I have made several comments on threads regarding the present banking crisis on this matter and think that it is time to try and explain in more depth. But basically we again have the conservatives/banking establishment lying to us again and every one swallows the lies. In part because the press keep reporting what banking establishment figures like Paulson tell them.
Let us be absolutely and categorically clear on this, the present catastrophic collapse of the US and world banking system that we are threatened with is not due to people not paying their sub-prime mortgages. The issuance of sub-prime mortgages to even the most derelict or mortgagees could not and did not cause the scale of the present financial problem. So what did cause the problem? Greed and lack of regulation in the banking industry caused this, those hooray henrys on Wall Street.
Lets be clear the total US mortgage market is about $700 billion a year, of that about 5 percent is sub prime. The total that all Americans owe on residential property mortgages is less than $21000 billion. Even sub-prime mortgages are backed by property that has some residual value, yes property values have declined, yes some people got mortgages that were over 100 percent of the property value but not the majority. Most mortgages are fully secured by property values even today. It is not fun for those who are loosing their homes but they are not the cause of the present banking problems, even the ones who Paulson accused of "shirking" their responsibilities.
At the very worst the most the banking industry would loose from the foreclosure of every mortgage is $1000 billion, and in all likelihood if it was just sub prime and Alt A then less than $150 billion. The Banks and financial markets could adsorb those losses with hardly a drop in bonus payments.
So why do we have a crisis? well its what happened to those mortgages after the new home owner signed the paper. Used to be that the bank who sold you the mortgage held your mortgage for 30 years as you repaid it plus interest, how quaint. This of course means that the bank had some self interest in making sure you could repay the money.
This process did slow things down and often the bank had to stop giving out mortgages, not because they ran out of qualified customers, but because they ran out of capital to lend. To over come this the option of unloading the mortgage to another bank was created hence we get Fannie and Freddie, they too purchased the mortgage for its duration and because they could borrow money a little more cheaply from other banks due to the implied (now explicit) government gaurentee they made money.
The Glass-Segal act prevented the big merchant banks from getting involved in this action but Gramm-Leach-Baily started to break those walls down. Then commercial banks looked on these stodgy but safe assets and said I think we can do something clever with these. And hence secutetized derivates were born. As the new market grew there was a dark cloud on the horizon, regulation. To prevent regulation darkening the party the bankers friend Phil Gramm stepped in with a back door amendment to a completely unrelated bill preventing any regulation of the fancy new derivatives market.
What is a derivatives market, basically it takes any comodity with a known value and income, breaks it up in to small pieces and sells each of those small pieces to investors. Those assets with value can also be leveraged, borrowed against. So you can lend against them and borrow against them and trade them. You can bundle them, collect the income and sell that. You can leverage that income and buy more, form some one else who is doing the same thing. At this point you have a swaps market.
You are creating a pyramid scheme, the Derivatives trade may be $40 trillion, it may be $70 trillion no one quite knows, there is no regulation and no transparency. That $40 trillion is based on a mortgage market that is worth perhaps $7,000 billion (total less the portion heldby Fanie and Freddie), it is in the jargon highly leveraged. Lots of people have borrowed against the same $1 many times, so if one sub prime mortgage fails and the property sells for a loss of $50,000 it is not a $50,000 loss for the derivatives market it is a $300,000 loss (assuming that the leverageing multiplier is 6 a very conservative estimate). If this looks like a Ponzi scheme its because it is.
Some people such as the credit rating agencys noted that a lot of the mortgage debt was not in good shape and started to down rate the quality of the assets. This was bad news from the ponzi scam artists because one of the place they could sell highly leveraged securitized derivatives was to pension plans. These are supposed to invest in only the very best quality (lowest risk) plans rated A or better (AAA may be ok). To make your crappy bundle of mortgages look a bit better you buy insurance, that sounds like a really good idea until you realize that the insurance company was investing the premium in the very same market they were supposed to be insuring.
It also tells you why lenders were so frantic to sell mortgages, not for the 5 to 7 percent interest they could get but because it could be leveraged 19 times or more, remember no one really knows just how high the multiplier is, even now.
So short version, it is not sub prime borrowers defaulting on mortgage payments, or even depressed property values that have caused this banking crisis. It is the greedy fools (I had a stronger term but that will do for now) on Wall Street who thought they were so clever they could create wealth from nothing, especially if no one was looking or regulating. It was the excessive leveraging of mortgages as securitized derivatives that caused the problem.
The people who are now demanding that we give them another $700 billion with absolutely no oversight or regulation are the ones who caused all this. I certainly don’t think they are worth what they get paid, after all pay me enough I could fuck up an entire economy too.
So do me a favor, next time a politician tells you this is the sub-prime crisis, tell them no its a crisis entirly created by Banks and their derivative traders. That includes Paulson.