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.”)

“Insolvency is a somewhat kind word,” Darity says, referring to both the foreign debt crisis of the ’80s and the current financial mess. “Really, the banks are bankrupt.”

In August 1982, Mexico’s minister of finance told U.S. Treasury officials and the International Monetary Fund that his country would not be able to make an interest payment on an $80 billion debt. Several other countries, including Brazil, Argentina, Chile and Venezuela soon announced that they too would not be paying interest on loans from Wall Street. It was obvious that the national economies of these highly indebted countries could not generate the funds necessary to pay off the U.S. banks.

The government has a non-bailout solution for this problem, but it simply refused to use it with big banks during the Latin American debt crisis and in today’s mortgage implosion. When banks destroy themselves with predatory loans, the government is supposed to take them over and work out their troubled loans with borrowers.

Shareholders who made bad bets on a busted bank get wiped out, and the management team responsible for the problem is shown the door. Eventually, the rehabilitated loans that borrowers can now afford get sold to a new set of investors and borrowers get relief.

In the ’80s, instead of requiring Citibank, Bank of America and JPMorgan to write off loans that were obviously never going to be paid back in full, regulators adopted a policy of simply looking the other way. Regulators knowingly allowed banks to pretend that their loans to foreign governments were perfectly healthy, ignoring the fact that the banks had not only suffered losses, but were essentially kaput.

It would be nearly five years after the debt crisis began before banks started accounting for losses on their loans to Latin American governments, according to the FDIC, with Citibank becoming the first to do so in May 1987.

This proved extraordinarily destructive to the economies of developing nations, particularly in Latin America. Accounting giveaways made it unnecessary for banks to acknowledge reality, so instead of reducing the overall size of the loans, they only haggled over individual interest payments.

“That was a major economic and political disaster,” says Luiz Carlos Bresser-Pereira, who served as finance minister of Brazil during the debt crisis. Bresser-Pereira was at the heart of Brazil’s debt negotiations with the U.S. Treasury Department, major U.S. banks, the IMF and the World Bank.

Enormous portions of the national economy in countries like Brazil became completely devoted to meeting one-off interest payments.  Once each payment was made, a new round of negotiations would begin for the next payment.

Long-term solutions that allowed the economies of countries like Brazil to recover were off the table. Actually reducing how much Brazil owed would have required the banks to take losses, but regulators would allow banks to value the original bad loans at full price. In several cases, banks even issued more debt to countries to help them pay the interest on old loans, building up an even bigger mountain of debt and putting even more pressure on their economies.

“This meant that they didn’t work out the loans for years and years and years, and so the interest carry got bigger and bigger,” Black says. “When they were paying high interest, people are actually suffering malnutrition. It’s a big deal in that context.”

When Bresser-Pereira initially began discussions with big U.S. commercial banks and the IMF, his country had imposed a “moratorium” on its debt — it was refusing to make interest payments until banks agreed to a long-term solution that would allow Brazil to get moving again. But banks were focused exclusively on short-term fixes.

“They asked me to suspend the moratorium, and I said, ‘Look, I will not suspend the moratorium if I do not have a good solution to the debt crisis. If we just suspend the moratorium and are not able to pay the debts, this makes no sense at all.’ ”

Banks did not begin to seriously negotiate with developing nations on the full scope of their debt burden until they had actually started accounting for big losses on those loans.

In 1987, when the U.S. banks were first starting to see some red ink from their loans to foreign governments, Bresser-Pereira pitched a plan to the Treasury Department that would reduce Brazil’s total debt burden. As banks wrote down the value of their loans, they became more willing to reduce that debt burden.

“It would have been much better for them to have agreed earlier, for sure,” Bresser-Pereiera says. “In 1987, they already knew that some of the money was lost, and they had already written it off in their balance sheets. So what they wanted was to continue to make business.”

It is important to note that serious negotiations only began in 1987 — Brazil would not actually reach formal agreements with its U.S. creditors until the early 1990s.

“This also relates to the accounting practices that are involved in the current crisis,” Darity says. “The foreign loans could be kept on the books as performing for far longer than domestic loans when the borrowers went into arrears. There are some similar kinds of accounting high jinks … in the current crisis.”

The order here is crucial. Banks do not worry about borrowers’ problems until their balance sheets make it financially acceptable to do so. By making it even easier for banks to hide losses on their balance sheets, regulators are approaching the issue precisely in reverse.

They should be forcing banks to take losses from bad lending, so that they have strong economic reasons to cut their losses and help borrowers stay in their homes. If banks do not have the funds to withstand the losses, the government should take them over and take care of their borrowers.

Instead, the government is protecting the banks, which are in trouble for engaging in predatory subprime lending, while the borrowers targeted by those lending schemes receive no relief.  

The Latin American debt crisis experience makes it pretty easy to predict the effects of today’s accounting trickery: banks will do everything in their power to keep borrowers under their current loan contracts so they don’t have to take massive losses on their balance sheets. This will involve short-sighted solutions that hurt homeowners and the broader economy.

We are already seeing some of this behavior from banks. According to Valparaiso University Law Professor Alan White, most borrowers who renegotiated the terms of their loan with their bank in the fall of 2008 actually ended up owing the bank more than they had previously.

Unlike the Latin American debt crisis, however, banks will not be shipping the economic calamity overseas this time — they’ll be detonating it in neighborhoods around the United States. But, as with the crisis of the 1980s, the culpable loan pushers will be saved, while the troubled borrower will be screwed.

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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