Wall Street financial wizards have conducted their businesses as though the complex financial products that generated billion-dollar compensation packages also created a protective moat beyond public accountability.

In the interdependent world of global finance that is now collapsing, home mortgages were abstractions. During this decade the basic human connection between lender and borrower in consumer finance was cut and thrown away as a quaint, easily discarded vestige of a bygone era.

In 1981, at the beginning of the era of retail banking deregulation, I wrote the first state consumer protection law for California to stop the practice of “playing the float” — holding customer deposits to earn money by delaying credits to the customer’s account. This abuse crept into retail banking because the full market effects of lifting the previous interest rate ceilings were poorly understood. Follow-up regulation was necessary to close a window of market failure.

Just as in the current crisis with subprime loans, competition could not and did not do the job after deregulation.

Getting out of this mess will require four things: public recognition of the scope and scale of the backlog of mortgage-related defaults, a return to basic human connections in mortgage lending, aggressive consumer protection, and insistence on generous capital cushions (rainy day funds to buffer unexpected losses).

Bring all the bad loans out of the dark recesses of investment and commercial bank balance sheets and into the light of public review. We cannot fix it until we see it.

Next, back to basics. Remember that houses are homes, not abstract transactions that can be made profitable with unreasonable levels of leverage/borrowing. I am not advocating a return to the horse-and-buggy days of lending. There is still a role for more conservative securitization, in which packages of home mortgages are sold to the restructured Fannie Mae and Freddie Mac, and a well-regulated private market. However, preserving the connection between originator and borrower is more likely to reduce fraud and consumer abuse.

This will require political and economic leadership to encourage Americans to return to the tough, unpleasant discipline of saving. At the heart of the current meltdown is a stark reality: America is the world’s biggest debtor in both the public sector (budget deficits) and the private sector (financial institutions and corporations). The U.S. financial system is now at the mercy of foreign sovereigns and institutions sitting on enormous piles of cash, much of it from the sale of oil and other products to us.

Shifting the bad loans, and the financial instruments based on these loans, on to the balance sheets of commercial banks will not solve the problems we face.

In the new pea and shell game, Bank of America has become the new private shell of choice. B of A, the nation’s largest bank, holds 10% of all deposits. It first absorbed Countrywide Financial, the biggest and most problematic subprime mortgage lender, with a loan from the Fed; this week it absorbed Merrill Lynch, with benefit of a waiver of a Fed rule designed to prevent the bank holding companies with FDIC-insured banks from lending to investment bank subsidiaries.

Bank of America, its depositors, and the FDIC are not the long-term solution to the accumulated pile of loans in default.

In August, the inventory of unsold foreclosed houses reached 750,000. With the takeover of Fannie and Freddie, the federal government will be the owner of some of these properties. These unsold foreclosures are depressing the home equity of the rest of us. RealtyTrac, a real estate value-tracking firm, estimates that one out of every six houses for sale in America is a bank-owned foreclosure.

Federal Deposit Insurance Corp. Chairman Sheila Bair testified Wednesday to the House Financial Services Committee: “The backlog of foreclosures and the credit crunch have combined to depress housing prices and homeowners’ equity dramatically. Steep home price declines are an important dynamic that drives up foreclosure rates. Falling home prices reduce homeowner equity, which then makes it more difficult to refinance or sell a home, leading to lower sales and higher delinquencies.”

Zillow.com estimates that 29% of homes are worth less than their outstanding mortgage balance. These owners have little incentive to keep making mortgage payments. Why not walk away and return the key? Short-sales will only add to the glut of unsold homes, driving prices down even further.

The relationship between the house as collateral for a loan and the many layers of complex new financial products grew ever more strained as the regulatory ground rules became a passive backdrop to a rapidly changing environment that featured three factors that converged to turn routine home loans into an international financial crisis: unregulated brokers, complex financial instruments, and international financial integration. I know that it is not fashionable to talk about human values in the same sentence as global money, but maybe that is the real problem. Where are Frank Capra and Jimmy Stewart when we need them?

Modern financial titans, like Sherman McCoy, the central character of “The Bonfire of the Vanities,” have unwound with a single wrong turn, carrying them from the heights of money, power, and privilege on Wall Street to the anger and rage of the ordinary folks in the South Bronx. Tom Wolfe’s metaphor of the fateful mistake helps us to see how connected we are, even though some may deny that connection.

Last weekend the bonfire raged out of control on Wall Street. This time the wrong turn took place more than 10 years ago, when the first experiments with bad loans were pushed on poor and unsophisticated borrowers who lived in communities that had previously been starved, through redlining, from receiving any loans at all. Target practice in poor communities proved the viability of the abusive terms: no exit fees, pay-what-you-want ARMs, liars loans, low teaser rates, and balloon payments. These same terms were then quickly adapted to middle- and upper-middle-class borrowers in search of a vacation home, or home equity for college tuition.

Within five years, Wall Street hedge funds perfected the lending techniques first used in poor communities. In the new financial structure for housing finance, unregulated, independent brokers sold loans by misrepresentations. Houses that people depend on for shelter became poker chips in a high-stakes game of liar’s poker. The late Gov. Edward Gramlich of the Federal Reserve warned that the introduction of “huge new sources of capital and financing of largely unsupervised subprime mortgage lenders” had caused problems with subprime loans.

He argued for re-establishing the connection between the lender and the borrower through banning the most objectionable provisions and through a mandatory “suitability rule” which would require lenders to make loans that are matched to borrowers’ economic profile and “in the borrower’s best interest.” The link between the borrower and the ultimate holder of the loan could be further strengthened by expanding existing rules to impose on the holder liability for fraud or other problems with the process.

The current crisis has been driven by the lack of adequate levels of cash to absorb the losses from defaults. Sovereign wealth funds have filled this cash gap, becoming the lender of last resort for cash-strapped commercial and investment banking companies like Citigroup and Merrill Lynch only nine months ago. The sovereign funds of Abu Dhabi , Singapore , and China were among a collection of funds that came to the rescue of these companies., China’s four biggest listed banks decided to scale back drastically their purchase of Fannie Freddie securities, triggering the government takeover of Fannie and Freddie just five days later.

Describing the mortgage meltdown is easy, but proposing a solution is less so.

For all the talk of “moral hazard” and “market discipline,” these after-the-fact buzzwords are a Rorschach test of whether you believe the government should play an active, aggressive role in controlling the risk-taking and profit-seeking party, just as the guests have started to arrive and loosen their ties.

 Today's NYT contains a story about the bargains that opportunity-seeking small investors are finding at the auction of foreclosed homes.  For those of us who specialize in the banking and commercial transactions field, the auction is a standard fixture of bad debt resolution procedures.  For me, however, as I described below in an earlier post, Race and the Subprime Mortgage Crisis, there is racial a disparity in foreclosures,  The four major conclusions of the ACORN study were as follows:

"For refinance loans, our findings show that in 2006:

1. High-cost loans made up a significant proportion of the home refinance loans made to

minorities.

2. Minority homeowners were more likely than white homeowners to receive a high-cost loan when

refinancing.

3. Racial disparities persisted even among homeowners of the same income level.

4. Minorities received a greater proportion of high-cost loans than they received of prime loans.

5. Lower-income homeowners of all races were more likely to receive a high-cost loan than upperincome

borrowers

" In 2006, 52.0% or one out of two, home refinance loans made to African-Americans were
high-cost loans and, 38.7%, or more than one out of every three, home refinance loans made to Latinos
were high-cost loans. In contrast, only 26.7%, or one out of four, home refinance loans made to whites
were high-cost loans."

The racial disparity in the distribution of these bad loans will lead to a racial disparity in the ownership of foreclosed properties .  I encourage Blackprof readers to watch the headlines as the foreclosures accelerate.  This will be a silent wealth crisis, that has the potential to further exacerbate the preexisting wealth disparities between blacks, latinos and whites.  

The scandalous, frequently fraudulent excesses of sub prime home mortgage lending are finally coming home to roost in the very coupes from which they originally escaped: money center banks and hedge fund portfolios. This is a market correction, the operation of Adam Smith’s “invisible hand”. 

This administration believes in letting the invisible hand determine winners and losers.  Except when it doesn't.  For the moment, the Bush administration is unsure about letting unmodified market forces impose sanctions on major market players who made bad bets .  It fears that this will unsettle the entire economy.

In the financial world, nothing is truly private. Homeowners deserve straight talk and direct action on the racial impact of the current subprime crisis.  The evidence is mounting that black homeowners and latino homeowners, even those with high incomes have been disproportionately affected by the unregulated lending practices that started in minority communities and now threaten the entire economy.

If the problem has a racially disproportionate origin, the solution should include sensitive attention to the racial components of the proposed solution.

If the government had stepped in initially to protect borrowers when the problems were first spotted in minority communties,  the general crisis, that now threatens the interdependent world economy, might not have grown to its current dimension.  Creative government leadership is required.  Adam Smith and private solutions will not protect the nation from the full racial impact of the snowballing subprime mortgage crisis.

What this has meant is that state governments have been deprived of the authority to protect low-income communities by overseeing many of the practices that have led to the mortgage crisis that we see currently.  A crisis that affects minority communities disproportionately.  So why the silence from the civil rights community?  Although a lack of resources or a failure to make the connection between the Court's decision and states' abilities to protect low-income communities from predatory lendors may explain some of the silence, my fear is that this is simply one more example of the civil rights community's blind faith in all things national.  Given the national political environment in which we find ourselves -- from Bush v. Gore to global warming to international human rights -- the black community's political leaders must rethink their per se distrust of states' ability to protect the best interests of minority communities.  In light of the Supreme Court's decision in Watters and the Court's decision to block the policies of local communities to ensure racial diversity in public schools, the time is ripe for a conversation about where progressive people should turn for policy innovation.  Trusting states need not lead us down the path of states' rights or the days of racial segregation with which we reflexively associate with states.  Failing to recognize that states may no longer be the bad actors in every instance is exactly what the success of the civil rights revolution meant.  How long will it take before we have this conversation?

In light of the shortcomings with conventional hierarchical civil rights organizations, how can we use technology to connect with one another to eliminate racial disparities in the United States?  Part of this question relates to specific applications, but the broader question is whether technology might allow for a cultural shift toward decentralization that allows a lot of dispersed and committed folks to work collectively to develop and implement solutions. 

Professor Hernandez writes:

The acrimonious relationship between Latinos and African Americans in Los Angeles is growing hard to ignore. Although last weekend's black-versus-Latino race riot at Chino state prison is unfortunately not an aberration, the Dec. 15 murder in the Harbor Gateway neighborhood of Cheryl Green, a 14-year-old African American, allegedly by members of a Latino gang, was shocking.

Yet there was nothing really new about it. Rather, the murder was a manifestation of an increasingly common trend: Latino ethnic cleansing of African Americans from multiracial neighborhoods. Just last August, federal prosecutors convicted four Latino gang members of engaging in a six-year conspiracy to assault and murder African Americans in Highland Park. During the trial, prosecutors demonstrated that African American residents (with no gang ties at all) were being terrorized in an effort to force them out of a neighborhood now perceived as Latino.

For example, one African American resident was murdered by Latino gang members as he looked for a parking space near his Highland Park home. In another case, a woman was knocked off her bicycle and her husband was threatened with a box cutter by one of the defendants, who said, "You niggers have been here long enough." 

Hernandez concedes that a number of factors play into the increasing levels of histility, but points out that we should not ignore the effect that "Latino culture and history in fueling the rift."  According to Hernandez, "[t]he fact is that racism — and anti-black racism in particular — is a pervasive and historically entrenched reality of life in Latin America and the Caribbean."  Thus, Hernandez concludes that "it should not be surprising that migrants from Mexico and other areas of Latin America and the Caribbean arrive in the U.S. carrying the baggage of racism."

The complete article can be viewed here.

Hernandez shines a much needed spotlight on the distinctive form of entrenched anti-black prejudice sourced from Latino culture that, as a result of the immigration flux, has begun to percolate here in the United States.

Although Hernandez raises many points worth discussing, the question I'd like to pursue here relates to strategic response.  If we take Hernandez' diagnosis as correct, what, if anything, should be done to remedy the situation?

Now if only the men that ran most of the countries that these women live in were as responsible and thrifty with the billions they are given by the international community.

I would have preferred a headline that led with the shocking Manhattan County gap and announcing a multibillion dollar national initiative by the private and public sectors to address  the War on Poverty. –Oops. I guess something like that was partially attempted  in the 60s. Well, I can dream from time to time. Now back to reality. Let’s see how my tax dollars are doing in the War in Vietnam—oops, Iraq.

Michelle Singletary's Washington Post "The Color of Money" columns do a fabulous job of conveying "Big Mama's" secrets of managing money.  In a recent column, "The Race Savings Gap" here, she comments on a study by two investment firms here that shows that African American's earning more than $50,000/year have not diversified their investments. 

The major findings are that upper middle income African Americans are primarily counting on real estate to live in retirement.  Survey respondents expected to live off of pensions, equity in their homes, or income from investment property.  This is problematic because real estate is one of the least liquid assets and is subject to cycles of decline that can make this a poor choice for being the only vehicle for accumulating enough wealth to pass on to the next generation, with or without being subject to the estate tax. 

The savings retirement gap between African Americans and whites is considerable.  The median saved by whites is $93,000 compared to $59,000 for African Americans.  The survey found that African Americans are decreasing the amount of their stock investments.  The survey takers are both investment firms, one black owned and the other white owned, so they have a direct interest in promoting stock ownership.  Nevertheless, the survey results are a wakeup call for Blackprof readers.

The take away message from this study is that if you want to be an African American whose estate is eligible to be subject to the estate tax, you must diversify your portfolio. This means a smorgasbord of investments including real estate, stocks, mutual funds, cash, business ventures, and reduced consumption.

The Brookings study is important because it calculates the cumulative impact on low income consumers of excessive prices for basic necessities and the concentration of the most aggressively priced, inferior quality services in poor neighborhoods. Those who make $30,000/year or less pay more than the middle class for the same products and services.  This is called a "ghetto tax" because the price difference is concentrated in neighborhoods where poor people live. These conditions create a drain on already marginal incomes.

The study shows that the conditions of robust competition assumed by many law and economics scholars do not prevail in neighborhoods where people making less than $30,000/year live. Yale Law Professor Ian Ayres argues in a forthcoming paper (podcast here),presented during the 2006 Georgetown-Harvard Conference on Economic and Social Inequality, that monopoly profits derived from similar conditions of racially disparate impact in labor markets are illegal. 

Major findings of price and quality differences for necessities for people who make less than $30,000/year include the introduction of new high priced services and products targeted at the poor, including the following:

• Banking services
• check cashing
• Pay day lending up to 15% of amount of check
• Car title lenders -APR up to 400%
• Tax Anticipation loans (California lawsuit challenging H.R. Block here)
• Mortgages
• Auto Loans
• Furniture
• Appliances

Other recent studies show overdraft charges on checking accounts, report here, and credit card risk-based pricing policies also have a disparate impact on the poor, report here.

Today’s New York Times reports (article here) that Dr. Anna Pou and two nurses, Cheri Landry and Lori Budo were arrested last night on suspicion of being principals to second degree murder in the deaths of patients in Memorial Hospital in New Orleans.  The deaths were among the 45 deaths that occurred at Memorial during hurricane Katrina. The hospital is owned by the scandal-plagued Tenet Health Corporation. Tenet Healthcare is the target of federal investigations and shareholder lawsuits.

Medical Corporate Cost/Benefit Analysis

Univ. of Pennsylvania law professor Arthur Caplan, director of the Center for Bioethics, an expert in health policies and ethics, said Tenet has a history of promoting profits over patient care. "I think at the end of the day, if you look at over the past 15 to 20 years of the company, you'd have to say the management has been pushing the bottom line, telling doctors to cut corners, basically saying we are going to evaluate you and promote you based on how well you make money, not on how well you take care of the patients."  Interview here 

Medical Whistleblower

                                                                                                              Dr. Bryant King

Dr. Bryant King, who was working as a contract physician at Memorial Hospital during Katrina, told CNN that while he did not witness any acts of euthanasia, but that “most people know something happened that shouldn’t have happened.” Interview here.

Before the storm 66% of New Orleans residents were African American.  Brown University Sociologist, John Logan, published a detailed structural analysis of New Orleans and the Coast after Katrina concludes “if the post-Katrina city were limited to the population previously living in areas that were undamaged by the storm – that is, if nobody were able to return to damaged neighborhoods – New Orleans is at risk of losing more than 80% of its black population”. (full report here)

• By race. Damaged areas were 45.8% black, compared to 26.4% in undamaged areas.
• By housing tenure. 45.7% of homes in damaged areas were occupied by renters, compared to 30.9% in undamaged communities.
• By poverty and employment status. 20.9% of households had incomes below the poverty line in damaged areas, compared to 15.3% in undamaged areas. 7.6% of persons in the labor force were unemployed in damaged areas (before the storm), compared to 6.0% in undamaged areas.”

Today, the racial composition of the city is still unsettled.  However, there are three important forces that will change the composition of the economic status of ownership of the land in New Orleans, whatever the racial composition of the residents of the city may be in the future.  

1.  Eminent Domain.  The Bring New Orleans Back Commission , plans to make aggressive use of the power of eminent domain authorized by the Kelo v. New London case which held that a city is entitled to take a privately owned residence to provide land for a private developer to advance a development plan that the elected officials deem to be for a “public purpose”.

2.  The Federal Government announced that it will raze 5,000 Units of Public Housing.
The  St. Bernard, C. J. Peete, B. W. Cooper and Lafitte housing developments where the demolition will take place represent more than 60 percent of the conventional public housing in the city.  This destruction of housing for poor residents prompted one former resident of the projects to say “they are trying to steal New Orleans from us”

3. Market Forces. The New York Times reports today that the prices of housing, even badly damaged housing, all over the city have increased in value above what the prices were before the storm.  “. Speculators, and bargain hunters have stimulated demand for housing, driving up prices, touching off a Post Katrina gold rush, in which “flooded houses in the city are being bought as well, often at deep discounts of as much as $50 a square foot less than they would have sold for before the hurricane” 

The combination of the three factors listed above will create virtually irresistable forces to displace the poorest former residents, including renters and  many owners of homes in the Ninth Ward, the area of the city most devasted by flooding from the breached levees.

In a series of posts this week I will explore the potential impact of the convergence of federal and local property ownership policies with market forces that will realign the distribution of ownership of private residential land in New Orleans after the storm.

Professor Charles Ogletree and I held the Georgetown-Harvard Conference "The Role of Race in Law, Markets and Social Structures exploring many of these themes.  The podcast of this conference can be found here .

Finally, I want put in a shameless plug for our new Georgetown Law Faculty Blog .  As you might imagine, Hamdan has dominated the posts since Thursday.  I have an earlier post on the Duke Lacrosse Rape issues. Today, the 4th of July, Randy Barnett has posted a Frederick Douglass speech: "What To A Slave is The Fourth of July? "

I look forward to your comments and a lively dialogue this month.