models" the banks own to assign values to these "toxic assets" without having to justify those numbers with concrete market information.
"The market would demonstrate that the value of these assets is much, much lower than what they've already got on the books," says Duke University Economics Professor William Darity. But once the new rules take effect, big losses on absurd mortgages will magically disappear with the stroke of a pen.
If that sounds like a back-door bailout, rest assured: it is. Even worse, it will actually hurt homeowners facing foreclosure. Allowing banks to use magical valuation models eliminates the incentives for them to modify loans that can't be repaid -- loan modifications that might enable families hit hard by this recession to stay in their homes.
Instead of encouraging banks to cut their losses by reducing the amount borrowers owe on their mortgages, regulators are giving them every reason to refuse to negotiate with their customers.
This is exactly what happened in the foreign debt crisis of the 1980s.
"The commercial banks at the time essentially pushed loans on the developing countries," Darity says. "They tried to make it as attractive as possible for these governments to take on external debt, not necessarily with an expectation that the debt obligations would be paid."
When it became clear that those countries simply could not afford to pay off the mountains of debt they had accumulated, the banks found themselves facing total financial ruin.
According to FDIC data, as early as 1982, at least eight of the largest U.S. banks -- including Citibank, Bank of America and JPMorgan -- would have been wiped out by the losses from those loans to foreign governments, yet all stayed in business thanks to accommodating regulators. So it is with those "toxic assets" today, with bank balance sheets stretched beyond the breaking point thanks to defaults on expensive mortgages that will never be repaid.
"You had a number of the largest money center banks that had losses so large that they would be insolvent," according to William Black, a senior banking regulator during the 1980s who now teaches law and economics at the University of Missouri. (A money center bank is one that lends to other banks, big corporations and governments rather than consumers. They're the ones often described as "too big to fail.")
See more stories tagged with: economic crisis, mark-to-market
Zach Carter writes a weekly blog on the economy for the Media Consortium. His work has appeared in the American Prospect, the Atlanta Journal-Constitution and on CNBC.
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