Tuesday, October 28, 2008

Meltdown for Dummies or Why is Socialism OK for Wall Street?

There is a simplistic explanation circulating among the conservative camp about poor people being the cause of the market meltdown because they bought houses they could not afford and defaulted on their mortgages. If you believe this then you are misinformed. The idea that a few thousand poor people who cannot make mortgage payments are capable of bringing down a world economy is simplistic to the absurd and intellectually dishonest. The present meltdown is a result of deregulated banks and securities firms selling bundled mortgages as commodities which morphed into a host of exotic financial derivative products that revalued bundled mortgages many times over. Current estimates value the cumulative total of derivative products flowing from repackaged mortgages at approx 48 to 1. These financial acrobatics increased the perceived market value of the mortgages in question to greater than the GNP of the planet. (Yes, the entire world). The creation of this market was done under the watchful eyes of Robert Rubin, Alan Greenspan, Larry Summers, Arthur Levitt, Ben Bernanke and Current Secretary of the Treasury, Henry Paulson, not exactly a platoon of liberals.
How does a mortgage become a derivative and why didn’t the Government stop it? “The radical banking deregulation legislation that McCain pushed so aggressively is what legally enabled those he condemned recently as “the Wall Street bankers and brokers who got us into this mess”. Have McCain supporters never heard of Phil Gramm, the man McCain picked to co-chair his presidential campaign, who sponsored the Gramm-Leach-Bliley Act and the Commodity Futures Modernization Act—both of which made legal, for the first time since the Great Depression, the credit swaps and hybrid instruments at the heart of the Wall Street scams?” (Robert Scheer, Truthdig.com)
The peak year for mortgage generation including sub-prime mortgages was 2004. The Federal Reserve is supposed to regulate corporate reserves to limit the growth of credit, but the Structured Investment Vehicles (SIV’s) created by Wall Street were one method to get around this rule. More leverage also meant more risk for the bank. This is all part of what's called the Shadow Banking System, meaning it gets around existing regulations. It was deregulation that led to the huge growth of the shadow banking system. In 2004 Wall Street successfully lobbied the Securities and Exchange Commission to loosen regulations on how much they could leverage against their capital reserves. This allowed the companies "to invest in the fast-growing but opaque world of mortgage-backed securities, credit derivatives, a form of insurance for bond holders; and other exotic instruments, according to the New York Times. The only real oversight left in place was self-policing by the investment banks themselves to determine if they were putting investors at risk.” (AlterNet.org, Gupta, Arun).
The trail leading to destruction of the international economy begins with the repeal of Glass / Steagall an act passed by Congress in 1933 that prohibited commercial banks from collaborating with full-service brokerage firms or participating in investment banking activities. Arun Gupta says that Wall Street’s goal was to figure out ways to increase profits while avoiding liability. There is a difference between structuring an investment to limit liability and structuring a series of investments to avoid liability. The street was moving everything off book to Structured Investment Vehicles to get around the rules of leveraging.
Gupta describes Wall Street as practicing wizardry in that they turn a debt (a mortgage) into a security (a stock). This is referred to as a Mortgage Base Security (MBS). The commercial bank sells the MBS to an investment bank. The mortgage payment finds its way to the holder of the Mortgage Based Security (MBS). The fee that the commercial bank charges the investment bank is approx. $1000 a mortgage. As you can see, this has to be a volume game or it’s not worth doing. The bank bundles hundreds of mortgages together, calls them securities; they then get rating companies to have the mortgages assured by Fannie Mae and Freddie Mac. The Bush administration was and is having trouble with the economy and job creation. In 2004 they saw the low interest rates and the rising value of the real estate market as a way to enhance the stock market. It was the Bush administration that pushed for broader acceptance of Sub-prime loans back in 2004.
The Sub Prime chapter begins here in earnest. Sub-Prime means that the loan is a higher risk but the investment returns are higher for lenders. Here is where the whole scheme comes off the tracks. Bundles of AAA rated mortgage backed securities (MBS) are sliced up and blended with BBB and or lower rated Sub Prime Mortgage Backed Securities. This product is called a Tranche. The purchaser of a Tranche may be a Hedge Fund, Pension Fund, Investment Bank, Money bank, or a Central bank. Something emerged called Collateralized Debt Obligation (CDO) where the banks are again using the same debt (your mortgage) as collateral to back up the purchase of the Tranche. To give the illusion of limited risk Credit Default Swaps (CDS) another product is a kind of insurance against default.
What you see happening here is for example, $40 billion in mortgages after leveraging is a potential liability of $1.6 trillion. The final chapter played out when the oversupply of housing spurred by apparent investment opportunities, and consumers using their house equity as a bank fell down like a house of cards. The real estate market got soft. ARMS (adjustable rate mortgages) reset to home owners, who were now, because of falling prices, upside down on the value of their houses. Financial institutions had nowhere near the cash reserves needed to cover all of the guarantees and insurances against failure because of the leveraged investments that had assumed a perpetual rise in housing prices.
The deregulation myth says that the market is self regulating and that Government has no place in their business. I beg to differ; the current meltdown is exhibit “A” in our case for oversight and regulation. It was the plethora of exotic and unworkable financial products that the market created to get around regulation that ultimately failed and melted down the economy. It was by no means the little guy who bought a house using an ARM because he was sold on the idea that the value of the house would go up and he could always cash out on the plus side of the deal.
Governments can’t run on air and the taxpayers cannot and should not bail out scoundrels. I see a corporate tax increase on financial business, and I see more regulation and oversight for investment companies. There has been enough corporate socialism for financial firms; it’s time we started to take care of the citizens of the USA. McCain is a big business socialist. Obama is working for middle class Americans - he is the choice.
Source http://www.alternet.org/workplace/102672/


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