The financial crash that almost destroyed our economy and is still causing havoc in this country has often been blamed on dumb home-buyers and the greedy bankers who took advantage of them, but there is surely a lot more to it than that. Let’s take a quick look at what actually happened and how and who was at fault.
It all started about 2000 when home prices were still rising, giving individuals who wanted either a home or an investment, neither of which they could afford, a seemingly foolproof road to either. It was all based on an optimistic but brain dead assumption that those housing prices would keep rising forever. This, of course, flies in the face of reason and a basic fact of life: nothing is forever.
Someplace along the line Bush made a speech on TV in which he said that the American dream was to own a home. I’m not blaming him for saying that. It is part of the American dream. So, however, is earning the money to pay for that dream. What happened was that too many people who weren’t in a position to own anything more costly than a six-pack and a slice, believed him. So did a lot of banks and lending institutions that were always on the lookout for new customers and new ways to make money.
What happened was that these moneylenders began to design a new financial product that made it look like these insolvent home desirers could actually make their dream come true. It was called a sub-prime mortgage and it flew in the face of every practical lending principal known to man.
Now before you jump in and start telling me that it’s more complicated than that, I know it is. I’m just trying to tell a simple, straightforward tale here, one that everyone can understand and while there are a lot of bells and whistles, the basic plot is all there’s room for.
In normal times if you want to buy a house you put down a deposit of 10,20,or 30% and take out a mortgage for the rest. Your ability to get that mortgage is based on your ability to pay it back. Your ability to pay it back is calculated by assessing things like salary, net worth, investments, etc., all of which are taken into account before a bank will give you a mortgage.
Now, there weren’t enough people around who met those fairly simple criteria so the moneylenders had to come up with a better scheme or they would lose all that business; and miracle of miracles… they did. Forget 10,20,30% down, forget ability to pay. None of that was important any longer because equity, the rising value of the house itself, replaced them all. The most egregious of these new mortgages were no money down, no payments for 1-3 months and an impossibly low monthly payment for from 1-3 years, after which the payments skyrocketed. But that was okay because by the time the rates went up the value of the house would have gone up and everybody would be covered.
Many buyers simply didn’t understand the book-length mortgage contract. Many others figured they would be able to sell the fast appreciating home at the end of the three year period for a profit, pay off the mortgage and have a little something left over for themselves to either invest in a new home or a bigger TV. The lenders saw the same thing, figuring that when the buyer sold the house, they would be repaid, get their contract fees and make a serious profit and best of all, they didn’t have to worry about the buyers failing before this happened because they wouldn’t be holding these mortgages for the length of their contracts anyhow. They couldn’t hold the mortgages because they constantly needed more money to do more mortgages and the way they got more money was to package these mortgages into bundles and sell them to big investment houses like Bear Sterns, Lehman Brothers and Goldman Sachs, who then, formed them into bonds, insured these bonds with AIG and sold them to their investors. It was win/win for everybody, or so they thought.
Then the market in housing, as it inevitably had too, slowed and the value of the houses, horror of horrors, fell below the price that had been paid for them, throwing a massive monkey wrench into everybody’s plans. Now the buyer couldn’t sell the house because he wouldn’t get as much for it as he owed to the lender. This meant that he wouldn’t see a profit from the sale, hell, he couldn’t even pay off the mortgage. It was a catastrophe… but it was only the beginning of the financial tsunami that would cripple the country.
But how did these people who couldn’t afford the mortgages that were now driving them into bankruptcy deal with their problem? Well, some tried desperately to hang on, find money to pay their bills and somehow continue to hold onto their homes while others just sat tight and waited it out until the banks that held the mortgages threw them out. Most just walked away. Why not they reasoned. They had almost nothing invested in the houses. Were these people being dishonest? Sure. Were the banks being dishonest by setting them up with financial products they couldn’t possible control? Sure.
Those regular people had conspired in their own downfall by lying on the forms that needed to be filed for them to get the loans that were far too expensive for them to afford. How screwed up were these loans? Well, how about a grape picker in California who earned $14,000 a year getting a mortgage on a $750,000 house? What do you figure his chances were to actually pay off that mortgage? What do you figure his chances were to make one single payment?
One would assume that this would destroy the banks and lending institutions that had created these mortgages but that was only partially the case because the banks and lending institutions, in order to create more and more mortgages had sold the ones they already held to the big investment houses like the afore mentioned Bear Sterns, Lehman Brothers and Goldman Sachs who packaged them into bonds and sold them to hedge funds and other investment vehicles. And so the risk was spread. Household Finance who created the lousy mortgage sold it to Bear Sterns who packaged it with a bunch of like mortgages, insured them all with AIG and sold the package to Domino Hedge Fund who put their investors money into this horrible investment. Why? Why did all these supposedly smart people make such an absolutely rotten investment? First because they’re not as smart as they think they are and secondly because they’re unbelievably greedy and when a dollar was to be made they never considered the danger of what they were doing, but mainly because they had been put in a position where they were losing, not their own money but that of their investors.
Wall Street went completely off the tracks in 1986 when John Gutfreund took Salomon Brothers public, thereby transferring the risk from the partners to the investors. In doing that Gutfreund also eliminated the reason to do the right thing, a crushing blow to all involved. It wasn’t long before the bankers realized that they could do better by making trades, as many and a often as possible than they could do actually betting on their trades so it no longer made any difference whether a trade was bad or good, just that it got made and the trader got his fee which was paid whether or not the trade made money.
So how were these obviously rotten securities able to be sold by all these supposedly knowledgeable investment people? The whole thing worked (or didn’t) because the investment community depends on ratings that are established by Moody’s, S&P and Fitch along with a few other smaller companies, all of which, were delinquent in their responsibilities. They were either too dumb to understand the product they were rating, too lazy to investigate what they were getting paid to rate, or dishonest enough to be cajoled or intimidated by the banks into giving a AAA rating to a sub par product.
Along with these undeserved ratings, the other guys who were supposed to know what they were doing estimated that there would be only a 5% failure rate when they should have estimated a 95% failure rate in the mortgages held by these bonds. Why? Because they were so busy selling the bonds they never bothered to look at them and actually find out what was in these packages.
They are where the problem started, because the Wall Street Investment banks somehow conned the ratings agencies into giving their AAA blessing to trainloads of bad loans. This enabled them to lend trillions of dollars to regular people seeking loans and mortgages. Those regular people had conspired in their own downfall by lying on the forms they filed, so as to get the loans that were far too expensive for them to afford. Then the bank’s machinery turned those faulty sub-prime mortgages into supposedly riskless securities that were so complicated that investors, even the most sophisticated, had to stop evaluating risk because they couldn’t understand what was actually in these packages.
From there on, the investors in the brokerage houses, the ones who financed the risk the brokers were taking, no longer had a clear view of what kind of risks those brokers were taking and as the risks got more and more complicated the knowledge of what the hell was going on diminished.
Capital was no longer allocated to productive investments but to more and more convoluted financial products whose goal was not the creation of a usable product but simply the making of more money, most of which was on paper and which, when the crash hit, disappeared as quickly as it had been made.
Even the very few guys who saw it coming assumed that the big banks had laid off most of that bad paper with foreign companies. If anyone notices a distinct parallel, here, with the way bookies work, raise your hand. The difference was that bookies are smart enough to lay off their bets. The big Wall Street firms, contrary to what was assumed, weren’t, and it cost them and the country trillions.
It wasn’t until a few smart guys investigated what was going on and decided to buy all these bonds they could get their hands on and short them, that the shit actually hit the fan.
Now all this could have been stopped but that would have meant two things. One, that someone would have to have been smart enough to see what was happening and two they would have to have been honest enough to blow the whistle on the whole mess. It seems that no one in our entire financial hierarchy fit both these criteria. There were guys who saw the whole thing coming. Read The Big Short, if you want a great blow by blow of what went down, but those guys weren’t big enough to make any impact. All they could do was make a few billion for themselves as they watched the rest of the economy go into the sewer.
They weren’t the only ones, there were people all over the country who saw it coming but none of them had enough clout to actually do anything except grab a little for themselves before it all went south. If this is true, you ask, how come the big guys, the guys who were in a position to save the ship, how come they didn’t jump in and stop it. Simple, really, they didn’t want to. They were making so much money so fast that they didn’t want to conceive of a situation where it would ever stop or horror of horrors reverse itself. And even if it did, it wouldn’t bring them down. With very few exceptions, the rich guys didn’t get killed in the crash. Sure they lost dough but for the most part that hardly put a crimp in their lifestyle. They had to put up with two houses instead of three, four cars instead of five, big deal. The guys who really got killed were the guys who had regular jobs in the companies that went bust as a result of the crash and ended up on the street.
In 2012 we are going to have litmus test as to whether the people who lost everything in the crash, finally understand that they must take care of themselves, or if they are still so naïve as to believe that the rich are really going to take care of them. Sure, go ahead, vote Republican you suckers and two things will definitely happen. The rich will get tax cuts and you will absolutely get what you deserve.