Briefly interrupting ever-bleaker pandemic news, we momentarily turn our attention to Wall Street, which has been clamoring for a hasty economic reopening regardless of expert advice to the contrary. A new ProPublica investigation examines whistleblower charges that some of the largest banks in the world have been "engaged in a systemic fraud" to inflate the value of commercial mortgages bundled into securities then sold to other investors.
If that sounds like precisely the sort of industry-wide fraud that led to the 2008 financial near-collapse, except that bundled residential mortgages have now been replaced with bundled commercial ones—you're right. We may be witnessing the seeds of the Great Recession Part II, hastened along this time by the pandemic that is threatening the entire world's commercial sectors even without banks playing Investment Jenga behind everyone's back.
ProPublica examined loans bundled into commercial mortgage-backed securities, or CMBS, after industry expert John Flynn filed a whistleblower complaint alleging the past profits of businesses included in those securities are being revised significantly upward, by the banks, when the loans are bundled off to be sold somewhere else. This would make the loans appear to be less risky than they were under the old numbers, and in ways that investors purchasing the bundles would not be particularly likely to suss out.
ProPublica found evidence that the whistleblower's claims are founded. A business with a net income of $1,101,207 in 2016 was claimed in a new CMBS to have had income of $1,352,353 for the same year. A loan for a trailer park, when bundled, was declared to have expenses "about a third lower" in past years than the business itself had reported during those years, boosting its income by nearly 30%. The investigators examined six loans, and found similar patterns in each.
The defenses by the banks ProPublica contacted do not inspire confidence, and boil down to "yes, we changed the accounting without disclosing that because yolo."
The next question is how big a problem this might be. Whistleblower Flynn says he was able to identify thousands of similar bundled loans, totaling about $150 billion in inflated value. For comparison, investors' total purchases of CMBS tally to about $592 billion.
Surprising nobody, the whistleblower report charges Wells Fargo and Deutsche Bank as among the biggest offenders—lending further credence to those that suspect both companies are, at this point, irreparably corrupt. And surprising nobody, the "reforms" enacted in the last financial crisis were supposed to help prevent industry-wide toxins like this from reoccurring; they proved too weak from the beginning, and have been steadily weakened more in the years since.
So that is the bad news. The worse news, is, of course, that the ongoing pandemic is now stressing commercial properties to an extent not witnessed in a century; there are going to be waves of commercial bankruptcies due to the pandemic regardless of shelter-in-place orders, as consumers drastically change their behavior in attempts to Not Die. The packaging of less desirable commercial loans into inflated-value investment vehicles seems a good way to compound the problem in ways nearly identical to those seen in the 2008 financial catastrophe: Investors discover that the bundles they have been selling each other have considerably fewer magic beans than advertised, highly leveraged institutions collapse, and the government is again asked to step in to save Wall Street from being wiped off the map by its own bets.
Already, the Federal Reserve and Trump administration has been working to "stabilize" these CBMS. What we don't know is whether it will work. Or how pricey it might get. And note that Wall Street has been extremely antsy to get the commercial economy jump-started again, even after the Trump administration botched every week of preparation time the lockdown gave us; that eagerness is not likely to be forgotten.
So add that to the pile, when you're sitting at home wondering whether there's still something else 2020 can throw at us. There's a near-100% chance that this Republican president will end his term of office in the same way the last Republican president did: handing off, to his Democratic replacement, a world "investment" economy that has been systemically looted and now stands in ruin, needing massive government intervention so as to attempt to protect every other economic sector from that potential collapse.
Oh, and a pandemic as well. Also a pandemic.