According to this report,
So we've been hearing it's the fault of greedy home buyers who ran out and purchased homes they couldn't afford. Or, conversely, maybe it was the fault of predatory lenders who made bad loans. Round and round the blame seemed to go. So I was completely baffled by Henry Paulson's announcement yesterday that it wouldn't help to buy up the toxic mortgages as promised in the bailout.
At least, it baffled me until I read this article. And that's when it occurred to me--he can't buy up the toxic mortgages to stave off the meltdown because a vast majority of these loans don't exist.
So let's get this straight...first there are toxic mortgages that were used as a kind of legal scam to get folks to buy houses they couldn't afford, and when the "grace" period ran out, SURPRISE! ...the borrowers defaulted on the loan and then the homes' values plummeted, leaving creditors with worthless paper.
Then there's the NONEXISTENT mortgages where this scam-generated paper wealth wasn't enough to satisfy the greed of lenders, so they just basically MADE UP some loans, something like "matching funds" except instead of funds, they were just more papers, with in this case, not only the collateral, but the buyer removed.
But this has been a long time comin'. It's the greed mixed with total lack of accountability in the financial sector that should have shocked us along the way, but instead was greeted with open arms.
I had been waiting for the end of Wall Street. The outrageous bonuses, the slender returns to shareholders, the never-ending scandals, the bursting of the internet bubble, the crisis following the collapse of Long-Term Capital Management: Over and over again, the big Wall Street investment banks would be, in some narrow way, discredited. Yet they just kept on growing, along with the sums of money that they doled out to 26-year-olds to perform tasks of no obvious social utility. The rebellion by American youth against the money culture never happened. Why bother to overturn your parents’ world when you can buy it, slice it up into tranches, and sell off the pieces?
And the results?
If you want to know what these Wall Street firms are really worth, take a hard look at the crappy assets they bought with huge sums of borrowed money, and imagine what they’d fetch in a fire sale. The vast assemblages of highly paid people inside the firms were essentially worth nothing.
People like Meredith Whitney, an analyst of financial firms for Oppenheimer Securities who, on October 31, 2007, was one of the first to sound the alarms of Wall Street's collapse, and Steve Eisman, a colleague who also worked as an analyst at Oppenheimer, warned the wheelers-n-dealers of Wall Street that this was a house of cards. But no one wanted to listen.
That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?"
In other words, these were "cloned", but not in the "real" sense of making another CDS out of "reality", but rather in the "fantasy" sense - code named "synthetic" - to make another risky, weirdo CDS out of ... nothing! Not even "thin air"! It's money-for-fantasy, the Ultimate Money Swap!
In short, the economy was bloated chock-full of fake "loan packages" by a world of unscrupulous, convoluted, almost unfathomable trade.
In 2000, there had been $130 billion in subprime mortgage lending, with $55 billion of that repackaged as mortgage bonds. But in 2005, there was $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds. Eisman couldn’t understand who was making all these loans or why.
When he found out, it was a revelation of the huge scam with many names - like "shorts" for example - not familiar to "main street" but which would ultimately come down crashing over their heads.
The juiciest shorts—the bonds ultimately backed by the mortgages most likely to default—had several characteristics. They’d be in what Wall Street people were now calling the sand states: Arizona, California, Florida, Nevada. The loans would have been made by one of the more dubious mortgage lenders; Long Beach Financial, wholly owned by Washington Mutual, was a great example. Long Beach Financial was moving money out the door as fast as it could, few questions asked, in loans built to self-destruct. It specialized in asking homeowners with bad credit and no proof of income to put no money down and defer interest payments for as long as possible. In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000.
But it gets worse, as the number of such cases skyrockets.
Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.
Which led to a huge house of cards.
“You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.
And for those who wonder what's a "BBB tranche"...
as Eisman puts it, “the equivalent of three levels of dog shit lower than the original bonds.”
So if they're that bad, why do people invest in them? And what could be worse? Worse? What's worse are the toxic mortgages that don't even exist! That never existed in the first place. That, when asked "When did you live?" respond "NEVER!" The demon packages, demon loans. That's what brought the house of cards down...
There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”
Who are "us"? Investors buying the toxic mortgages. The market was so delusional and drunk with greed that they actually made up fantasy/false mortgages to satiate it.
And here we are now, our economy on life-support. And we, the people, and the taxpayers, are footing the bill. How do you like that?