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Home Sweet Gone
Behind every great bubble and its subsequent bust lies the power of Wall Street's trading operations. In the case of our national housing market saga and toxic subprime fallout, it's true that banks and specialist lending institutions rapaciously extended credit to ill-equipped borrowers.
But that's not the whole story. Housing value fluctuations weren't just caused by lending run amok, but by the trading that enabled the lending and made a precarious situation even worse.
Regardless of whether you adopt the progressive view of the crisis (banks lured borrowers with reckless procedures) or the conservative one (borrowers should have known not to get in over their heads), lenders knew it was an easy game to lavish money and extract fees from consumers as long as they had lots of customers wanting to own the home of their dreams.
More than that, they knew they could package and sell loans to investors, indirectly through Wall Street firms, and directly, to traders, creating room on their balance sheets to originate even more mortgages. Trouble was, investor appetite for the once-lucrative sub-prime mortgage packages dried up as credit did. Investment banks that bet their client investors would be there forever got crucified and are paying the price with multi-billion dollar writedowns and ejected CEO's. But so are homeowners, for whom every piece of bad news makes their individual financial situation seem worse.
With Citigroup's $11 billion writedown, on top of the $2.2 billion writedown the firm had already announced in third-quarter earnings, more of that destructive news poured from Wall Street. Citigroup's writedowns were not just due to losses resulting from borrowers defaulting on mortgage payments, but to exuberant trading on top of the mega-exuberant leveraging of those trades.
This latest writedown spelled the end of Chuck Prince's four-year reign over Citigroup (he assumed the helm from Sanford Weill, who, with then-Treasury Secretary Robert Rubin, was instrumental in shattering the barriers imposed by the Glass-Steagall Act, the law that had kept the commercial and investment banking functions of banks separated since 1933. And in a circuitous twist of fate, Rubin, who in 1999 stepped from Treasury Secretary into the role of Citigroup's vice chairman, has now jumped to the top of the banking hydra.
But it's not just Citigroup's writedown, or Merrill Lynch's $8.4 billion one, or J.P. Morgan Chase's nearly $2 billion one, or Wachovia's $2.4 billion one that continue to suck the air out of the bubble they created. It's the collective implosion of trading positions around Wall Street. And given that these are mid-earnings announcement write-downs, it's possible more bad positions wait in the wings.
Merrill's writedown led to the booting of CEO Stanley O'Neal, who admitted that he didn't quite get the magnitude of impending trading losses. Wall Street traders at other houses would have been aware of it much sooner, since their own trading positions in sub-prime mortgage via CDO's (collateralized debt obligations, the packaged loans supposedly supported by the underlying value of the assets on which their debt rests) were shrinking before them.
Traders' bets were simple: since lenders were lending at high, or sub-prime, rates, they could buy prepackaged bunches of those loans and sell them to investors seeking to benefit from this high-payment steam. The downside risk, they calculated, was that some borrowers wouldn't pay their mortgages and default. But, if those defaults occurred to a low enough percentage of all the mortgages in package, there would be more than enough non-defaulting loans to keep money flowing in.
And, even if defaults were happening at a quicker rate, they reasoned, surely home values would continue to rise such that any foreclosed properties could be sold back to the market at a profit. Then came the perfect storm.
Rising defaults (for lack of ability to pay, over-appraised properties and too much supply) led to a credit panic, as foreclosures began flooding the market with supply. Prices dropped, which caused less borrowing because potential borrowers were either scared, already in the market or unable to obtain new mortgages at favorable terms. Then, trading losses mounted, caused by evaluating positions based on declining mortgage payments and home values.
While politicians are focused on stricter lending practices or debating the merits of Treasury Secretary, Hank Paulson's $100 billion Wall Street trader bail-out fund, they miss a glaring point. If lenders couldn't offset their loans to Wall Street, their lending practices couldn't have spiraled out of control. If Wall Street hadn't leveraged these positions, their losses wouldn't have brought the economic and psychological damage to the housing market that mere inability on the part of borrowers to repay their loans would have caused. There is no chance that trading limits will be imposed, and for this particular cycle, it would be too late to assuage the volatility in the housing market anyway. But greater transparency of the role of trading that created much of the housing upward and downward hysteria would go a long way to calming it the next time.
Nomi Prins is a senior fellow at Demos, a nonpartisan public policy think tank. She is the author of Other People's Money: The Corporate Mugging of America and the forthcoming Jacked: How "Conservatives" Are Picking Your Pocket.
Copyright © 2007 The Nation
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13 Comments so far
Show AllI'm not an "economist", but I know an "inflation" occurred in the prices of residential real estate for several years running that was not really acknowledged in the government's consumer price index. It had a lot to do with American interest rates being artificially pegged too low too long by the Federal Reserve after 9/11 for what in retrospect seems like political appearances.
We have a problem with not only "adjustable" mortgage rates, but also the fact that many people signed up for a HOUSE PRICE that was too high and as unrealistic for them as the fine print terms of their mortgage. When it all shakes out, some buyers get hurt badly and some buyers of the mortgage bonds get hurt badly. But the realtors, title insurers, appraisers, home inspectors, advertisers, "sell this house" TV shows, governments that collected realty transfer fees, and "flippers" who stopped and got out soon enough---the various transactional middlemen-- will have done just fine.
Ain't the free market a wonderful thing when we start deciding that what's important in real estate is whether the countertops are granite?
"The downside risk, they calculated, was that some borrowers wouldn\u2019t pay their mortgages and default. But, if those defaults occurred to a low enough percentage of all the mortgages in package, there would be more than enough non-defaulting loans to keep money flowing in."
Nonsense. They calculated that with their hands on the throats of so many american homeowners, they would be able to get a bailout in the form of aid to the terrified homeowners. Bottom line, they knew that they would be able to force taxpayers to pay for their rapacious behavior. The worst part of it is that most will respond by simply bending over.
My concern with a bailout is it won't allow the necessary price correction to allow housing to be affordable for many again. A $400,000 townhouse build in 1970's is ridiculous in Northern VA especially when the price was $125,000 back in 2000 or $260,000 back in 2003. Those prices were more in line with incomes.
A great website on the housing bubble is www.patrick.net
From Everbank's daily currencies email:
"The plan only covers those who took out mortgages for the beginning of
2005 through the end of this July, and haven't been delinquent on their
payments. Homeowners who've already sacrificed to pay the higher
"reset" interest rates won't get help. Nor will those who have missed
mortgage payments, have already lost their homes, or obtained mortgages
before or after the approved dates."
So, like so many helping hands the banks offer the "bailout" will help very few.
check out Ellen Brown's, Web of Debt www.webofdebt.com
and Riane Eisler's Real Wealth of Nations. www.realwealtheconomy.com
The subprime/Wall Street game is part of a well-orchestrated system that benefits the few at the expense of the most.
Can a nation survive that manufactures only debt and bombs?
Who will bail out the United States of America? If the present gang of robbers and fools are not stopped, our nation may be in the same shape as all those unhappy homeowners who thought some kind of magic would pay their mortgage for them. Of course, if the right-wing fundamental Repugs including the commander in criminality get their RAPTURE soon, it won`t matter as the rest of us can start over again which probably needs to happen anyway.
A speculative investment - by definition - is one where you expect to make money not off dividends but off the price going up - IOW: shifting it to some other poor sucker before the bubble bursts. Houses do not generate income. Therefore, as an "investment", they are entirely and completely a speculative one. That houses tap into that instinctive nest-building urge makes no difference. A house is not a working investment and never will be.
Now ... what's true for individuals is true of society as a whole (in this case, anyway). An enormous chunk of national effort has been sunk into something that cannnot generate a working return. Houses, insted of farms, mines, manufacturing plants. Houses that just sit there in tracts, housing people. A nation that does this will ruin itself, no matter the specifics of the laws, societical structures or financial instruments by which it is done.
Keep an eye on the real economy.
This situation is about to hit the UK in a big way. Our lenders have fuelled the ever increasing house prices for years now. The government does not factor in house prices to the rate of inflation (?). It's a popular game to blame estate agents or greedy sellers, but a buyer can only pay as much as they are allowed to borrow. The banks are in a no lose situation if they play the game sensibly, because if a borrower defaults, the bank can reposses the property, and start all over again. It is therefore in the bank's interest to push people to the limits, in order to maximise profits and pay good dividends to shareholders.
This is called CAPITALISM or the FREE MARKET.
Wonderfull!!!
In the current market madness many people have thrown good sound economic sense and frugality out the window, and this applies to our country as a whole. So what happens when the repo-man calls in the bill? Do we go to war to maintain our standard of living, meaning we steal what we can no longer afford? A little common sense has to enter into the picture somewhere. Only buy or charge what you can pay for at the end of the month. Live in a smaller house where you KNOW the monthly payments won't go up. Defy instant gratification and SAVE for what you want. Have credit cards and other types of "easy" credit put us in a daze, making us forget about the "ethics" of good old fashioned saving? We as individuals presently reflect the state of society we live in more than most are willing to admit.
Chessgames, I agree with you for the most part, frugality is something rarely practiced in today's material World. As far as credit cards go, a lot more self restraint, and an ability to ignore peer pressure would go a long way to curbing some overspending and inflation. The house market (at least in the UK) is a different matter. It has probably taken off on much the same lines as the credit card boom, but it doesn't alter the fact, that the lending institutions have been reckless with their money.
If the same rules were applied today, as they were when I first bought a property, then I would only be allowed to borrow 3 times my salary. We are now seeing banks offering 6 times salary, and not carrying out sufficient checks, to ensure ability to pay.
They say "a fool and his money are easily parted", but in the current economic climate there seems to be undue pressure being put on people.
I definitely believe the banks tried to trick people. When I refinanced my home 2 1/2 years ago, one of the major (predatory) lenders mentiioned above sent out both the refinancing papers --and an additional home equity loan for the exact amount! Luckily I read the loan papers they sent carefully even though they came off the Internet in small print.
When I called the company the following day to say that their notations of two different loan numbers were in error, I was told that I had already signed them and nothing could be done. I explained that I *HADN'T* signed the home equity loan papers and the other loan went through ok.... but I definitely lost whatever trust I had with the loan company.