Rob the Poor to Pay the Rich

Every day CNBC features talking heads who drone on with the same platitude that there is fear in the market regarding the lack of transparency in the banks. "Lack of transparency" is really a euphemism for "bankrupt." Whether it is Citicorp, AIG, Fannie Mae, or your pension funds, all these large financial institutions own or guarantee trillions of dollars worth of collateralized debt obligations (CDOs) that contain subprime mortgages and other worthless collateral which people now realize are total scams. The most outrageous part of this drama is that the government will allow these investment bankers who dreamed up this financial engineering in the first place to receive millions of dollars each in the form of yearend bonuses for underwriting all this worthless paper. This latest boom and bust of not only subprime mortgages, but of all types of credit ranging from out-of-control consumer credit card issuance to rampant private equity acquisitions have created the largest transfer of wealth from the poor to the rich in modern history. None of the experts on television will ever admit to it because if the average American actually understood what has happened, social upheaval would probably ensue.

Mark to model (as opposed to mark to market) is the method these large financial institutions value CDOs. They claim to use this method because the market for these securities has evaporated. To put it bluntly, valuing these things using "mark to market" is legalized stealing. If no one wants to buy a worthless piece of paper, it should be valued at ZERO-- not ten million or a hundred million or whatever arbitrary number they're currently using--because any other number is by definition inflated. The conflict of interest lies in the fact that the traders whose bonuses and jobs depend on making profits from trading these securities are the same people who price these securities. If they mark them to zero, not only will they not receive a bonus, they'll most likely be out of a job so they have every incentive to lie about the value of these securities. Auditors can't keep them honest because auditors just ensure that banks follow a checklist of procedures. Auditors have no way of verifying whether prices are inflated when each bank uses proprietary computer models to value these securities. But according to a friend of mine who is the head of risk management at a large British investment bank, these auditors don't even know how to ask the right questions.

It is entirely possible that all of the U.S. banks are currently bankrupt. Just because Citicorp generates billions of dollars every day in revenue doesn't mean that it has any equity left. Between 2005 and 2007, over a quadrillion dollars of CDOs were underwritten. A one percent writedown would amount to at least a trillion dollars worth of losses. Most CDO analysts at the large investment banks have already publicly stated that they expect at least several hundred billion in writedowns, although to date, less than a hundred billion has been announced.

My guess is that neither the Treasury nor the Fed has any idea what to do about this credit mess. Treasury Secretary Paulson has no risk management experience. He was a relationship banker, meaning he was just a plain old sales guy, who politically maneuvered his way to the top job at Goldman. Insiders say that he accepted the Treasury post knowing that he was soon to be ousted. At the Federal Reserve, nobody on the board of governors, including Bernanke, has any experience with these types of markets either. When I met with Gerald Corrigan, former New York Fed President and current Vice Chairman at Goldman Sachs in October 2006, I asked him why his Counterparty Risk report only addressed how to deal with operational risk and not credit risk. He confessed that risk managing CDOs was well over his head and added that no central banker had any idea what to do if things went wrong. So much for leadership at the top.

Where do we go from here? I wish there would be an equitable solution possible, but I'm getting cynical in my old age. Realistically, I bet all the bankers will get to keep the hundreds of millions they all made selling and trading these securities while the rest of America face foreclosures and bankruptcies since politicians in Congress and elsewhere depend too heavily on Wall Street to get elected and to stay in power. I doubt Congress will never do the right thing and pass legislation that will demand more transparency in banks. They will never pass legislation for more regulation of financial services now that this industry is more than twenty percent of our economy. Most likely, the final chapter to this credit mess will end with taxpayers footing the bill should the government need to step in and bail out one or more of these large financial institutions. Meanwhile, the rich Wall Streeters will dream up the next innovative way to fleece the world again.

Comments

[BRUMALIA]

Great post!The largest transfer of resources from the poor to the rich.

[jdbid1]

Great article and right on the money. No pun intended. I agee that the experts will never tell the truth but the people affected the most, the poor, aren't listening anyway. They are too busy trying to make a living. I saw first hand how young first time home buyers got in over their heads in a new housing development. The builder talked them into upgrades to max out their mortgage and the lender showed them how they could make a smaller payment with a total disregard of what the future would hold. The result is that our County once touted as the fastest growing in the U.S. now has the distinction of being the third leading the way with forclosures.

I also wonder if the good news for our retailers with the increase in Holiday sales will sour when it is discovered how much of it is attributed to credit card debt. Again, the rich will get richer and the poor well, who cares, it's their fault anyway, they didn't read the fine print and spent more than they could afford. And look at how much they are helping the economy.

[ibsteve2u]

Bad enough when the power to make decisions is placed into the hands of idiots, but when those idiots are also greedy...

[ElkoJohn]

the "free" market economy strikes again,,, the question is, free to do what?
`

[hopeless277]

Why no call it what it really is? Legalized theft. Republicans are actually just a bunch of con men and outright thieves. Their disdain for government is a front for theft of taxpayer money. It will continue until the country falls into recession. And then it will get worse. This country is SOOOOO over.

[GoreSavingPlanetForJesus]

I agree with every point except one. It's true these scam artists should be held accountable for this type of lending (regarding mortagages). It's disgusting.

But...it also sickens me that people are so stupid that they actually agree to these loans just to get into a house. Most people spend more time learning about the next computer or mower that they want to buy, than the most important contract of their lives...their home loan.

If you didn't care enough to learn more about the biggest decision of your life, don't cry when it falls apart.

[HeresJohnny]

Nice article, Ann. I appreciate your taking this issue head-on. I wonder, though, about the Treasury and the Fed. You state that you're not sure whether they have any idea what to do about this crisis. Since it is a crisis of their own making, it's more likely that they are rubbing their hands together in anticipation. It's an old trick, getting people's greed to work against them. These types of loans were the specific, intended result of actions taken in '01 through '03 by the Fed to reduce interest rates. First they expanded the supply of credit greatly, and now they get the return on this investment by contracting the credit. This will allow the big money to buy good businesses cheaply, which was the original goal all along. The credit crunch will have the ancillary beneficial effect of allowing buyers to add to their real estate holdings at rummage sale prices.

A lot of people are talking about the CDOs, which were the cause of this first-stage collapse. They are huge pools of mortgages lumped together and sold to larger companies who want asset-backed securities that also provide a source of monthly income in the form of mortgage payments. My understanding is that these CDOs were grouped together by risk, and that would make sense: higher risk normally translates to higher returns/losses. People who should not have been issued mortgages began to go into foreclosure in large numbers, and the fact that CDOs were widely held by banks all over the world dispersed the pain when the value of these securities plummeted. All of this is old news, by the way.

There is a bigger problem on the horizon that people are only now beginning to discuss, that of Adjustable Rate Mortgages (ARMs). Look around you. How many of the people you know have an ARM? Many of these will start to reset in 2008, and good luck affording the mortgage payment then. Too many people who bought homes assuming that the value would never decrease are finding out otherwise. Perfect storm, indeed.

[Novista]

There are some who see only greed, speculators, and ignorant mortgagees. I have no numbers but I've been watching the trends -- and I know for a certainty that everytime you see 'subprime' in a financial news report, it is misdirection.

Even before August, default problems were kicking in on prime mortgages. That is people who had good credit but all it takes is a medical problem or loss of job and you're toast.

According to one news item today, 100,000 people in mortgage services have lost employment. Even last year, suppliers and contractors were stealthily downsizing. Yet our glorious government statistics on employment say, "Don't worry, be happy."

A lot of people should really be wondering about their pension funds, rather than slagging off the alleged villains of this fiasco.

And do remember, 'asset securitization' was brought to you in 1970 by the Department of Housing and Urban Development.

[americaforme]

BIG FLASH....OIL,GREENSPAN,BUSTING AGRESSIVE BANKS, HAVE BEEN ON THE AMERICA DREAM,GOBBLING GATHERING IN THE SHEVES LIKE EDICTS FROM THE THRONE ROOM,IN A FREAKING FAIRY TALE.THE OLD FASHION WAY. THE HARD WORK SUCKERING FOLKS HARD PRESSED TO SEE THEIR YOUNG ONES GO WITHOUT ESENTIALS, BITE THE BULLET, SIGNING ON THE RIDE...29%INTREST EUROPE WAS OBITERATED IN THE SAME WAY BEFORE WW2.LET THE BANKS FEEL THE PAIN TOO.SOME NITWIT CEO MADE GOBBS OF MONEY STRIPING THE POOR FOLKS.ORCHARDS OF BEAUTIFUL HUMAN BEINGS STRIPPED,IN THE LAND OF THE FREE.

[SouthernYankeeBelle]

Just think we voted for this administration. Remember Bush's base is the haves and the have mores. Right at our expense. All of the people that voted for this administration will be to blame because they were more worried about the bedroom issues and guns. Go figure

[brooklyncitizen]

In light of this dismal picture, any reccommendations?

[swift goat pet for truth]

Great job. Nice analysis.
You mention consequences for the US.
How "at risk" are foreign markets? Did companies like HSBC, ABN Amro, etc. buy a lot of this junk?

[jhNY]

I have no doubt that taxpayers will be, to the greatest degree possible, made bag-holders for all the debt racked up by the financial sector of the economy, and deprived of all money that can be shaken loose from them by their financial masters and the facilitators of those masters in the halls of congress. But what confuses me is where the taxpayer's money will come from? The debt arising from the present financial crisis is beyond the dreams of avarice, larger than our capacity to pay, no matter how obligated we may be made to be by law. What then?

And when the firestorm has passed, and the mutual funds that underwrite our retirement are hollow shells containing no value, where will retirees turn for redress?

[Sundialsvc4]

Where does it go from here?

D-E-P-R-E-S-S-I-O-N.

A Depression far, far worse than the one that began in 1929.

A Depression that would love to expand itself to the world financial markets but that instead, I believe, will be neatly isolated into America. A Depression that also will spell the end of America's hope and illusion of hegemony and/or "world domination." It will spell the permanent end of the Dollar as the world's reserve currency, and of the world's illusion that this nation is a strong, confident nation whose word meant law.

It will certainly spell political upheaval as the people exact their retribution upon the political and civil leaders which allowed this to occur. It will spell deprivation as this country's "trading partners" fully comprehend that this muscle-bound armored soldier is wearing no pants and no shoes ... and has not the ability to domestically manufacture either of these things.

We will learn what "national security" really means.

Then, this country will turn inward, and it will rediscover itself. Tens of thousands of idled factories. Hundreds of millions of smart and resourceful people. And a cold fury, borne of humiliation, that once directed properly cannot be stopped. That "Uncle Sam bearing his muscular arms" is actually not far away at all.

[Henry]

Standard and Poors and Moodys are the rating firms that gave "risk grades" to these securities. If they were a scam and the rating firms were complicit, then we have the Arthur Andersen/Enron problem. After all it is Supply Side Economics, is it not?
There is this problem with mark to market: the resepective homes that are collateral for the loans bundled into securities will each need to be foreclosed upon and then sold from bank ownership to provide a "market sales price". As this process of foreclosure/sale proceeds into 2008, the supply-demand factors will lead to increasingly lower prices(more sales). So. . .the market price at any one time is doomed to go lower the more that is foreclosed!