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Who
can pretend to know everything about the housing meltdown? The complicated
intricacies of this backroom dealing seem to unfold everyday, baffling even
the savviest of market watchers. Perhaps, as the financial titans look for
ways of covering their tracks, hiding their losses and hoping that, by the
time this incident completely reveals just how badly these
investors/lenders/borrowers acted, we will have been too confused to point
fingers at any one person.
One of the most telling announcements that we are in trouble from
every angle came from the White House recently. They have partnered with
eleven of largest mortgage services companies. You know them as the enablers;
the folks who lent money to anyone with a heartbeat and five bucks to their
name.
This partnership is an effort to get more fixed rate mortgages to the
ten percent, yes, that’s right, the one in ten people who may have been
eligible for a fixed rate mortgage when they first applied but who had
instead, opted for something subprime, to borrow their way out of the
problem.
Those ten percent had gambled with their otherwise pristine credit,
bought a house that may have been larger or more investment worthy than they
may have afforded otherwise and now they need help. Some of the simplest
solutions, any Monday morning quarterback can clearly see were overlooked or
flat out avoided by those same mortgage service providers when the loans were
first generated. Offering to fix some of those rates once the problem of
foreclosure seemed unavoidable could have created a good deal of organic empathy
for this bunch of rascal-ly characters. But they didn’t.
Instead, faced with the opportunity to turn at least a portion of the
meltdown around, they decided to head in the opposite direction and modified
only one percent of the mortgages whose low initial interest rates or teasers
as the industry calls them were about to expire.
Now, those teaser rates are about to expire on a much larger group:
the investors who bought those mortgage backed securities. Until recently,
these lenders, which essentially is what a bondholder is, were still
receiving their monthly payment. These investors, who bought low-rated bonds
called collateral debt obligations, purchased them because of the much higher
yield offered over their better-rated counterparts. Higher yields for
increased risk.
But now, those higher rated bonds are also suspect. As the underlying
problems with poorly rated C.D.O.s, which stems from possibility of mortgage
holders defaulting on their loans, make their way off the books ($20 billion
have been written off so far), the owners of better rated debt obligations
are beginning to worry. And with good
reason.
That concern has created
the need for a confidence booster, a bailout of sorts. Unsold C.D.O.s still
exist. Banks are still holding mortgage-backed securities and are finding no
buyers for them. But to hear these financial institutions tell it, these
C.D.O.s are rather pristine with no real danger of subprime mortgages
suddenly surfacing once they are sold. “No need to look under the hood,
son,” the salesman said, “it runs like a charm.” No bad
loans hidden under the seat. “Clean as a whistle!”
Two things are wrong with
that pitch. First, there is the level of trust needed to take someone at
their word and secondly, the belief that there is no one’s interest but
yours at stake when the offer is made. But banks aren’t all that
honest, even with themselves and worse, they aren’t all that sure what
the other hand is doing or even holding.
That said the banks have
hatched a plan. Why not form a group where these C.D.O.s of questionable
make-up can be bought and finance it with borrowed money? Brilliant. And
where do you borrow that kind of money? From the Treasury. And where does the
Treasury get its cash? You.
Government debt is now
barely worth the paper it is printed on as investors across the globe,
fearing the trusted word of the banks, have piled in looking for some safe
haven. This has pushed prices higher and that has brought the yield down on
one-month government bills to under 3.5%.
The result of all that
concern is now called the Master Liquidity Enhancement Conduit, a coalition
of three banks – Citigroup, JP Morgan and Bank of America, headed by
Henry Paulson, the Treasury Secretary created with the hope that this will be
enough to keep the financial markets afloat.
This group, using
borrowed cash, as I mentioned before, will buy Structured Investment Vehicles
or S.I.V.s. Many of those S.I.V.s, which bear a remarkable resemblance to
SUV.s with the same potential for unexpected rollovers and sudden fiery
events. S.I.V.s, which is simply a fund holding numerous C.D.O.s, have the
all of the same underlying problems: unknown risk, slowly unfolding defaults
and the potential of several trillion dollars worth of losses.
In other words, the worst
is still ahead of us and the solutions so far have not been adequate enough
to stem that rising tide. The froth that Greenspan referred to the mortgage
markets as possessing just a few short years ago has turned into an overflow
of suds in a tub with the water running, metaphorically speaking.
Foreclosures take time to
work their way through the system and they have only just begun. That slow
process could take many more segments of the economy down with it in the next
several years. But not to worry. As Mr. Paulson might say, “no need to
look under the hood, son. It runs like a charm. Clean as a whistle!”
Paul Petillo
www.BlueCollarDollar.com
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