PART ONE
INFLATED INVESTMENT GRADES CalPERS, the nation’s largest public pension fund filed suit in July of 2009 against the three top ratings agencies: Moody’s Investors Service, Standard & Poor’s and Fitch -contending that the AAA ratings given by the agencies to mortgage backed securities “proved to be wildly inaccurate and unreasonably high”. Note: In March of 2016, they settled for $130 million – much too low in this author’s opinion. What if all over the world, every school was told they could hire teachers trained by only three institutions? What if all teachers were paid by the students they graded? The grades would be so clearly biased that Grade Point Averages would lose all meaning. Then the colleges and universities would slowly discover that each incoming class was better connected and less educated than the last one. And then let’s say the companies hiring these college graduates unknowingly grossly overpay sub-par students and have no way of getting that investment back. As much as everybody would like to pass on these losers, they have infiltrated the global business environment, and the whole thing melts down. The mortgage market could take the hit from defaults and foreclosures. The total mortgage market in the United States is roughly $11 trillion. Of this, banks and thrifts service $6 trillion – the rest are owned by Insurance Companies, Commercial Banks, Fannie Mae and Freddie Mac. Of that portfolio, only 2.5% is in the process of foreclosure, and generally only half of that is actually written off. So, what could cause the global economy to crater when the actual potential loss is only $75 billion? What could possibly have amplified and spread this modest rise in losses to meltdown proportions? For years, investors in mortgage backed securities have been taking for granted the face value of the promised return, not bothering to perform the due diligence that would protect them from such false assumptions. For some ironic perspective on how much money $75 billion really is: according to the Financial Times of August 10, 2009, “US banks stand to collect a record $38.5 billion in fees for customer overdrafts this year, with the bulk of the revenue coming from the most financially stretched consumers amid the deepest recession since the 1930s, according to research. The fees are nearly double those reported in 2000.” That means every penny lost to defaults and foreclosures can be covered by two years of collecting bank fees, just fees – no interest income, or servicing income, or trading income, just fees, and not ALL fees, just overdraft fees. So how can $75 billion morph into over a trillion dollars in bailout funds? When a tutor is passed off as an unbiased, third party evaluator, the student’s worth to colleges is inflated. They then pass that along to the employers, who have a “D” student being paid “A” wages. Subprime mortgages are “D” students, and they should get the jobs reserved for “D” students. But if their teacher/tutor puffed all their grades, and didn’t admit the mistake until long after the wages had been paid, and spent by subprime student – now you see the results of a true Conflict of Interest. It is not a polite term for business people who are “too cozy” – it is a trap for the morally amenable, and the damage affects us all. The Big Five Accounting firms were brought down by this exact same hubris – offering unbiased paid opinions on accounting structures that they had helped design. It was not the appraisers, or the low down loans, or the subprime lending, not the borrowers, not the lenders, though the market correction would have been painful when real estate values decreased. The amplification of these losses lies squarely with the companies that made these investments look better than they were, for profit. For more info: "Overrated – the sub prime mortgage meltdown could finally end the credit ratings racket" by Jesse Eisinger originally published by Portfolio Magazine in September of 2007. For this intrepid reporter's latest see his book: https://www.nytimes.com/2017/07/05/books/review/the-chickenshit-club-jesse-eisinger-.html Calpers Sues over Ratings of Securities: https://www.sfgate.com/business/article/S-P-settles-for-helping-to-fuel-subprime-mortgage-6060009.php |
PART TWO
THE PRINCIPAL PIE: Greedy Ratings Agencies Take it All I’ve been reading a government report – a weighty tome published in April of 2011, and am impressed by how much they got right. It’s called “WALL STREET AND THE FINANCIAL CRISIS: Anatomy of a Financial Collapse”, and it’s a page-turner. In the introduction, these Committee members state: “The investigation found that the crisis was not a natural disaster, but the result of high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street.” This 646 page congressional investigation concludes that mortgage based securities were overvalued by the very people entrusted to audit them and this conflict of interest was largely to blame for the global financial tsunami that started with a little subprime meltdown. The report goes on to say: “The Subcommittee’s investigation uncovered a host of factors responsible for the inaccurate credit ratings issued by Moody’s and S&P….[they] were paid by the Wall Street firms that sought their ratings and profited from the financial products being rated. … The result was a race to the bottom.” Not everybody agrees. One acquaintance said that some blame rests with greedy buyers who flipped houses, suburban dwellers who were living large, borrowers with monstrous appetites for material goods, a group one might call American Dream Chasers. Seems to be a very small group of people whose negligible influence in the corridors of power could not have brought entire continents to their economic knees. But how to prove that? First task – historical perspective – what are they now, what were they at the height of the meltdown, and what were they before the meltdown? The Mortgage Banker’s Association publishes quarterly statistics on Delinquencies and Foreclosures. Let’s focus specifically on one-to-four residential properties. 2011 – Third Quarter Delinquency Rate : 7.99% 2011 – Third Quarter In-Foreclosure Rate : 4.43% 2009 – First Quarter Delinquency Rate : 8.22% 2009 – First Quarter In-Foreclosure Rate : 3.85% 2004– Second Quarter Delinquency Rate : 4.43% 2004– Second Quarter In-Foreclosure Rate : 1.16% Second task - what is the dollar effect of these percentages? How big a piece of a banker’s principal pie do they eat? The Federal Reserve releases a Statistical Supplement every quarter called “Mortgage Debt Outstanding”, again focusing on just the one-to-four residential properties: 2011 – Third Quarter = $10.336 trillion dollars 2009 – First Quarter = $11.031 trillion dollars 2004 – Second Quarter = $7.571 trillion dollars The portion of bad mortgages – the percentage of a ten trillion dollar pile of money that went into Foreclosure - rose from 1% to 4% over the last seven years. That’s a record increase, but if we take 2011’s third quarter for example, if every single foreclosure was completed, the potential loss might be $457 billion dollars. Typically, however, banks do realize an average of 50% of their principal owed, so it’s more like $228 billion. Commercial banks and savings institutions insured by the Federal Deposit Insurance Corporation (FDIC) reported an aggregate profit of $29 billion in the first quarter of 2011. One year’s profits – one year – would suffice to reduce the principal on all homes currently being foreclosed upon by 25%. Imagine how much lower monthly payments could be then. If the banks had been truthful about the true worth of these assets, the concentric circles of misery generated by the dirty pebble thrown would never have spread beyond a few quarters of less than stellar banking profits. Useful Inernet Links: Permanent Subcommittee on Investigations: Anatomy of a Financial Collapse https://www.fdic.gov/news/news/press/2011/pr11091.html https://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm |