(I am quoting above from the print edition which arrived for us today in the U.S. mail. The subtitle is: They had a party. Now you’re going to pay.)
If you’re having a little trouble coping with what seems to be the complete unraveling of the world’s financial system, you needn’t feel bad about yourself. It’s horribly confusing, not to say terrifying; even people like us, with a combined 65 years of writing about business, have never seen anything like what’s going on. Some of the smartest, savviest people we know ”” like the folks running the U.S. Treasury and the Federal Reserve Board ”” find themselves reacting to problems rather than getting ahead of them. It’s terra incognita, a place no one expected to visit.
Every day brings another financial horror show, as if Stephen King were channeling Alan Greenspan to produce scary stories full of negative numbers. One weekend, the Federal Government swallows two gigantic mortgage companies and dumps more than $5 trillion ”” yes, with a t ”” of the firms’ debt onto taxpayers, nearly doubling the amount Uncle Sam owes to his lenders. While we’re trying to get our heads around what amounts to the biggest debt transfer since money was created, Lehman Brothers goes broke, and Merrill Lynch feels compelled to shack up with Bank of America to avoid a similar fate. Then, having sworn off bailouts by letting Lehman fail and wiping out its shareholders, the Treasury and the Fed reverse course for an $85 billion rescue of creditors and policyholders of American International Group (AIG), a $1 trillion insurance company. Other once impregnable institutions may disappear or be gobbled up.
The scariest thing to average folk: one of the nation’s biggest money-market mutual funds, the Reserve Primary, announced that it’s going to give investors less than 100 cent on each dollar invested because it got stuck with Lehman securities it now considers worthless. If you can’t trust your money fund, what can you trust? To use a technical term to describe this turmoil: yechhh!
There are two ways to look at this. There’s Wall Street’s way, which features theories and numbers and equations and gobbledygook and, ultimately, rationalization (as in, “How were we supposed to know that people who lied about their income and assets would walk away from mortgages on houses in which they had no equity? That wasn’t in our computer model. It’s not our fault”). Then there’s the right way, which involves asking the questions that really matter: How did we get here? How do we get out of it? And what does all this mean for the average joe? So take a deep breath and bear with us as we try to explain how financial madness overtook not only Wall Street but also Main Street. And why, in the end, almost all of us, collectively, are going to pay for the consequences.
Read it all. If you want to know what I meant in my comment below about monocausal explanations, the Time Magazine print cover is exhibit A–KSH.
I read these things and think that I am on some other world. Surely this is not Earth and the United States loan industry. When I get a mortgage I have to sign multiple forms as to who I am, my finances, race, gender, etc., etc.. It is one of the most regulated industries this side of the old USSR. So, amongst all this many layers of regulation, how did so many loan officers make so many bad loans? And, why is no one else asking the question?
There is more in this pot than the broth that you get from mass media. There is meat down in there. Will we ever get it?
Don
I just wonder if everyone that took out a mortgage continued to pay that mortgage, would we be in this mess? As much as the media and politicians are painting this as a bailout of Wall Street, I wonder if it isn’t a bailout of the deadbeat American Borrower.
#2 No, we wouldn’t be. But that is the point: the F&F;originated paper used a federal guarantee that there would be no signficant foreclosure rate and loss of principal. The risk of the underlying real estate transactions was not properly used to correctly establish interest rates or downpayment requirements. So, the government effectively had to absorb the issuing companies.
roberts..you are a renaissance man if I ever saw one.
Anything but an admission of Wall Street’s full and knowing complicity because BY ALL MEANS we must defend the wisdom on the “free market.”
Kendall, thanks for posting the Time’s story.
This whole thing is the result of Government social policy. The social policy pushed by politically correct legislators and regulators has been to provide housing for the economically marginal populace. In some respects, the pressure was applied to lending institutions to accomodate those who would normally be refused credit at the local five and dime. Another aspect was the perceived lack of risk when mortgages were consumated and immediately sold . That would work in an upmarket but woe to those holding that marginal paper when the down market hit – as we are now seeing. The house of cards came tumbling down and we will all be saddled with the consequences for generations to come as part of a socialist solution.
http://www.youtube.com/watch?v=bIxADYfdpD0
From Bloomberg:
McCain says of [b]Wall Street,[/b] “Mismanagement and greed became the operating standard†and does not single out Fannie and Freddie as the sole or even primary culprit. There is a pathological resistance to admitting the truth of this — Wall Street mismanagement and greed both knowing and complicit.
centexn: I know Roberts. You’re right.
[blockquote] even people like us, with a combined 65 years of writing about business, have never seen anything like what’s going on [/blockquote]
Assuming that they are referring to at least two or more people with a combined 65 years of service they must have an average age of 38 or less years of writing about business. Maybe Time magazine and the rest of the news media should have kept some of their older writers who don’t panic so easily. But then the bail out might not have happened so fast.
Did Fannie Mae and Freddie Max back baloon mortgage loans?
There is one thing which have caused this mess, and two ways it happened. The one thing is greed. The two ways are, 1. Short selling, where I sell some shares I don’t own in the expectation the price will fall and I can buy them cheaply. Now I’m sorry, but selling something I don’t actually own sound a lot like fraud to me. It should never have been legal to do this.
2. The second is not just the dodgy loans themselves, but that the banks traded and sold these loans as assets. The paper trail on some of these loans is apparently so confused, that some borrowers are in a position of being able to challenge the foreclosure, because the institution doing the foreclosure can’t actually prove the debt. I borrow from bank A, I owe money to bank A. If Bank A sells my debt to bank B without my knowledge and while still holding my morgage then as far as I can see I still own money to Bank A. Bank A may own something to Bank B, but that looks like a separate transaction to me.
Jon R
10 One of the big contributing reasons for the current mess is that F&F;relaxed its mortgage equity requirements in order to increase their ability to lend in “above average valued markets” (which would be better described as over priced). So, lower down payments and bigger balloons were part of what ensued.
11 Second point: agreed. But short selling is just the reverse of buying on margin. In fact, in order to do so, you have to “possess” the shares sold. How is that done? The brokerage house matches up its in-house accounts who hold company XX shares with the shares that you wish to short sell. The lending account gets paid for that usage at a normal rate of interest, plus accrued dividends, as now someone else actually owns the stock. Eventually the short sale has to be covered; the shares repurchased and returned to the lender. So the sale of the stock is physically by the original owner, but all the transaction risk and gain accrues to the short seller. There is nothing mysterious or duplicitous about this process. The same economic role is played by the futures markets, in which any number of participants offer to sell in the future shares or commodities they never will own or offer to buy same when they have no intention of ever receiving it (the futures exchanges have special jokes about people who forget to close out their calls on say, porkbellies, and then have to take possession of the actual items).
What the goverment needs to do is get the construction industry back to work on highways, roads, airports, bridges, government buidings, etc. What is needed is time for the excess inventory of single family homes to be absorbed. They need to contract with construction companies for these things. The sooner the better.
There is fraud all over this fiasco, and a large number of people should go to jail for a large period of time.
Moreover, the government’s selective bailout is just another movement toward a culture in which its inhabitants (I hesitate to call them “citizens,” because that would imply some degree of reciprocal responsibility on their part) are “insured” by the government, i.e., responsible taxpayers, against all unfortunate consequences of their decisions, e.g., abortion on demand, 9/11 victim payouts, Katrina’s federalized improvements, and now this. Other than a strong sense of rendering unto Caesar that which is Caesar’s, what is the incentive to me, the mortgage-paying, non-Louisiana dwelling, self-insuring citizen, to behave responsibly?
Lord, have mercy.
Tom,
But surely there is a difference between “lending,” and “selling” something. Does the actual ownership of the shares change in the first transaction? If not, then it is fraud. If the ownership does change, then why do you have to return the shares?
Jon R
#16 Last first: because the short borrowed them, so he has to return them plus dividends.
First last: sure bet; there is a difference (the obvious one, it involves money passing in return for assets) and there is an ownership change. The issue you apparently are having trouble dealing with is the fact that the borrowed account’s shares get sold without that account having aa apparent legal call on them at the end of the lending period. They do have a call, and the shares MUST be returned, so that the original long position is reinstated. You might be interested in searching for the technical term of “short squeeze”, which illuminates the risks that shorts take.
BTW, the kid who said “The Emperor has no clothes!” was the original short seller. Too bad he never made a cent off that observation that there was no value in the garments on display.
#17 Tom, OK so he has sold my shares, at a rate lower than they were worth before he borrowed them! Now he has to return them, but he doesn’t have them anymore. What happens if he can’t buy them back? I’m sorry, but I have a real problem with the stock market, it seems to be so much fairy gold. One minute it is there, and when dawn comes, it is gone. I prefer real property. We bought our house about five years ago, it has since apparently more than doubled in value even if the market falls by 10-20% we are still well in front.
Back in the 80s we had fun with a definition of the difference between a businessman and those people starting with E. At the end of the month, they both pay their Amex card with their Visa card, at the end of the second month the businessman pays his Visa with cash, the E guy pays his Visa with his Amex card. (you can make the chain as long as you like by inserting as many cards as you like)
regards,
Jon R
Tom Roberts, #17,
I am not an accountant and do not understand much about this, but I do have a mortgage on my home and would like to understand what is happening.
Can you explain this crisis from the perspective of the person who has the mortgage? For instance I find a mortgage company, go to the closing and receive a mortgage from Bank #1, I pay my mortgage payment every month and receive a statement of receipt of payment every month. Suddenly I receive a letter from Bank #2 saying that Bank #1 has sold my mortgage to Bank #2 and that I am to now pay my mortgage payments to Bank #2. After checking with Bank #1 I faithfully pay my mortgage payment to Bank #2 and receive a receipt for payment of mortgage from Bank #2 every month.
The principal amount I owe is now much less than it was when I received the Mortgage from Bank #1 because I have been making regular payments.
It sounds like you are saying that Bank #2 only borrowed my mortgage from Bank #1 and that they have to pay back the whole amount even though they have been receiving steady payments from me. It sounds like Bank #2 has used my mortgage payments for other things rather than to reduce my mortgage debt.
How do they account for this in Bank #1 and Bank #2 records? Am I as a home (mortgage owner) owner at risk even though I have been paying my mortgage regularly? Doesn’t the SEC have regulations against misuse of my payments?
Surely, I must be misunderstanding you. please let me know what I don’t understand about this.
Betty, one of the numerous forms you signed, if not a condition of the base mortgage itself, gave the mortgage holder the right to sell your mortgage. This is done for a number of reasons, usually liquidity needs of the primary lender. Then lender usually gives up a percentage of the value in this transaction. This is the incentive for the second bank to purchase the mortgage. It can be sold to any party, usually a bank that likes that kind of paper. As long as you make your payments, you will be protected. If the second bank becomes insolvent, some other party will become the owner of your mortgage and you could end up paying them. The bottom line is that a mortgage is a loan backed by real estate as an asset.
The underlying problem is that unscrupulous lenders made mortgage loans to people who should not have been entitled to them. In addition, loans were made with little or no money down, so the borrower had even a lower investment in the property. Somme of the buyers were speculators betting on ever-increasing property values, or people buying property to be rented out. These sub-prime loans were quickly off loaded to other banks and the first (unscrupulous) lender gets off Scott-free. The fault lies primarily with the first unscrupulous lender, but the bank who bought the bad loans acted irresponsibly with their funds as well. Since there loans were bad from day one, as soon as there is any downward pressure in the market, such as over-building, loss of jobs, inflation, the house becomes worth less that the mortgage loan against it. That is where most of these bad loans are now.
Everyone’s situation is unique. If you have considerable equity in you property, that is, if the value of your home despite any adjustment for fair market value is still higher than the mortgage, you are still OK. Yes, we have lost some “net worth†on paper, based on over-inflated values from a year or two ago, but there are still unequivocal underlying values in a single-family home. First, it is a home, not just an investment. It is where people live. Second, it has an intrinsic replacement value. What would it cost to replace your home? Where I live, that it still about $130 per square foot, excluding land.
What is needed to sole the problem is to absorb the excess inventory in the housing market. This will take time, and we cannot afford to have all those building construction industry workers out of work that long. What is needed are Federal, state and local government building programs to work on roads, bridges, airports, terminals, government buildings, schools and so on, to get these people back to work for a period of time. For those who are in foreclosure, they need to be able to keep their homes and refinance their mortgages at lower rates for interest and principal to reflect the real value of the property. They will have to be for residents only, no speculators, and have to agree to live in the home for some period of time to qualify. The government will have to step in and pay the difference between the old mortgage and new mortgage to the lender, or at least some discounted amount.
Charles B,
I don’t think you can attribute the problem wholly to “unscrupulous lenders” when there are catastrophes like Hurricane Katrina and now Hurricane Ike, where many people who were well qualified to obtain mortgages simply lost their homes and jobs and were unable to maintain their mortgage payments as they could before the disaster occurred.
No one can predict the future and it seems to me that the idea of selling mortgages to unscrupulous speculators is also a problem in that speculators seem to think they are protected because the government will bail them out when the economy takes a downturn.
I agree, it is not wholly one thing. But not too long ago, and I am old enough to remember, we had a similar situation in the S&L;scandal, where banks were getting over-stated appraisals and making bad loans. The problem now is that bad loans were made and off-loaded, with institutions and individuals relying on ever-increasing property values. The entity that made the initial sale got their money, then quickly discounted the paper into residual derivative markets. The only risk the original lender took was the time they held the mortgage before they could sell it off and cash out. This, combined with frantic over-building, produced a surplus of homes for sale in the housing market. Excess supply combined with fearful buyers means lower prices for the entire market, including existing houses. Leverage is only a good thing when prices go up. When prices come down, it is very painful.
I remember driving through the suburbs of Detroit in the 2005-2007 period, watching all the McMansions going up, wondering who in the world is going to buy all these houses? Who can afford them? Stories of young couples with $3,000 house payments and two new leased cars in the driveway were not uncommon. It’s OK. They will be able to sell the houses for profit in just a few years. Why not? Everything is going up 6 to 10 percent a year. 20 years ago they would not have been able to get the house loans or the car leases.
It is true about losses due to the hurricanes. As a former Floridian, I do feel for them. My dad went through the hurricane of 1925. But I don’t think we can lay the major problems on those events.
Speaking of Ike, I have a good friend from Texas who sent me some of the devastating photos from Ike. His attitude is: This is Texas. They will have it cleaned up and put back together in about six months.
Betty, I was describing short selling of stocks, which are equities, as opposed to debt instruments such as mortgages. Equities imply no claim to a payment stream, such as your mortgage represents, as they are simple ownership instruments. At best their owners might receive dividends or a share of buy out proceeds. The whole stock market concept is different then from the banking industry, which is the principal behind the Glass Steagall act passed back in the 30’s (and repealed in the 90’s). CharlesB pretty well described what banking is all about: putting a limited sum of money into a project (say, a mortgage) and expecting a stream of payments back. Truly, they “rent” money. Nothing special here, until the guy who lent you the money sells the mortgage to another entity who buys it on leveraged money. When that goes from leveraged entity to leveraged entity, you get the current crisis.
Now, a big historical caveat: bankers have ALWAYS funded your mortgage out of somebody else’s dollars. These are called “deposits”, and are the other side of any bank. But limiting banks’ mortgage activities to a simple percentage of deposits plus cash and Treasury note equivalents posed a limit upon the total lending profits of any bank. So we allowed them to consolidate across state lines and buy and sell their mortgages. The banks made more money, but the institutionalized risks became exponentially greater. That is why we are bailing out all these yahoos, not because you don’t pay your mortgage, unlike the Depression scenario, but because the leverage eventually exceeded intrinsic risks posed by any temporary dip in real estate prices or average mortgage defaults. Today we have a crisis with less than 1 in 4 houses not paying their mortgages on time. The Depression had half of all mortgages in [u]default[/u], which is considerably worse.
Now if we get a series of bank closures, the same will ensue as people won’t get to refinance, but that is less likely than when FDR closed the whole banking system in 1933 and my grandfather took a very long vacation from Wall Street.
Charles B, #22,
[blockquote] His attitude is: This is Texas. They will have it cleaned up and put back together in about six months [/blockquote]
The full story isn’t in on Texas yet, Hurricane Ike was a category 3 Hurricane and Hurricane Katrina was a category 5 Hurricane, there is a difference, but even so, people in Texas will need help from the federal government in order to recover.
I wonder if you or anyone in the mortgage business or the government realize how massive hurricane Katrina was and how many homes were destroyed by Hurricane Katrina on the Mississippi Gulf coast alone, not to mention in New Orleans.
Inadequate Home Owner’s Insurance Compensation, and now exorbitant insurance premiums, deprive many of the ability to build or rebuild or even to find other housing. This directly affects Mortgage payments. There are many factors to be considered when asking the government for this bail out and I am uneasy about the government acting so fast without calmly considering all alternatives to a bail out.
I hope your optimistic friend from Texas is right but isn’t optimism the thing that got the mortgage industry into this fix in the first place.