In what could be a movie plot, the story starts with a meeting of Wall Street traders eating Chinese food on a cold February night in 2005. They met to figure out how they can turn the massive U.S. mortgage securities market into a cash cow for Wall Street, just like the $12 trillion corporate credit market. They had no idea at that time how the plot would develop into today's subprime meltdown that could actually set us on a bullet train heading toward the ultimate Wall Street disaster flick - the next Great Depression.
This could make for great movie entertainment if the story weren't true. Bloomberg first exposed the depths of this story in December 2007, but so far the rest of the U.S. financial press has pretty much ignored it. I wonder why. The only other newspaper that picked this up was the New Zealand Herald, but I did see discussions of the story on various other hedge fund blogs.
Bloomberg's primary source for the story was Greg Lippmann, one of the key players in the story, who was then a 36-year-old trader at Deutsche Bank. He was part of what Bloomberg calls the "Group of 5" that included Goldman Sachs (NYSE: GS) Trader Rajiv Kamilla (34-years-old) and Todd Kushman (32-years-old) of Bear Stearns (NYSE: BSC). Representatives unnamed in the story came from Citigroup (NYSE: C) and JP Morgan Chase (NYSE: JPM). Through a series of meetings that grew larger and larger, including ultimately almost all Wall Street banks, subprime mortgage securities were born. The International Swaps and Derivatives Association, which sets trading terms for dealers on these complicated financial vehicles, finally got involved to help draft what ultimately became the subprime mortgage securities contract. The inability to appropriately price these securities based on their high risk has already resulted in over $100 billion in write-downs by Wall Street banks and brokerage houses, as subprime foreclosures continue to mount.
Lippmann denies in the Bloomberg article that the subprime mortgage securities he helped create and CDOs banks then packaged and sold to investors (and held on to themselves) caused the subprime crisis. But Rod Dubitsky, director of asset-bank research at Credit Suisse, disagrees. He told Bloomberg that these derivatives are "like wearing a seatbelt that allows you to drive faster. . . No question, it changed the game dramatically."
What game was that? Money for mortgages that otherwise could never have gotten funding. Wall Street needed mortgage securities to sell and since most of the people who already owned homes in 2003 had already refinanced to the lowest rates possible thanks to the Federal Reserve's 1% rate policy, they had to tap a different, more risky market to build those mortgage securities - the subprime market. People who could not qualify for prime mortgages jumped at the chance to own a home they otherwise could never have afforded.
Mortgage brokers and banks forgot all the safeguards put in place for prime mortgages, and the U.S. real estate bubble inflated as credit got easier and easier to get. Investors sold to other investors driving up prices further. Mortgage fraud became commonplace as liar loans became the joke of Wall Street. It seems as if they didn't care as they were planning to make their money on the securities they designed that they thought would shield them from the risks they were taking.
Moody's, Standard & Poors and Fitch ratings services approved these complicated securities based on historical data used to grade more traditional mortgages. They didn't realize until it was too late that they hadn't adjusted properly for the high-risk mortgage loans underlying these securities. Only after foreclosures mounted did the rating agencies act. Why did it take them so long?
In just two years, this appetite for more and more mortgages, fueled by Wall Street banks' desire to create new mortgage securities they could sell, helped grow the subprime mortgage market into a $600 billion dollar market in 2006. In 2001, that market accounted for just $160 billion. Today you'll be hard-pressed to find investors for subprime securities.
Not only were the ratings agencies asleep at the switch, the Fed was too, as it ignored abuses in the lending market that made this rapid growth possible. While Alan Greenspan got numerous warnings about the abuses, he chose not to act.
The Fed finally woke up in August 2007 when the credit markets froze and the Fed pumped $38 billion dollars into the markets. Numerous other steps have been taken by the Fed since then including more infusions of cash into the system and interest rates cuts.
But the credit squeeze continues to haunt the credit markets today, making it hard for corporations and commercial real estate developers to get cash. What looked like a specialized, highly complex derivatives market problem has now impacted credit availability worldwide as banks take larger and larger writedowns. They just don't have the money to lend.
All this reminds me of the roaring 20s when credit was freely available for stock speculation. It was this easy credit mentality that inflated the stock bubble of the 1920s and ultimately led to the stock crash of 1929 and the Great Depression.
Today, the easy credit practices of mortgage lending, which the subprime mortgage securities made possible, inflated the housing bubble that just burst. The havoc this has wrought on the global credit markets may lead us into the next Great Depression. I hope I'm wrong, but similarities are there. Fellow blogger Peter Cohen wrote earlier this week about how this may be the bank's worst earnings period since the Great Depression, Yesterday, I wrote about the impact on commercial real estate lending. There have been numerous stories about the difficulties corporations are facing refinancing short-term lines of credit. All these credit woes will lead to job losses as corporations and commercial real estate developers must cut back since they can't get the cash they need.
We're no longer facing just a subprime crisis. It's now a broad global credit crisis that seems to show no signs of abating. Bad news mounts on almost a daily basis. Can the Fed or the Congress truly take any action to slow this bullet train to disaster? Only time will tell. We can all pray that the years Fed Chairman Ben Bernanke spent researching the Great Depression will help him devise strategies to avoid the next one, but it's time to prepare for what will be a long, difficult financial crisis even if we can avoid the big "D."
Lita Epstein has authored more than 20 books including "Reading Financial Reports for Dummies" and the "Complete Idiot's Guide to the Federal Reserve."
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Reader Comments (Page 1 of 1)
1-24-2008 @ 11:03AM
Byron Spain said...
Greed won over fear. When people place their life savings in the hands of young, greedy and yes, stupid individuals, things like the subprime mortgage fiasco occur. Instead of giving these greedy fools bonuses, they should be fired and barred from further employment in the securities industry. Warning, anyone who trusts another to make their investment decisions is a bigger fool than the greedy creeps who work in the industry.
2-02-2008 @ 12:41PM
Rainbolt said...
Why do you suppose that the New Zealand Herald was the first one to pick up this news?
Any thoughts?
1-18-2008 @ 1:56PM
Boards0000000 said...
This economic stimulus package is a nice idea, however, it won't fix things. Many homeowners lost 100's of thousands of home equity. Anyone who bought a home from 2003-2007 in Florida, California, Nevada and Arizona most likely has lost all of their down payment (20%) plus more so they now owe more than what the house is worth. So they've lost all their down payment and now owe a liability on their house, which used to be their biggest asset. In many cases it was their only asset. These people are sunk and are walking away from these liabilities and or going bankrupt. An $800. rebate is better than nothing but it won't solve their dilema. Their financial futures have been changed for the long term.
This subprime created problem has spread to prime borrowers, banks, bond insurers,mortgage companies, credit card companies, auto sales and loans, underwriters, wallstreet, bonds, construction workers, retail, manufacturing, etc. It's spurring walk aways, foreclosures, bankruptcies. It's hitting all areas of our economy. People see the Fed's chasing the snowball down the hill, but nobody seems to notice the avalanche behind them and heading towards us all. Whether or not you own stocks or a home you will in some way be effected in the long run.
1-18-2008 @ 2:01PM
Steve in Denver said...
It's quite an experience watching this generation of "analysts", "Researcher", "Experts", and the googleplex of media types experience their 1st financial debacle. I've lived through 2 others since the late 70's, and can say without equivocation that the bloviating and hyperbabble occurring now is unprescedented. The VAST majority is nothing but white noise and has created its own Bermida Triangle of Bull *#@^. Holy cow people, stop gassing and get out and function. The economic fundamentals are fine.
1-18-2008 @ 3:16PM
armrob said...
this reminds of the Enron debacle where all the big analysts and experts failed to see it coming (or chose not to) until it was too late.
they can think of all the plans they want, it simply won't work for the simple fact that many bad decisions were made and someone has to take the loss. it's simple as that.
unless we can turn back time, they have a lot of writedowns coming ! the money has alreay left the building with early investors who sold their homes for big profit, brokers, analysts and CEOs who got their big bonuses and stock options for creating that huge mortgage market.
now that it's blowing up, someone needs to pay for these bonuses. it's gonna be the shareholders, the homeowners and with the new fiscal plan, the tax payer as always !
1-19-2008 @ 6:28AM
Elaine said...
Above, you wrote, "Bloomberg first exposed the depths of this story in December 2007." Not quite! Real Estate and Mortgage Fraud analyst and investigator Ralph R. Roberts reported on this long before Bloomberg ever did. Take a look at Flipping Frenzy dot com to see for yourself. Roberts has been covering this--and other mortgage meltdown related developments--for over two years now!
1-19-2008 @ 4:26PM
Brenda said...
If the talking heads would stop spouting off doom and gloom, things wouldn't be as dire as they are. Bernanke should just keep his stupid mouth shut, his ramblings are not doing a thing to improve this horrible situation. Instead of the banks foreclosing on these homes, they should restructure the mortgages to today's interest rates. People who still have a job and can afford to pay a reasonable mortgage, at a fixed rate (no more ARM's), would be able to keep their homes. I refuse to believe that we are headed for another Depression like 1929. This credit crisis will eventually turn around, as it did in the 90's. We have to be patient and ride out this storm, the economy is cyclical but we've been here before and we'll get out of this crunch.
Brenda
NY
1-19-2008 @ 8:43PM
Brian said...
This was no accident! What do you mean, "seem"?!
Everyone knew but simply decided to gamble - "let someone else pay for it...how about the good ol' american public, they've bailed us out before..."
1-22-2008 @ 6:57AM
mike said...
THESE JERK WITH BONUSES DIDNT/SEE IT COMING. YEA - WE SAW IT COMIN LAST FALL ALL THE MONEY GOING FOR GAS AND OIL AND PEOPLE COULD NOT MAKE MTG PAYMENTS AND NO MONEY FOR CHRISTMAS AND BILLS AND JOBS BEING REDUCED ETC.. EXCEPT FOR THE RICH THEY WANT A BAILOUT - SCWEM THEM NOW - LET THEM LIVE LIKE THE REST OF US