I spoke to a friend of mine who has run and/or owned a mutual fund for decades, one run on the old-fashioned notion that you look at companies, analyze their prospects for profit, take a large position in the best companies and then persuade others to buy your mutual fund based on your analytical acumen and management skills you bring into those companies as a major shareholder. (It's actually the way capitalism ought to work.)
My friend convinced me that there was not that much to understand - not in retrospect, anyway. Once he walked me through the scheme, it set me to wondering why people actually don't want the derivatives market more-tightly regulated.
A Washington Post-ABC News poll issued Monday showed "that on the complicated topic of derivatives... 43 percent [of respondents] support federal regulation of the vast derivatives market; 41 percent are opposed; and 17 percent, nearly one in five people, expressed no opinion on the topic."
Something tells me that those who are either opposed to regulating derivatives or have no opinion essentially haven't a clue as to what a derivative is and therefore have no idea how fertile the derivative field is when it comes to the opportunity for creating fraud.
And fraud it was that melted down the American and world economy in the last few years. The lynchpin of the meltdown was the issuance of billions of what William K. Black, (a lawyer, professor and the Executive Director of the Institute for Fraud Prevention from 2005-2007), calls "liars loans," taking his lead from the term used by executives who ran "specialty" loan companies - companies that market loans to marginally risk-worthy people.) Yes, internally the executives actually used the term "liars loans." These corrupt executives knew much more than anyone is insisting upon, including members of both major political parties. We know these loans also as ninja loans, sub-prime mortgages, and adjustable rate mortgages (ARMs).
A liars loan is a mortgage (or in some cases auto or commercial loan) whose sole criteria is based on the mortgagee's attesting to his or her creditworthiness without back up information. In an interview, Black said, "Liars loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets."
One company alone, IndyMac, generated more bad loans than were generated during the entire Savings and Loan Scandal of the 80s and 90s. Counterintuitively, these loan institutions listed such loans as "assets."
On the strength of those assets, loan institutions took such loans and "bundle" them, and "sell" them to other institutions, more likely than not an investment bank such as Goldman-Sachs. The loan institution is then able to take the new capital they have received from the investment banks for the old (liar) loans and lend more money to the non-creditworthy. You can practically see the pyramid a-building. In return, the investment bank draws off some portion of the interest paid on the mortgages in the bundle plus fat fees for the deal.
In the beginning, the Goldmans of the world knew that the bundles contained some unbelievably risky loans, but also some stable ones. They calculated the risk-reward ratio and ran with it. Why? Because they knew not that the loans would be paid off, but that the default ratio would be very, very high. Crazy, eh? Read on.
As the pool of truly creditworthy borrowers dwindled, opportunities for banks and other loan institutions to lend good money to good risks practically evaporated. (The creditworthy pool moves at its own relatively slow, steady pace; as one might assume, it is large but nevertheless limited.) More poor risk borrowers had to be found. And they were. People with $65,000 incomes were buying houses selling for $450,000 with $420,000 mortgages and $3,000-per-month payments on top of taxes, utilities, etc. (Of course, all this fraudulently issued credit also had the incidental effect of artificially driving up housing costs, costing good-risk home owners billions in equity in homes they purchased at peak price only to find the prices plummeting. This made ALL home prices fall. Many of the good-risk types also, based on this false inflation of prices, took out home equity loans, i.e., second mortgages, and found themselves now the proud owners of a total debt that outweighed the deteriorated value of their homes.)
Next the investment banks who took the bundles began using them as collateral to make other deals with other financial institutions that then used them to make more deals, down the line. Thus, the Ponzi aspect of it. But along the way, because of the sterling reputation of Goldman and its ilk, these junk status bundles, bathed in the reflective glory of grand institutions, rose to AAA ratings. Solid institutions like pension funds, college endowments, and municipalities with investment portfolios snapped them up at sky-high prices. Got it?
Something tells me that those who are either opposed to regulating derivatives or have no opinion essentially haven't a clue as to what a derivative is and therefore have no idea how fertile the derivative field is when it comes to the opportunity for creating fraud.
And fraud it was that melted down the American and world economy in the last few years. The lynchpin of the meltdown was the issuance of billions of what William K. Black, (a lawyer, professor and the Executive Director of the Institute for Fraud Prevention from 2005-2007), calls "liars loans," taking his lead from the term used by executives who ran "specialty" loan companies - companies that market loans to marginally risk-worthy people.) Yes, internally the executives actually used the term "liars loans." These corrupt executives knew much more than anyone is insisting upon, including members of both major political parties. We know these loans also as ninja loans, sub-prime mortgages, and adjustable rate mortgages (ARMs).
A liars loan is a mortgage (or in some cases auto or commercial loan) whose sole criteria is based on the mortgagee's attesting to his or her creditworthiness without back up information. In an interview, Black said, "Liars loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets."
One company alone, IndyMac, generated more bad loans than were generated during the entire Savings and Loan Scandal of the 80s and 90s. Counterintuitively, these loan institutions listed such loans as "assets."
On the strength of those assets, loan institutions took such loans and "bundle" them, and "sell" them to other institutions, more likely than not an investment bank such as Goldman-Sachs. The loan institution is then able to take the new capital they have received from the investment banks for the old (liar) loans and lend more money to the non-creditworthy. You can practically see the pyramid a-building. In return, the investment bank draws off some portion of the interest paid on the mortgages in the bundle plus fat fees for the deal.
In the beginning, the Goldmans of the world knew that the bundles contained some unbelievably risky loans, but also some stable ones. They calculated the risk-reward ratio and ran with it. Why? Because they knew not that the loans would be paid off, but that the default ratio would be very, very high. Crazy, eh? Read on.
As the pool of truly creditworthy borrowers dwindled, opportunities for banks and other loan institutions to lend good money to good risks practically evaporated. (The creditworthy pool moves at its own relatively slow, steady pace; as one might assume, it is large but nevertheless limited.) More poor risk borrowers had to be found. And they were. People with $65,000 incomes were buying houses selling for $450,000 with $420,000 mortgages and $3,000-per-month payments on top of taxes, utilities, etc. (Of course, all this fraudulently issued credit also had the incidental effect of artificially driving up housing costs, costing good-risk home owners billions in equity in homes they purchased at peak price only to find the prices plummeting. This made ALL home prices fall. Many of the good-risk types also, based on this false inflation of prices, took out home equity loans, i.e., second mortgages, and found themselves now the proud owners of a total debt that outweighed the deteriorated value of their homes.)
Next the investment banks who took the bundles began using them as collateral to make other deals with other financial institutions that then used them to make more deals, down the line. Thus, the Ponzi aspect of it. But along the way, because of the sterling reputation of Goldman and its ilk, these junk status bundles, bathed in the reflective glory of grand institutions, rose to AAA ratings. Solid institutions like pension funds, college endowments, and municipalities with investment portfolios snapped them up at sky-high prices. Got it?
Enter William Black again: "This stuff, the exotic stuff that you're talking about was created out of things like liars' loans, that were known to be extraordinarily bad. And now it was getting triple-A ratings. Now a triple-A rating is supposed to mean there is zero credit risk. So you take something that not only has significant, it has crushing risk. That's why it's toxic. And you create this fiction that it has zero risk. That itself, of course, is a fraudulent exercise. And again, there was nobody looking during the Bush years. So finally, only a year ago, we started to have a Congressional investigation of some of these rating agencies, and it's scandalous what came out. What we know now is that the rating agencies never looked at a single loan file. When they finally did look, after the markets had completely collapsed, they found, and I'm quoting Fitch, the smallest of the rating agencies, 'the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined.'"
Meanwhile, back at Goldman, et al, the executives connived at an even more diabolical plot. These bundles - the derivatives - are traded like any other stock or commodity, meaning that their value can move up or down as the market honestly - in normal circumstances - dictates. Just as if he is buying shares in Ford Motors, the basics trader can buy shares in these bundles, hoping, of course, that they move up at which point he sells to make a profit.
In parallel, more sophisticated traders can also buy futures contracts, essentially bets on which way the value of the bundles will move. Goldman bet on their own deals to go down because they knew all along the value of the bundles would sink like a stone. And they made tens of billions when the deals went south.
Now we have junk loans bundled together then sold to investment banks who then repackaged and resold them while goosing the ratings on the bundles, all the while betting the value will go down. Makes your skin hurt, doesn't it? This is why there was guillotining during the French Revolution. Let them eat cake? Hah, let them eat bundles.
From 65 to 80% of the bundles were composed of bad loans. Terrible in a great economic climate, but cataclysmically toxic in even a mild downturn. As the bank/investment bank/insurance company beast grew hungrier and defaults occurred on the original liars loans, the rates on the surviving original mortgages were raised. The mortgagee paying the barely-affordable $3000 discussed above, now had to pay, $3600 per month and simply could not afford to. Thus began the foreclosure domino debacle. Everyone along the chain fell prey to the ravening, from borrower to specialty loan institutions, from building developers to banks that lent money to the loan institutions, from building supplies dealers to governments who had reckoned on tax revenues from the new home owners who now were in default.
All except... Goldman and its fellow fraudsters, all of whom made money every step of the way right down to and after the deep default period because, after all, they had bet on the value of the bundles going down.
The last word of this chapter goes to Mr. Black: "The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again... this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis."
Posts
No comments:
Post a Comment