Following The Subprime Money Trail

 

So it occurred to me that this mortgage crisis needed a little scrutiny based on the assumption that bankers and lenders aren't inherently stupid.  With all the crying about who's to blame, it'd be wise to "follow the money".  It's easy to wave off some of this as conspiratorial drivel, the ravings of lunatics who see some Oz-like man-behind-the-curtain around every corner, or simply liberal diatribes intent on lifting the veil on the neo-conservative New World Order, but the world of speculative investment works on a very simple principle:  What's important isn't to be "right", but to be profitable.

 

A quick primer on how the mortgage industry works.  The traditional model operated on mortgage payments to fund lending.  It was a slow-growth business, meant to rely on small payments over long terms, hardly a sexy(read: quick) way to earn profits.  To guard against risk, full doc and 20% down was required.  Enter the mortgage-backed securities market, whereby loans were now funded not by mortgagee deposits, but by buyers of these securities, or speculative investors.  Funds for loans are no longer dependent on the deposits, but rather on the capital of speculators, a much sexier (read: easier) profit maker.

 

So how do banks benefit from this type of system?  Well, they get revenue from the mortgage payments, and they receive a fee for selling mortgages on the secondary market, not to mention the fee charged for allowing investors to buy into the mortgage-backed securities.  The down-side is if the borrowers can't make their payments, which is exactly what's caused the current crisis ... but is that really a down-side?  Consider that mortgages are collateralized debts:  if the borrower defaults and goes into foreclosure, the bank takes over the property.  Now conventional wisdoms says its unprofitable for a financial institution to hold properties, what with upkeep, taxes, etc., but let's look at who actually gets paid in the transaction:  the banks!  Lien-holders on the property get paid, but they of course are beholden to creditors, who, by and large, are the banks from whom the initial purchase capital was borrowed in the first place!  Since loans are really just paper money -- as opposed to cold hard cash -- there's very little fall-out regardless of the number of middlemen in the entire web of ownership, so the banks get these properties for little more than a song! 

 

Well, what about independent servicers, you say?  If they are watching their revenue stream dry up, the smartest thing to do is sell, and with an ever-growing portfolio of foreclosed properties, they become a fairly attractive purchase for the banks, who can now become the owners of millions of dollars worth of properties overnight!  A great example is BofA's purchase of Countrywide, actually a portfolio lender that services its own loans -- $1.5 trillion worth of mortgages, a sizeable portion of which are subprime loans, all to the tune of around $6 billion including costs for the transaction.

 

Here's where the conspiratorial musings come into play.  Baron de Rothschild once said, "When there's blood on the streets, buy property."  One has to stop and think, where exactly is there blood on the streets?  Well, this mortgage bubble has been going on for about five years or so, starting just in between 9/11 and our invasion of Iraq in 2003.  What if the entire purpose here was to "buy property" while there was "blood on the streets" of Baghdad?  War, especially in the Middle East, would spell economic trouble all the way around, creating a huge amount of volatility in the markets, making profits rather unpredictable.  The traditional mortgage model certainly wasn't going to make quick profits or increase property holdings in short order, no matter how low Greenspan decided to drop interest rates, so the only thing to do was to exploit a capitalization vehicle that would make restrictions like 20% down or full documentation obsolete as guards against risk, by offering unheard of yields on bonds that would never be paid back!

 

Properties are overvalued?  So what?  It never cost the banks their full value to acquire.

 

Bond yields can't be delivered?  So what?  That's the danger of speculative investing!

 

Write-downs are totaling in the billions?  That's okay -- tax exemptions are provided to mitigate losses!

 

Ultimately, the banks end up holding the one tangible good that everyone needs, even before fuel and food:  real estate.  For pennies on the dollar. 

 

Hardly a stupid move for people interested in profits.