December, 2008 archive

Bonddad explains “securitization”:

This is where securitization comes into play. Instead of making one big pool of mortgages we “carve up the cash flows” – meaning, we make a series of bonds that pay people at different times. For example, one bond will pay principal and interest to a specific bond holder for three years beginning 3 years from now and ending 5 years from. Another bond holder will get principal and interest payments for 7-10 years from etc…. That’s all that securitization is – pooling a group of mortgages with similar characteristic (interest rate, length of maturity) and directing the various cash flows to different people at different times. That’s all.

This process has been going on for the better part of 25-30 years now without much incident. So – what went wrong this time?

The biggest problem with securitization is no one has a vested interest performing due diligence on the borrowers – the people taking out the mortgage loans. The mortgage brokers write the loan and sell it to a large investment bank. The investment bank pools the mortgage and carves it up into different bonds. The bond holders don’t hold all the collateral, only pieces of it. As a result, no one really owns all the mortgages for an extended period of time. Instead, the most they own is a piece of a larger pool of mortgages.

Let’s go back to the first few paragraphs. Remember – we’re using collateral composed of residential mortgages. What if we’re writing a lot of mortgages to people who aren’t credit worthy? That’s the central problem with the mortgage securities market right now – mortgage brokers wrote a lot of loans to people who couldn’t afford them. In other words, the collateral used as the basis for mortgage backed bonds was bad collateral. No matter how you carve the cash flows, you’re still using collateral that will eventually default.

Addendum, That Evening:

Mithras thinks Bonddad isn’t clear on what is the cart and what is the horse.

Frankly, I think that Bonddad pretty much nailed the mechanics of the process; that’s what I was interested in when I put up the post this morning.

As to where it went wrong, well, we can argue over the mechanics of what went wrong, and everyone can be right and everyone can be wrong all at the same time.

Whether it started to go wrong on Main Street, with the mortgage lenders, or on Wall Street, with self-designated Masters of the Universe, is really not the issue.

It went wrong when financial types convinced themselves and their regulators that the “invisible hand of the market” (whatever that is) was somehow inherently moral.

It doesn’t matter whether the initial mistakes were made by lenders or by Wall Street.

For all practical purposes, they colluded. Main Street signalled it was willing to make junk loans. Wall Street signalled that it was willing to “securitize,” well, just about anything, as long as it could find marks buyers. Hell, they would have “securitized” free paper matches if they thought they could find buyers.

Chicken or egg? Egg or chicken?

Doesn’t matter.

What matters is that, when greed takes control, good sense and judgement and moral sense go out the window. The “invisible hand of the market” knows not morality, but worships wealth.

I must say, though, that, as far as I am concerned, Mithras has a better handle on a solution: Make sure that the box of stocks Wall Street is trying to sell is not a box of air.

That breaks the fraud.

All that matters for a solution is breaking the fraud at the most efficient possible location.

A fable of our times.

Via Susie.

Here’s the Big Picture of How They Did It.

Back in the Olden Days, the United States suffered financial “panics” every 20 years or so.

Yes, that’s what they were called. “Panics.”

From 1929 through 1931 came the biggest panic of them all. It was termed the “Great Depression.” (The term “Depression” was adopted to avoid using the term “panic.”)

In its post mortem, it was discovered that the financial system of the 1920s was based on air.

Financiers were buying and selling air.

As long as no one noticed they were selling air, prices and “wealth” continued to increase.

Once the air was discovered (the stock market crash of 1929), the whole damn pile went to hell.

In response, the United States created watchdogs (“regulatory agencies”) to ensure that, when someone bought a box of “financial instruments” (aka, stocks and bonds), there was something in the box other than air.

Under regulated capitalism, the United States economy flourished. Yeah, there were speed bumps from time to time, but it was basically sound from the end of World War II until today. Well, yesterday. Well, a few years ago.

(By the way, the term “recession” was coined to avoid having to use the term “depression.” Recession = Depression = Panic.)

In the mid-1980s, the Republican Party began to castrate the regulatory agencies.

In the late 1990s, they accelerated their actions; in the early 2000s, they reached their political climax of releasing wolves in the hen house.

They used two primary strategies.

In some cases, they exempted certain types of “financial instruments” and financial organizations from regulation.

In other cases, they reduced the size of the agencies’ staffs and restricted their activities so that they were unable to discharge their duties.

Once again, air returned to the markets.

And, once again, this fall, persons finally opened their boxes of stocks and bonds and “securitized” “financial instruments” and found their boxes, well, full of air.

The Great Crash of 2008 is not an accident.

It did not result from some mystical inevitable “business cycle.”

Republicans did it.

And they did it to all of us.

And to the rest of the world. Q. E. D.

———————–

Also posted at the Great Orange Satan.

Merry Christmas,

In the United States, consumers cut spending for a fifth successive month during November and their incomes shrank, according to a Commerce Department report that pointed to deepening recessionary pressures.

It said spending contracted by 0.6 percent after falling even more steeply by 1 percent in October. Incomes contracted by 0.2 percent after a slight 0.1 percent gain in October.

New U.S. orders for long-lasting manufactured goods fell 1 percent in November, a less severe drop than anticipated.

The number of U.S. workers filing new claims for jobless benefits jumped by 30,000 to a 26-year peak last week. Initial claims for state unemployment insurance benefits rose to a seasonally adjusted 586,000 in the week to December 20 from a revised 556,000 the prior week, the Labor Department said.

(signed) George W. Bush and the Republican Party

The future of your economy.

They’re headed for the Bushborough.