A Power Grab at the Expense of All

 | Jan 31, 2012 | 5:00 PM EST  | Comments
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After the last presidential election, President Obama's chief at the time, Rahm Emanuel, made a famous and controversial statement: "You never want a serious crisis to go to waste." What he was referring to was the outcry over the recent financial crisis, and the incoming administration's ability to harness the political will that crisis afforded, in order to achieve its goals. What he principally meant was healthcare and energy policy. 

Absent from his discussion and rationale, then, was the consideration of there being a link between the citizens' request for political action and the action ultimately taken. The outcry in 2008 was for some response to the housing and financial crisis that was unfolding.  The administration chose to steer that political capital into healthcare reform.

At that time, the political wisdom was that the capital markets and housing would recover, along with the economy, as a result of the monetary and fiscal policies enacted by the Bush administration. Since then, the belief in the economy's ability to recover from the housing crisis has been assumed. No real consideration has been given by the current administration, by Congress, or by the banks about whether it will continue through the current election cycle.

In reality, throughout the past four years U.S. homeowners have suffered through a series of loan-modification programs that have proven to be unsuccessful.  When attempting to determining why that is, the most logical conclusion is that it was intentional. The housing and financial crisis has provided political capital that, once it's believed to be over, will no longer be available. In other words, fixing housing is the political equivalent of killing the goose that laid the golden egg. 

This Friday, the states and banks are due to accept a $25 billion settlement with the federal government concerning past mortgage fraud.  This is the issue about which I originally wrote last summer, and then again a few weeks later. Through this process, there has been a kind of Kabuki theater atmosphere between the banks and the federal government concerning the settlement. It hasn't been unlike watching professional wrestling. 

Americans were supposed to believe that the administration was vanquishing the banks. But, as this process has played out -- tightly controlled and choreographed as it is by a few state attorneys general and federal government bank representatives -- some unanticipated new information has begun to come to light.

In particular, the attorneys general of New York and California have learned of other issues within the banks  that were not a part of the settlement, and they're now looking into those issues. Just as the housing crisis has been creating political capital for the executive administration in Washington, it is now beginning to do the same for politically ambitious state politicians. As a result, the federal government and banks are beginning to lose control of the process with amid imminent state lawsuits and prosecutions.

This doesn't bode well for money centers with high concentrations of residential mortgage debt -- JPMorgan Chase (JPM), Bank of America (BAC) and Wells Fargo (WFC). If these banks find themselves forced to defend actions at the state level, it will become prohibitively expensive. 

This is the real reason President Obama has tasked New York attorney general Eric Schneiderman with investigating mortgage-backed securities fraud. His true function will be to create another federal settlement before the states can individually pursue it. This has become damage control for both the federal government and the banks.  Just as the robo-signing fiasco has lead to this first settlement, and now another investigation, there will be more.

Basically, what was originally supposed to be an all-encompassing settlement for the banks  is becoming a piecemeal process that will most probably increase in cost as more and more state level politicians eye a piece of the political capital to be had.  This won't be easy for investors to follow, but keep an eye on what Eric Schneiderman does.  The easiest way for the federal government and banks to regain control of this process and its costs is to try to preempt the states, embarking on expanded investigations into multiple businesses and practices of the banks. 

In the immediate term, as well, this will cause uncertainty at banks to continue. It indicates that their willingness to lend will not improve in the near future.  Luckily for investors, that can be tracked easily.

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