JumpStart Executive Director Laura Levine and Southeast Regional Director William Cheeks (jumpstartcoalition.org)

The JumpStart Coalition for Personal Financial Literacy, a national nonprofit advocacy group that aims to improve the financial management skills of America’s youth, draws lots of attention for its surveys measuring how much kids really understand money. Last spring, Federal Reserve Chairman Ben Bernanke even led a joint news conference to announce JumpStart’s most recent findings, calling it “a leader among organizations seeking to improve the personal financial literacy of students from kindergarten to the university level.”

The 180 corporations, government agencies and nonprofits that are partners and provide financial support to the coalition get prominent billing on JumpStart’s Website, and share in the prestige of a group that promotes national standards for financial literacy education in the country’s classrooms.

But also included in the coalition is CompuCredit, an Atlanta subprime lender that specializes in high-rate credit cards, payday loans, auto financing and debt collection, focusing on customers with poor credit scores. In December of last year, CompuCredit reached a $114 million settlement with the Federal Deposit Insurance Corporation and the Federal Trade Commission, which had charged CompuCredit and two partner banks with deceiving hundreds of thousands of customers by failing to properly disclose upfront fees and credit limits on their cards, thereby sinking borrowers further in debt. In addition, JumpStart’s Southeast regional director, a paid consultant who serves as a liaison to the group’s state affiliates, also counts CompuCredit as a client of his private consulting firm.

JumpStart executive director Laura Levine said that she was aware that CompuCredit belongs to JumpStart’s coalition, and that the coalition’s Southeast Regional Director William Cheeks also works for CompuCredit as a consultant. But, she said, no questions had been raised about the situation until an inquiry from TWI. Levine said JumpStart staff would explore the matter.

“No one’s called it to our attention as a problem,” Levine said. “Now that we’ve talked about it we will look into it further.”

JumpStart is not taxpayer-funded, although government agencies like the FDIC and Freddie Mac are partners. Corporate partners pay $5,000 annual dues to the coalition, with lesser fees for government groups and nonprofits. Membership has to be accepted by the board of directors, Levine said. Businesses that only do payday loans would never be approved for membership, she said, but the situation “gets into a real grey area” when a company, like CompuCredit, offers a range of financial products.

JumpStart describes its mission as promoting financial literacy through advocacy, research, standards for financial literacy education, and educational resources.

It also maintains an online clearinghouse of approved personal finance materials for educational use. Its partners provide financial support, and JumpStart in turn offers guidance and resources to help member organizations with their own financial literacy efforts. It does not allow any coalition members to sell or distribute their own products through JumpStart.

Regarding Cheeks, Levine noted that he is a consultant, not an employee, and that JumpStart can’t dictate what clients his private firm might accept. “We’re a coalition of organizations and entities that share a commitment to financial literacy education,” Levine said. “We have a lot of financial services firms that may be competitors, or may have different positions from each other. They aren’t working for us. They came to JumpStart to share in our support of financial education and financial literacy efforts.”

But Irene Leech, president of the Virginia Citizens Consumer Council, said she found CompuCredit’s involvement with JumpStart troubling.

“I’m disappointed,” said Leech, who also specializes in consumer issues as a Virginia Tech professor. “It’s distasteful, and it doesn’t improve its efforts. I would have absolutely said no to both these situations, at a bare minimum. I have a pretty high expectation for a group like this. There are many professional and academic organizations that I belong to that are members, along with the consumer groups. They’re the entity that everyone is looking to when it comes to measuring financial literacy with a high degree of accuracy.”

Leech added that “I just wouldn’t have thought that their leadership would have wanted to go this way. I’m really sad they’ve gone this route.”

In Virginia, JumpStart’s state coalition was credited with helping require financial literacy education in school curriculums, and also is active in other states to promote financial literacy at a local level, Leech said. Next month, JumpStart will sponsor its first national educator conference for K-12 teachers, devoted specifically to personal finance education. FDIC Chair Sheila Bair is scheduled as the keynote speaker.

At last spring’s joint news conference, Bernanke said the regional Federal Reserve banks work closely with JumpStart state coalitions on financial literacy issues. And JumpStart is probably most well-known for its biennial financial literacy surveys, which usually receive wide press attention. The April 2008 survey found that graduating high school seniors still were struggling with financial literacy basics.

Regarding the coalition partners, Levine said that “Many of our partners conduct financial education or support financial education activities–JumpStart’s role is to support, in some ways, what the partners do. For example, if a partner has a financial education product, we list it in our clearinghouse to try to help users find it. So, we don’t specifically ask them to do things for us.  We ask them to base their materials on the national standards, to help advance the
mission of the coalition.”

“We generally recommend their participation in financial literacy activities and efforts,” Levine continued, “but we don’t specifically ask them to do things.  Partners support us financially for the effort that we do, generally, on behalf of all, such as publication of the standards, operation of the clearinghouse, (and) promoting Financial Literacy Month.”

Leech said JumpStart has been very successful, particularly at the state level, in getting more businesses to join the coalition. But while partners from Merrill Lynch to Experian sponsor JumpStart surveys, conferences and other activities, CompuCredit should be treated as a different case, she said. Subprime lenders often seek to align themselves with more mainstream organizations to deflect controversy over their practices, Leech noted. CompuCredit’s membership in the JumpStart coalition reminds her of businesses that create fake consumer groups with benign-sounding names as cover, she said, and there should be no grey area in determining whether the firm belongs in JumpStart.

“I’m not buying any of it. We all know that folks are being taken advantage of” by subprime firms and payday lenders, Leech said.

For his part, Cheeks, president of a Georgia fiscal management consulting firm, described himself as a retired Equifax executive whose main goal is consumer education. As to whether any conflict of interest exists by consulting for both JumpStart and CompuCredit, Cheeks said that “I consult with a lot of companies” and added, “I’m not going to get into that discussion.”

“I work to help consumers understand credit – how credit works, how to improve their credit,” said Cheeks, a former Vice President for Consumer Education at Equifax. “I do that for all of my clients. I am a consumer educator. That is exactly what I do. With JumpStart, my focus is kids. I want to get to students as early in life as a possible, so they can build a good credit history.”

He declined further comment regarding CompuCredit.

Guy Cecala, publisher of Inside Mortgage Finance, which covers the subprime industry, said subprime lenders like CompuCredit usually have a problem when it comes to supporting financial literacy, since some basic lessons would be not to take out payday loans or to pile up debt on high-rate credit cards.

The FDIC, for example, said its charges against CompuCredit stemmed from a fee-based credit card marketed to consumers with low credit. The FDIC said the solicitations “failed to adequately disclose significant upfront fees and misrepresented the consumer’s initial available credit. The solicitations appeared to offer credit cards with a $300 credit limit; however, consumers were immediately charged as much as $185 in inadequately disclosed fees, leaving them with as little as $115 in available credit.”

CompuCredit did not admit or deny liability in the settlement of the charges. A company spokesman did not respond for comment.

Subprime lenders have been reinventing themselves since the mortgage crisis hit, turning to conducting mortgage loan modifications or offering foreclosure counseling, Cecala said. CompuCredit’s affiliation with JumpStart fits that mold, he said.

On its Website, CompuCredit says it provides a “much needed second chance” to consumers overlooked by traditional financial institutions. It also lists financial literacy among its philanthropic activities. The company also features a “financial wellness” section, which includes a financial literacy guide for consumers.

Levine said Cheeks has been a consultant for Jumpstart for about five years. CompuCredit has been a coalition partner since at least 2007, she said.

CompuCredit has been involved in controversy over its financial literacy efforts before. The Southern Christian Leadership Conference drew criticism for entering into a 2007 partnership with CompuCredit, with plans for joint “economic empowerment” workshops aimed at educating minorities borrowers about credit, and a co-branded credit card.

“It’s a concern for the same reason the subprime lending problem should have been a concern five years ago,” said Geoff Smith, vice president at the Woodstock Institute. “There are certain communities that are more at risk, but if it goes unchecked … it has the potential to spiral and affect all parts of the economy.”

It’s certainly gone unchecked so far.

On stretches of Chicago’s North Side, they call some neighborhoods “condo ghost towns” now, because so many of those new developments are vacant. Neighborhoods that used to be considered trendy and on the way up are headed in reverse, blighted by vacancies and decline. This isn’t going away anytime soon. Washington may not see it yet, but people who live there are well aware that it’s going to take a very long time to rebound from this mess.

From American Banker:

Though the banking industry has opposed such a bill for two years, lawmakers have agreed to narrow the scope of the legislation to win industry support. So far, Citigroup Inc has indicated it would back the compromise. At a press conference this afternoon, lawmakers are expected to unveil a bill that would only apply to nontraditional loans originated before the law’s enactment date. The legislation would also require that borrowers made good-faith efforts to work with their lenders to rework their mortgages before initiating the bankruptcy process. Lenders who violated the Truth in lending Act would also waive certain priority creditor rights afforded under bankruptcy protection.

American Banker’s sources said Citigroup approached Sen. Charles Schumer, D-NY, with the possible compromise in December. The bank, the recipient of government bailout money, feared a tougher version would be enacted in a new Obama administration. Negotiations are ongoing, according to American Banker:

Citigroup’s negotiations continued this week with Sen. Richard Durbin, D-Ill., the primary Senate sponsor of the mortgage bankruptcy bill, and Senate Banking Committee Chairman Chris Dodd, who has been a vocal advocate of the legislation. “The senator has been in touch with Citi since last year and as recent as this week and is working together with Dodd and Durbin to try to make this happen,” said an aide to Sen. Schumer. It’s unclear how quickly the legislation could move — or whether other banks will sign on to the Citi deal. Sen. Schumer said in a statement he wants to attach the bill to the economic stimulus package.

Also there’s no word yet from housing advocates as to whether they’ll support the compromise. Still, considering the idea never had a chance of seeing daylight for the past eight years, any progress is better than nothing. The fact that banks and lawmakers are even tackling this also suggest how severe the foreclosure crisis has become.

Tanta also often taught the mainstream media a lesson, calling out reporters for doing lazy or misleading stories. And the fact that she could delve so deeply into a complicated subject and still attract a large audience probably was the biggest lesson of all, especially for newspapers laying off experienced reporters and pushing for shorter stories.

From Calculated Risk’s tribute:

Tanta liked to ferret out the details. She was inquisitive and had a passion for getting the story right. Sometimes she wouldn’t post for a few days, not because she wasn’t feeling well, but because she was reading through volumes of court rulings, or industry data, to get the facts correct. She respected her readers, and people noticed.

Here’s how the New York Times described her influence:

Thanks in large part to Tanta’s contributions, Calculated Risk became a crucial source of prescient analysis as the housing market at first faltered, then collapsed and finally spawned a full-blown credit crisis.

Tanta used her extensive knowledge of the loan industry to comment, castigate and above all instruct. Her fans ranged from the Nobel laureate Paul Krugman, an Op-Ed columnist for The New York Times who cited her in his blog, to analysts at the Federal Reserve, who cited her in a paper on “Understanding the Securitization of Subprime Mortgage Credit.”

Tanta’s real name was Doris Dungey, and she most recently lived in Upper Marlboro, Md. Most regular readers never even knew any of that. In the blogosphere she was just Tanta, and everyone who cared about the mortgage meltdown knew her name.

(flickr)

Given the reality of a credit crunch that shows few signs of easing despite the billions of dollars of government money thrown its way, an alternative to offering the new president-elect congratulations might be: “Welcome to hard times.”

The honeymoon period that most new presidents enjoy has probably been voided this time around. From Day One, as the former Democratic presidential candidate, Sen. Hillary Rodham Clinton used to say, President Barack Obama will face a financial crisis that only threatens to become more severe at the start of 2009. And it’s one for which there are no simple fixes — only controversial and painful remedies that may or may not work.

Illustration by: Matt Mahurin

“It’s really analogous to choosing a new skipper for the Titanic after it already hit the iceberg,” said Guy Cecala, publisher of Inside Mortgage Finance, which covers the subprime lending industry. “It’s not the kind of situation where the president can sit down and and concentrate on a plan. He’ll be in damage-control mode every single day.”

The first big problem: The subprime mortgage mess that has led to so many foreclosures already is only about three-quarters of the way through, Cecala said. Foreclosures overall set a new record — with a 71 percent jump in the third quarter of this year, according to RealtyTrac. But more are coming, and soon, as subprime loans with adjustable rates reset this month and in 2009, hiking monthly payments as much as 40 percent.

The Center for Responsible Lending predicts some 2.2 million subprime foreclosures in late 2008 and through the end of 2009.

As bad as that sounds, subprime loans aren’t the only — or even the worst — problem.

Alt-A loans, or liar’s loans, that required no income or employment verification, reach their peak default year in 2009. And Alt-A loans comprise a $1-trillion market, compared to the $885-billion total for subprime loans, according to Inside Mortgage Finance.

The Alt-A loans are already in trouble, with Bloomberg data showing 16 percent of loans made since January 2006 some 60 days late. RealtyTrac is forecasting further defaults in the next few years.

Most people don’t understand that the Alt-A market is larger than the subprime market, and don’t realize how much of the mortgage mess still remains, said Dimitri Papadimitriou, president of the Levy Economics Institute of Bard College in New York. “A lot of people really have no idea of the size of this,” he said. “If you want to paint a depressing picture, it’s quite possible.”

In the meantime, payment option adjustable-rate mortgages, that allow borrowers to choose the amount of their monthly payments, begin their three- and five-year resets in 2009, and continue for the next three years — or for the duration of new president’s entire first term.

These loans allow borrowers to pay only the interest on their loans for the first few years. But then their payments jump dramatically, and some borrowers may be facing increases as high as 63 percent, Fitch Ratings concluded recently. That kind of hike could add an extra $1,053 per month to a borrower’s payment.

“The POARMS are definitely the next disaster waiting to happen,” said Kathleen Keest, senior policy counsel at the Center for Responsible Lending.

It’s not likely that borrowers will sell or refinance their way out of any of this, given that the steep decline in home prices is only likely to continue. Nearly 1 in 6 homeowners now owe more on their mortgages than their homes are worth, according to Moody’s Economy.com.

“With more people upside down, if you lose your job, or someone gets sick or hurt, it’s even easier to make the decision just to walk away,” said Lawrence White, an economics professor at New York University’s Stern School of Business.

Add to that the deteriorating economy, which is likely to ensnare more and more prime borrowers, who could lose their homes to foreclosures because of rising unemployment, corporate cutbacks and layoffs.

“You don’t have to overanalyze the situation,” noted Cecala, of Inside Mortgage Finance. “All these problems are just going to get worse.”

Given all this, the new president may not be able to wait until he takes office to take action, said Desmond Lachman, a financial markets expert with the American Enterprise Institute. The credit crisis is so severe that Obama should begin stepping in immediately, possibly by using his position as a senator to propose a stimulus package, Lachman said.

Martin Feldstein, a Harvard University economics professor and adviser to the campaign of Rep. Sen. John McCain, first pushed that idea in a Washington Post op-ed last week. His point was that with both candidates also serving as senators, both had options to act early, if elected. From Feldstein:

Further legislation to deal with the economic crisis should not wait until the new president takes office. Fortunately, the president-elect will be a senator and can propose legislation without waiting to be sworn in as president. Immediately after Nov. 4, the winner could, and should, take the lead in the legislative process.

The problems with mortgages are just one piece of the bigger credit crisis, which has shown little sign of improvement despite the $700-billion government bailout, Lachman said. The auto industry is imploding, consumer confidence is at a record low, and home prices keep falling. Banks stubbornly refuse to lend. If the new president-elect waits until his term in office begins to start moving on the crisis, it could be too late, he said.

“The economy is literally falling off a cliff,” he said. “We’re just in this downward spiral. In my view, you can’t wait until March or something. There’s a lot riding on this.”

The new president will have to make decisions that may be bold, unorthodox and with unfortunate long-term consequences, Lachman said. But the dire economic situation will give him little choice.

And it’s not just the start of his term that will be consumed by the financial crisis, Lachman said. Obama may find his entire presidency defined by difficult economic times, just as Franklin Delano Roosevelt did, some 75 years earlier. Friday’s news conference on the economy – Obama’s first as president-elect — marks only the start of a long battle ahead.

Illustration by: Matt Mahurin

For the first time in more than a year, the nation’s decimated housing market is showing a spark of life. But like everything else that’s been turned upside down by the credit crunch, it’s not clear whether foreclosed homes selling at fire-sale prices are an encouraging sign — or just a false hope of a rebound that’s still nowhere on the horizon.

In hard-hit Southern California, sales of existing houses shot up by 65 percent in September, compared with a year earlier — the biggest annual increase in two decades, according to the real-estate information provider MDA DataQuick. Sales rose the most in areas where foreclosures drove down prices, the data showed. In the San Fernando Valley, the sales jump was even higher — 82 percent, with foreclosure sales spurring the spike.

Illustration by: Matt Mahurin

In Prince William County, Va., the heart of the exurbs of Washington, foreclosure sales are so hot they’ve set off a buying frenzy, with realtors who had long time on their hands busy once again. Foreclosure sales are also spiking in Atlanta, parts of Florida, Nevada and even in neighborhoods in Detroit, which barely experienced much of a housing boom to begin with.

The uptick in sales comes after a brutal 12 months for the housing market, which has been in free fall since the meltdown of subprime mortgages last year and the credit crunch that followed. In July, the nation’s inventory of unsold homes hit an all-time high of nearly 4.7 million, the National Assn. of Realtors said.

At the same time, home prices recorded their sharpest ever annual drop, falling 16.3 percent, according to the Standard & Poor’s/Case-Shiller Housing Index, a closely-watched measure. Meanwhile, foreclosures in the third quarter rose by 71 percent over the same period last year, RealtyTrac reported.

Given that dismal reality, any kind of movement in the housing market should be cause for celebration. But it’s way too early for champagne.

At L.A. Land, blogger Peter Viles of The Los Angeles Times took a closer look at the September sales figures for Southern California, and pointed out that sales of homes not in foreclosure actually fell — probably to their lowest levels in recent history. The Orange County Register blogger, Jon Lansner, concluded that sales last month were weakest in the county’s beach towns, which experienced far fewer foreclosures than in communities like Modesto or Stockton.

That helps explain why overall sales are up — while prices are still down. In the nine-county Bay Area, for example, the median sales price fell by 36 percent, while sales soared by 45 percent — leading The San Jose Mercury News to proclaim “Homes Sales Sizzle, Prices Fizzle.” That 82 percent sales jump in the San Fernando Valley, meanwhile, was accompanied by a 37 percent drop in median sales prices.

Even figures for new home sales released on Monday didn’t change the picture. The report from the U.S. Census Bureau showed a slight 2.7 percent increase in September sales, compared to August. But Calculated Risk noted that this marked the lowest September sales volume since 1981, and called the numbers “very weak.”

Foreclosed home in San Diego County, Calif. (Flickr: Sean Dreillinger)

Homebuyers are looking for Basement Bob-style real-estate bargains. And that’s about it.

“You’re going to see a lot of bottom-feeding right now,” said David Wyss, chief economist at Standard and Poor’s. “The vultures are out. But they’re providing a needed ecological service. We’ve got to get rid of these diseased properties.”

Wyss put a Churchillian spin on all this, explaining that selling off foreclosed properties is “a necessary phase” to the start of any housing recovery — it’s the end of the beginning. Still, there are reasons for the lack of enthusiasm among housing experts looking at these foreclosure sales.

It’s not clear yet what kind of buyers are purchasing the homes, said Danilo Pelletiere, research director of the National Low Income Housing Coalition, an advocacy group.

If a buyer is “an individual homeowner deciding to get off the fence” and buy, that’s a positive change, because there’s nothing worse for a neighborhood than a vacant, abandoned property. Plus, it means someone who might not have been able to afford a house in the past finally achieved a dream.

But if buyers comprise mostly investors and speculators, that could be a problem, Pelletiere said. It means the home might stay empty, which does little for the community.

And the property could keep falling into disrepair. Some speculators buy properties in bulk and hold them, which can artificially prop house prices up.

“We just don’t know who is buying the houses,” Pelletiere said. “The other problem is the degree to which the market still has yet to fall.”

In communities like Fairfax County, in Virginia, local governments are preparing to launch programs to buy up foreclosed properties and make them available to middle-income families looking for affordable housing. If the foreclosure market is hot, local authorities will be tempted to get in now and buy the homes.

Fairfax County alone is preparing to spend $10 million and buy up to 200 homes. But if the values of those homes drop, the local government will take a financial hit, Pelletiere said.

All this is a difficult balancing act for local governments, that have to figure out how to time the market correctly — something that has tripped up everyone from Donald Trump to amateur speculators who watch late-night infomercials.

It’s hard enough to do in ordinary times. With a credit crunch, it could become a guessing game. This means the first opening in years for affordable housing will be increasingly difficult to navigate, said Peter Tatian, a senior research associate at the Urban Institute, who studies subprime lending and housing policy.

“This whole situation is unprecedented,” Tatian said. “There is an opportunity here to take advantage — in terms of affordable housing. It looks like people are finding a lot of bargains right now. But it’s also unfortunate that a whole lot of people had to suffer first. That makes it hard to say if the foreclosure sales are a good thing or a bad thing. We don’t know how much they are going to help in the long term.”

The sales spike in Prince William is particularly noteworthy, because prices rose to record highs here during the boom and fell just as hard. Prince William, along with Prince George’s County in Maryland, last spring racked up foreclosures at one of the fastest rates in the nation, according to a study by George Mason University’s School of Public Policy.

Lance Young, a real-estate investor in Northern Virginia, said he’s still shying away from buying foreclosures in Prince William: “It’s too hairy there,” he said, referring to the sharp swings in home prices.

It’s also difficult for investors to buy up the kind of five-bedroom, luxury homes that fill Prince William’s subdivisions and rent them out, because you can’t charge enough to cover the mortgage payment, Young said. He thinks prices still have far to fall, with more foreclosures looming.

“There’s still a lot of pain out there,” he said. “We’re only halfway through this thing.”

In recent months, Young has bought four foreclosed houses inside the Washington Beltway, far closer in to the District of Columbia than Prince William County. He flipped three, and lives in one.

It’s not like the old days of four or five years ago, when you could buy a house, demand any price, and quickly sell it, he said. Young gets his foreclosed houses at a steep bargain, meticulously rehabs them and then sells them for modest profits.

Everything’s different now, Young said. It’s not worth it to buy out in the exurbs like Prince William, because house values have fallen so far, they no longer compensate for the long commute.

Foreclosed houses are often in bad shape, making wading into that market an expensive venture. Young has viewed houses where the former owners let the taps run, locked the doors and left. By the time neighbors saw water pouring from the house, the hardwood floors were ruined.

All around the country, losses on foreclosures have been higher than lenders expected, S&P’s Wyss said. Banks have far more foreclosures than expected on their hands, and they have no experience at managing so many. It’s one reason why foreclosure prices are so low, and may not climb much.

There’s more to complicate the question of a rebound. The foreclosure sales spike happened in September, before the credit markets imploded. Buyers might have gotten loans in September, but they might not get them now. In addition, winter is coming, traditionally a slow time for real-estate sales.

The spikes in foreclosure sales could mean the end of the beginning, as Wyss says. But in a credit crisis in which banks just aren’t lending, and homes that haven’t been foreclosed on aren’t selling, it could also be true that the end of the beginning remains nowhere in sight.

The list of major subprime lenders for 2006 and 2007 resembles the casualty roster from the Battle of Verdun in World War I. Only difference: way fewer walking wounded this time.

Of the 30 biggest subprime home lenders in 2006, measured by dollar volume, 22 have gone bankrupt, shut down, been sold or been seized by Uncle Sam. Most of the survivors have scaled back.

I guess the warnings all those years from the housing and consumer groups who regularly testified before the Federal Reserve were right on the mark after all. Too bad no one ever listened. The only bright spot here: It’s not like we’ll miss any of these lenders.

RIP, subprime.

And remember about the door on your way out.

Our story Tuesday outlined that argument, in which conservatives blame the Community Reinvestment Act for the flood of subprime lending that led to the housing meltdown.

Morris, however, says it’s clear that competition drove bad lending. Consider a 2005 Standard & Poor’s report that reviewed a sample of collateralized debt obligation deals, or CDOs. The CDOs are investment-grade securities backed by a pool of bonds, loans and other assets.

The CDOs used mortgage-backed securities as collateral, and judging by the sample, “there appears to be a high preference for subprime over prime” securities, S&P reported. Subprime represented 62 percent to 75 percent of the residential mortgage-backed securities in 31 of 39 transactions, the report said.

And why did investors choose subprime over prime?

Simple. High yields, S&P explained.

Which is just what we said – profits, not poverty activists, were at the root of subprime’s growth.

Even in 2005, S&P seemed to raise a few warning flags about all this, although clearly no one paid much attention. From the report:

In addition to the risk of housing price declines and higher interest rates that could affect the

performance of the RMBS (Residential Mortgage-backed Security) market, structured finance CDO managers are concerned with the payment shock associated with some of the affordability products. This concern is especially acute because these products are being offered to subprime borrowers with lower FICO scores and higher LTVs.

But the subprime mortgage-backed securities market rolled on. By 2006, subprime and Alt-A loans comprised 41 percent of all new mortgages issued. We all know the story from there.

The lesson from this, when it comes to claims that low-income borrowers are to blame for the ailing financial system: follow the money, not the rhetoric.

U.S. Department of Treasury (U.S. Department of Treasury)

Part 1: U.S. Failing to Defend Dollar

The U.S. national debt is rapidly rising. If Congress signs off on the Bush administration’s $700-billion rescue plan for Wall Street’s troubled financial markets, the debt ceiling will have to be raised to $11.3 trillion. The debt was $9.4 trillion in March. An immediate response to the bailout plan was a falling dollar, which so far has lost half its summer gains in trading this week.

A big chunk of U.S. debt is owned by foreign investors whose currencies’ values are rising relative to the dollar. Already, many have sustained investment losses because of the dollar’s fall in value. With the dollar now losing ground because of the financial crisis on Wall Street, at what point will foreign investors stop buying U.S. Treasuries entirely and throw the country into a debt crisis? Indeed, why hasn’t Washington experienced a sovereign debt crisis before?

The real reason the United States has avoided such a fate is that it finances its debt in dollars. That means Washington can literally print dollars to service and repay its obligations.

America’s special status derives in part from the fact that the dollar is the world’s major reserve and trading currency. The dollar was also once pegged to the gold standard, though that peg, of course, is long gone. But the aura of stability created by the strength of U.S. economic and military power has continued to support the dollar.

But the dollar’s dominance in world markets may be coming to an end. Even when the dollar was rising this year, there was talk of re-denominating trade flows and pricing commodities like oil and agricultural produce in other currencies. Now, with the greenback reversing course, such talk is likely to return.

Illustration by: Matt Mahurin

They is no shortage of signs that the dollar has fallen out of global favor. In the early 1970s, Japanese exports were invoiced almost exclusively in dollars; today only 50 percent are. The Taj Mahal does not accept payment in dollars for its admission fee — only rupees, India’s currency. Some supermodels, even drug dealers, want to be paid in euros, not dollars.

Foreign investors, including central banks, have reduced their dollar-based investments. The percentage of dollars in total world reserves has fallen from a high of 72 percent to around 60 percent. Dollars held outside the U.S. have declined from 1.83 percent of world trade in 2002 to 1.22 percent in 2006.

Foreign investor demand for U.S. Treasury bonds has also softened. Low nominal (negative real) interest rates and the weakness of the dollar are to blame. So is the declining credibility of the Federal Reserve and U.S. Treasury.

For example, foreign investors in Fannie Mae and Freddie Mac debt had long regarded it as “implicitly” backed by the U.S. government. They, as well as more than 60 central banks, hold more than $1,400 billion in debt securities issued by of U.S. agencies, including Fannie Mae and Freddie Mac.

But the travails brought on by the housing meltdown in the United States raised questions about the two mortgage giants’ ability to met their debt obligations. On July 23, the Financial Times reported that the U.S. embassy, after Kuwait’s minister of finance announced that the fund was no longer planning to invest in the agencies’ debt, called the Kuwait Investment Authority, the world’s sixth-largest sovereign wealth fund, to reassure it that bonds issued by Fannie Mae and Freddie Mac were sound. As it turned out, foreign-investor concerns that the mortgage companies would default on their debt in part triggered the U.S. government’s takeover of Freddie and Fannie.

That was in early September. As October nears, Washington needs an estimated $1 trillion to complete its rescue of troubled financial institutions weighed down by toxic mortgages and mortgaged-backed securities. Will foreign investors continue to step up and buy U.S. debt at a time when the creditworthiness of the world’s biggest borrower is under a cloud?

Scrooge’s nightmare, described by Charles Dickens, in which “solid” British assets are changed into “a mere United States security” may become a reality.

At a minimum, Washington will probably have to pay higher interest rates to finance its insatiable borrowing. Ultimately, it may even be forced to finance its debt in a foreign currency. This would expose Washington to currency fluctuations. But, most important, it would not be able to service its debt by printing money. Like all borrowers, Washington would face the discipline of its creditors.

For the moment, however, the dollar is hanging on -– barely. To a degree, this reflects weakness in the euro and yen because of Europe’s and Japan’s economic slowdowns.

The dollar is also a beneficiary of the “too big to fail” syndrome. Foreign investors — especially central banks and sovereign wealth fund investors in East and South Asia, Russia and the Persian Gulf — hold substantial dollar investments that would sustain catastrophic losses if the U.S. were to default on its debt.

The International Monetary Fund estimates that the Gulf Cooperation Council — Saudi Arabia, the United Arab Emirates, Qatar and other Gulf States — could lose $400 billion if they stopped pegging their currencies to the dollar.

So what must the U.S. do?

In 1989, economist John Williamson described a set of economic prescriptions, which he coined as the Washington consensus, that became the “standard” reform package that the International Monetary Fund imposed on countries wracked by economic crisis. The controversial–and highly criticized–package included calls for more fiscal policy discipline; less public spending on subsidies; tax reform; market-determined interest rates; competitive currency exchange rates; trade liberalization; reducing barriers to foreign direct investment; privatization of state enterprises; and deregulation. While many regard this formula as discredited, others still attest to it.

These prescriptions were intended for emerging markets. But, certain aspects of the package could be seen as appropriate for the world’s leading economic power — and premiere borrower.

Some of these elements–fiscal discipline, for example–will be politically difficult to achieve in Congress. Moves to cut farm subsidies face deep-seated opposition. Tax reform seems unattainable. And welcoming more foreign investment is politically dicey. Surveys show that most Americans want U.S. companies to remain in U.S. hands.

But the weak dollar has triggered the “closing down sale” of U.S. assets. On Sept. 29, shareholders of InBev, a Belgian-based brewer, will vote on the company’s $52 million bid for U.S rival Anheuser-Busch, the brewer of Budweiser, the quintessential American beer. Abertis Infraestructuras, a Spanish company teamed with Citigroup, bid $12.8 billion to lease and operate the Pennsylvania Turnpike, America’s oldest major toll road, for the next 75 years. And sovereign wealth funds have provided much of the capital needed to re-capitalise the U.S. financial system buffeted by the housing meltdown. In return, they have acquired major stakes in U.S. companies.

Stephen Schwarzman, head of Blackstone, a private equity firm, put it this way in an opinion piece in the Financial Times in June: “The U.S. is the world’s largest debtor nation and we are now in an uneasy relationship with our creditors. … If we were forced to rely mostly on domestic borrowing, we would have to pay very high interest rates. The consequences would be increased inflation, a dollar falling even faster and very slow [or negative] economic growth. If the investment climate for [sovereign wealth funds]is poor in the U.S., the countries with large dollar reserves (which are the owners of most of the sovereign wealth funds) could … look for alternatives.”

The “adjustment” may be under way. The dry, measured economic prose of the Washington consensus does not capture its human elements. It would require reductions in U.S. real wages and living standards on a scale unfathomable to most Americans.

If you doubt this, just ask the average citizen of any country that has taken the IMF’s “cure.”

Despite its gargantuan appetite for borrowing, there is much to admire about the United States. It remains far wealthier than the new economic titans China and India. It is peerless as a science and technology powerhouse, accounting for 40 percent of total world spending on research and development. Between 1993-2003, America’s growth rate in patents averaged 6.6 percent a year, compared to 5.1 percent for the European Union and 4.1 percent for Japan. America’s economy, with its growing population, secure legal and property rights and well-developed financial markets, remains highly attractive to investors.

But as Warren Buffett 2006 letter to shareholders observed, “Foreigners now earn more on their U.S. investments than we do on our investments abroad … In effect, we’ve used up our bank account and turned to our credit card. And, like everyone who gets in hock, the U.S. will now experience ‘reverse compounding’ as we pay ever-increasing amounts of interest on interest. …. no matter how rich you are, borrowing on top of borrowing is not a great long-term financial plan. I believe that at some point in the future, U.S. workers and voters will find this annual ‘tribute’ (of interest payment on the debt) so onerous that there will be a severe political backlash … How that will play out in markets is impossible to predict– but to expect a ’soft landing’ seems like wishful thinking.”

And here’s what Economist magazine said: “[P]ublic credit depends on public confidence…The financial crisis in America is really a moral crisis, caused by the series of proofs …that the leading financiers who control banks, trust companies and industrial corporations are often imprudent, and not seldom dishonest. They have mismanaged…funds and used them freely for speculative purposes. Hence the alarm of depositors and a general collapse of credit…”

Those words appeared in the Nov. 2, 1907, issue of the magazine in response to the Panic of 1907, when a crashing stock market led to a run on banks and trust companies.

The U.S. faces a challenge to reestablish its economic credentials. Without drastic and radical action, America’s ability to continue to borrow from foreign investors to finance its escalating debt is likely to become ever more difficult.

Satyajit Das is a risk consultant and author of “Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.”

At the time of publication the author or his firm did not own any direct investments in securities mentioned in this article though he may be an owner indirectly as an investor in a fund.

It would not be such a bad idea for Wall Street to do the same now.

There are plenty of quality community colleges, for example, and there’s probably still time to sign up for a course each week in understanding investments.

Tanta at Calculated Risk – a mortgage broker by trade – has some additional thoughts on this. She’s among a growing number of people calling for the bailout to include some punitive measures for Wall Street, or some provisions to help homeowners.

One would be to allow bankruptcy judges to modify mortgage loans — so the borrower would owe the fair-market value on the home, not the inflated loan amount.

Here’s Tanta:

What I really really like is the idea of subjecting CEOs to the same petty humiliation everyone else gets treated to. I suggest that for every separate asset these CEOs sell to the government, they be required to write a Hardship Letter over a 1010 warning (that’s a reference to the statute forbidding lying in order to get a loan) explaining why they acquired or originated this asset to begin with, what’s really wrong with it in detail, what they have learned from this experience, and what steps they are taking to make sure it never happens again.

Furthermore, the Treasury Dept. will empanel a committee of the oldest, most traditional, and bitterest mortgage-loan underwriters — preferably those downsized to make way for automated underwriting systems — to review these letters and opine on their acceptability.

Look for more calls for Wall Street to take some hits in return for $700 billion from taxpayers.