Reason Magazine - Staff > Jeff Taylor

• Teaser Freezer Burn
  

  Given the amazingly complex world of high finance—full of derivatives, hedges, and tranches—Treasury Secretary Henry Paulson last week hit upon a stunningly simple plan to fix the nation's subprime mortgage mess: Lie. And don't just lie, but get everybody together and agree to lie, thereby making the lie become truth.

  The fiction Paulson and the major banks are promoting is that extending the low "teaser rates" initially offered to many subprime borrowers fundamentally will help them and—here is a big lie—transform them from bad loans to good.

  Put another way, if the problem of bad subprime mortgages was caused by delusion over lending risk, this latest solution enshrines delusion as the defining characteristic of the American banker—backed by a facile enabler in Uncle Sam and his trillions, of course.

  Financial risk analyst Chris Whalen calls Paulson's plan"appalling." Whalen's Institutional Risk Analytics zeroed in on the banks' unwillingness to acknowledge risk in their lending portfolios back in 2005. Now he sees the so-called "teaser freezer" plan as an attempt to put Humpty Dumpty back together again and build a floor underneath uncertainty in the financial sector. Except that he estimates around one-third of teaser borrowers will default anyway, a measure of just how dumb lenders are in handing out loans to people with bad credit.

  "It is probably in their best interest to walk away. They have no equity," Whalen says of the hapless borrowers.

  The possibility of their underwater borrowers actually taking a walk terrifies the banks, however. Banks would have no choice but to write down and make real phantom losses lurking just off their books. What to do? How about pretending that the loans aren't actually bad. How do you do that? Pretend that the borrowers can pay them back. How do you do that? Pretend the teaser rate is the real rate. Presto, problem solved.

  At this point, some adult would ideally step in and say, "no, that's fraud." But clearly Treasury is not that mature. And it appears the Fed has resigned itself to some form of greater idiocy coming out of Congress on the subprime front that maybe, just maybe, the teaser freezer can head off.

  However, the stubborn fact remains that banks will lose money on teaser rates. Regulators and investors both know this. Who exactly are we trying to fool? Besides inattentive voters.

  Meanwhile, by allowing big banks to keep their rot off the books, the potential exists for it to continue to spread. Whalen and other experts have wondered for months about losing the ability to price risk, or even recognize it given the complexity of the constructs floating around financial markets. The Paulson fix only exacerbates the problem by continuing to assert that real world constraints do not matter. And the stakes are already high.

  "We could lose a money center bank next year," Whalen warns.

  Should you duck your head out of Treasury's "let's pretend" camp for a second, one notices that there are major legal obstructions to rewriting millions of loan contracts by federal fiat. Contrary to the wish of some in Congress, mortgage lending is still largely an activity engaged in by two private entities, each of whom assume very specific obligations. This is not a federal program to be tweaked at the margins. Real estate lending contracts are a dozen pages long for a reason. And each contract is different yet just as legally binding, depending on a given state's law. That's right, state law.

  It is unclear how federal action to extend low-low teaser rates can square with state lending laws which may require an actual change in the underlying contract. Unless the idea is just to do this all informally, with a notification letter from lender to borrower and as long as federally chartered banks get approval from their federal regulators to pretend.

  After all, what is a little lie between friends?

  Contributing Editor Jeff Taylor is a writer in Charlotte, North Carolina.

• Rant: Unconnected Dots
  

  For years federal authorities have argued that antiquated laws kept the cops from stopping 9/11. They said the failure to prevent the terrorist attacks demonstrated the need for the PATRIOT Act and every other proposed expansion of the government’s surveillance powers. But in testimony before Congress in September, Director of National Intelligence Michael McConnell changed tack, saying “9/11 should have and could have been prevented” after all; the authorities simply “didn’t connect the dots.”
  
  McConnell did not draw the obvious conclusion: If greater federal power was not needed pre-9/11 to stop terrorists, then even more federal authority is not needed now. Instead, McConnell argued that the Protect America Act—which allows the attorney general and the director of national intelligence, without judicial oversight, to authorize surveillance of international phone calls and email involving people in the U.S.—made vitally needed changes to the Foreign Intelligence Surveillance Act.

  How does the supposed need for greater surveillance power square with McConnell’s declaration that 9/11 was preventable and his lament that “we didn’t connect the dots”? How did we get the dots without the Protect America Act?
  
  Via good old-fashioned police work that top officials in the Federal Bureau of Investigation ignored. Federal agents on the ground knew that hijackers Khalid al Mihdhar and Nawaf al Hazmi had sought pilot training. They knew Zacarias Mous­saoui had sought the same sort of training; he was carrying 747 manuals when he was picked up on immigration charges. In the days leading up to 9/11, Minneapolis FBI agent Harry Samit repeatedly tried to obtain permission to search Moussaoui’s laptop computer and belongings. Headquarters refused to seek a warrant.
  
  New details on just how costly that denial proved to be were first published in a widely overlooked September 10 story by Greg Gordon, McClatchy Newspapers’ Washington reporter. Gordon discovered that the FBI had enough information to arrest part of Al Qaeda’s financing network in the days before 9/11—information that could have stopped the hijackings. Cue McConnell’s dots.
  
  Moussaoui’s fellow jihadists considered him a loose cannon and security risk. They were right: The key to the whole network was right there in his notebooks. Al Qaeda operative Ramzi Binalshibh wired $14,000 to Moussaoui in August 2001, and Moussaoui sloppily recorded the routing number.
  
  But authorities never looked at that notebook. Instead, FBI brass rejected Agent Samit’s attempts to search Moussaoui’s belongings, citing lack of information that Moussaoui was a known terrorist or foreign agent. The notebooks were not searched until after the attacks.
  
  Gordon notes that investigators almost certainly could have traced Moussaoui’s money back to an Al Qaeda moneyman in Dubai; Binalshibh’s transactions would have led them there. The Dubai contact used one of his Western Union receipts to jot down a phone number in the United Arab Emirates. That number received calls from 9/11 hijackers while they were living in Florida prior to their attack.

  As Gordon reports, FBI agents at Moussaoui’s trial testified that had he confessed to the plot after his August 16 arrest on immigration charges, thus giving them access to his notebooks pre-9/11, they could have moved on 11 of the 19 hijackers. But Washington steadfastly refused to move on information developed from the field offices. Rather than endlessly tweaking the intelligence-gathering statutes, the White House should have spent the past six years addressing the “obstructionism, criminal negligence and careerism” that Samit cited as the roadblock in his investigation. It obviously has not.
  
  It was bureaucratic hubris, not a lack of actionable intelligence, that allowed 9/11 to happen. The same hubris continues to demand that ever more raw surveillance data be dumped into the same slavering but useless federal maw.

  Contributing Editor Jeff Taylor is a writer in Charlotte, North Carolina.
  

• Rudy, the 700 Club and the Hilton Head Country Club
  

  Last week, televangelist Pat Robertson's endorsement of former New York City Mayor Rudy Giuliani sent pundits scurrying to declare a watershed event: A social conservative h