In A Worldwide Banking Meltdown?, I've previously noted specific instances across the world in which the subprime mortgage/asset-backed securities mess has infected the financial system.
Now, due to widespread abuses in the completely unregulated hedge fund sector and the completely unregulated mortgage banking sector, a massive bloodbath is underway.
Follow me below the fold for some amplifying comments on Bonddad's Special Comment.
Bonddad correctly stated:
Let me begin with this: this is not financial Armageddon, nor is it the end of the world. However, there are some serious problems that have come home to roost and it will probably take awhile for these problems to work out. In addition, working these problems out will be painful. While a complete meltdown is not in the cards, neither is a quick rebound from current events.
I respectfully direct your attention to a fascinating graph from a recent Bear Stearns/Credit Suisse conference call, obtained by another blog page (h/t to Terabyte for bringing this to me):
There could not be a better illustration of what Bonddad is expressing here. The chart starts in January 2007. As you can see, the subprime mortgage sector of the total ARM reset schedule peaks between January and June of 2008. (The X axis in the chart uses two-month increments.)
For a clearer look at the numbers, let's use a table:
Mortgage resets (in billions)
Jan 2007 $22
Feb 2007 $25
Mar 2007 $35
Apr 2007 $37
May 2007 $36
June 2007 $42
July 2007 $43
Aug 2007 $52
Sept 2007 $58
Oct 2007 $55
Nov 2007 $52
Dec 2007 $58
Jan 2008 $80
Feb 2008 $88
Mar 2008 $110
Apr 2008 $92
May 2008 $76
June 2008 $75
July 2008 $50
Aug 2008 $35
Sept 2008 $26
Oct 2008 $20
Nov 2008 $15
Dec 2008 $17
This does not even take into consideration the massive wave of ARM resets from Option ARMs, Alt-As, and Agency ARMs that combine to peak several years from now. Put all this together, and it's hard for me to see how the American real estate market and the mortgage financing industry can possibly recover within the next five years.
This is a hangover of epic proportions.
I will note that one reason the stock market is taking so heavily today is that the biggest mortgage banking company in the US, Countrywide, is in danger of sinking to Junk status in its debt rating. This means that in order to obtain financing for any reason, they must pay punitive risk penalties. This is the largest mortgage company in the country! The biggest, safest, leading company in the field.
And as you can see by the cold numbers above, no end is in sight. For the next year, we will be working out the consequences of what I think is the biggest financial scam in American history.
From Bonddad:
The system of buying and selling mortgage securities and the mortgage underwriting business worked against themselves for the last few years. As the system of buying and selling mortgages wanted more mortgages to buy and sell, mortgage underwriters were happy to oblige by writing more mortgages. This was partially responsible for the lowering of lending standards. Because there were so many mortgage investors, it was thought the risk of the less credit-worthy borrowers was spread out among enough buyers that a default wouldn’t seriously hurt anybody.
It's Enron all over again, except on a much vaster scale. The whole thing depended on a market that could never stop rising. Just as Enron's business model was based on using their increasing stock price as a corporate asset, the mortgage-backed securities sector was dependent on a steady stream of new real estate deals, and put pressure on underwriters to sign off on deals that in a sane market would never get approved.
Consider these three elements: (1) a special class of completely unregulated investor markets (hedge funds). (2) Completely transparent credit ranking procedures from Moody's and Standard & Poor's, so that it was shamefully easy for financial institutions to tart up cobbled-together asset-backed securities (funancial instruments backed by bundles of subprime mortgages on artifically inflated real estate) into allegedly safe, investment-class AAA or AA securities. (3) And a Culture of Real Estate in the U.S. that mirrored the junk bond mania of the 80's and the dot-com boom of the 90's. But real estate was elevated to the status of a shibboleth. Everyone owns a home. Safest investment in the world. You don't need to save for years to own a home. Don't delay getting your piece of the American Dream. Or you may be left behind.
The purest real estate propaganda. Keep roping those suckers into the tent.
This is the root of the whole thing. An entire class of financial instruments fraudulently created through a loophole in credit regulations. Potentially trillions of dollars got sunk into these securities by investment funds across the world. eager to get in on the American real estate bonanza.
Is it possibly an accident that all of the seeds of this devastation took root during a period when both the White House and the legislative branch were thoroughly dominated by Republicans?
This is the Dorian Grey in the White House:
Americans were distracted for years by the artificial real estate boom. No one wanted to think about Bush's systematic undermining of American constitutional principles, and his contempt for the rule of law. Not while everyone got to treat their homes like a piggy bank on steroids. Bush even now insists the economy is robust and that nothing is essentially wrong.
The Worst President Ever is about to become this century's Herbert Hoover.
To wrap up, Bonddad again:
Fourth – and not like they listen to me anyway – but unless there is a serious slowdown in the economy, the Fed should not lower interest rates right now. That would simply bail-out a lot of people who got us into this mess. And frankly, they need for the market to hand them their hat (as it were). Sometimes the only way to learn a lesson is to swallow the bitter pill called "responsibility." Lowering rates just isn’t the answer.
The Fed continues to quietly inject funds into the credit system. Clearly, as of now it isn't helping. An interest rate cut is also useless. All it will do is spur a panic. "What does the Fed know that we don't?"
The way to fix this is to do the following:
- Force the securities rating companies to keep their evaluation criteria secret, so that companies can't tailor instruments to get that desirable AAA rating;
- Impose Federal regulations making it a crime to allow securities specialists access to underwriting organizations;
- Impose oversight on the hedge fund industry. Bring hedge funds into the same regulatory infrastruture that all other funds exist under;
- Ban fraudulent mortgage writing. This means no more subprime loans of any kind, painstakingly codified into law. Thousands upon thousands of people have been ruined because they bought into the happy talk from the realty industry and the Cult of Real Estate. Without means of support and the ability to sustain a reasonable risk premium, a mortgage should never be underwritten;
- Elect Democrats. Democrats believe in reasonable regulation of markets. Republicans could care less who goes broke so long as their fat hedgge fund and financial sector buddies get taken care of;
- Sit and wait. The companies and traders who engaged in this behavior deserve to go to the poorhouse. They do not deserve governemnt intervention. As I think I've illustrated, and Bonddad eloquently stated so much better than I could, it will take quite some time for this mess to work out of the system.