corbett (![[info]](http://l-stat.livejournal.com/img/userinfo.gif){kind=small} corbett) wrote,@ 2009-03-23 20:51:00 |
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I'm No Financial Wizard, But Here's What I Think Anyway
The original problem: Banks began lending to people they shouldn't have. The banks saw dollar signs when they should have seen stop signs. It was like a Nat Geo film of a shark feeding frenzy: the banks ignored the risks inherent in lending to those without income or in a sub-prime status because the addictive instinct for these guys is profit. Banks need to make money to be able to lend more money, after all. Yes, it really was that simple.
The deeper problem: Those mortgages are seen as assets (because if you default on your mortgage, they get to keep your house and you get to hurry up and find someone with a large truck to haul your stuff from the curb.) Now the bank has a real problem: they have an empty house, a money-making asset that isn't making any money. As bank-owned properties pile up near each other, the asking prices for the properties drop and the surrounding property values drop, leading to an even greater devaluing of all local properties. There's a tremendous amount of profit the bank has lost on this single mortgage that's gone tits up. Not only has the bank lost out on the gamble for homeownership-by-those-that-shouldn't, but now your home's value has dropped considerably as well. Oh, but it gets worse because...
The problem gets even more fucked up: Granted, to this point, it's sort of a no-brainer in that the banks brought this on themselves by throwing caution to the wind and not lending sensibly. As a nation, we've dealt with these kinds of banking problems before - most recently, the S&L issues of the Reagan years. But the problem is compounded several times in the whiz-bang 21st century era because of the rise of large financial bank-holding companies, hedge funds, large corporate insurance companies, and government chartered mortgage guarantee corporations. All of these their roles to play, but by-and-large what they all did was consolidate your mortgage and my mortgage and your never-employed neighbor's mortgage into something called a mortgage-backed security. These mortgage-backed securities were then sold as even larger assets to investors and banks as solid AAA-rated investments. Then insurance companies, like AIG, and others came along and made bets - they couldn't call it insurance because insurance is regulated by the government - called Credit Default Swaps (CDSs) that insured that these mortgage-backed securities would always make a profit and never lose money. Then there were default swaps on top of default swaps on top of default swaps.
Stop me when this starts to look like a house of cards. Oh, I suppose I should have made that suggestion right after the point where you take a mortgage with Bank A. Well, you know, if I had done that and if the world really worked that, a lot of already-rich guys on Wall Street wouldn't be as rich as they are today.
When The Cards Came Crashing Down: That house of cards began to fall when your unemployed douchebag neighbor walked away from the house he couldn't afford, defaulting on his mortgage. The millions who didn't understand the ramifications of No Down Payment, AltA, and Adjustable Rate Mortgages have made a massive impact as well. I already mentioned the problems that a default on the mortgage causes the bank holding the mortgage... and it doesn't really take a genius to see how that problem ripples upward through the house of cards built on top of those shitty mortgages: While the bank is losing money on the failed mortgage, the investment bank that owns the larger mortgage-backed security that includes that mortgage (or more typically, just a portion of that mortgage) is now taking a loss on the larger asset, which in turn means that investment bank can call up the guys at AIG and cash in on the default swap (that is: unregulated insurance on the mortgage security.)
But the insurance companies like AIG didn't have enough cash to pay out on the trillions - TRILLIONS - of dollars in credit default swaps that they made. If AIG could not make the agreed-to payments to the large banks and other institutions that held the mortgage-backed securities they owed, then those institutions would be in serious trouble of going bankrupt. The bankruptcy of investment houses holding trillions of dollars in mortgage securities would continue a cascading effect that would destroy the already troubled banks.
Ah, their arrogance and greed cuts them off at the knees, you say. Perhaps, but consider the consequences of the problem already: depleted bank reserves and so many defaulted loans brought the credit markets (that is, banks lending to other banks and thus lending to consumers) came to a screeching halt. Without a nearly flawless credit score, it's become nearly impossible to obtain a new mortgage, refinance at today's lower rates, or hell - even get a loan for a new car.
Consider this then: Because Bubba the Jobless down the block lost his home eight months ago and the bank has been unable to sell the property, like countless others, the property values in your neighbor (and many, many others like it) have plummeted. While the house was a great value and investment when you bought it five years ago, suddenly you're what's considered "under water". That is, the value of your home has dropped so much that you now have negative equity (meaning, you now owe more on your mortgage than the home can be valued at). Because of the broader problems in the markets and government intervention (has it really been helpful? For you?), mortgage rates are at a true low... but you can't do a damned thing to reduce your monthly payments because being "under water" means there isn't a bank or institution that would touch you. They aren't going to give you a loan to (re)purchase an asset (your house) at a price greater than it's actual worth (today). That is unless you are willing to pay off the full amount that brings you to current assessed value (PLUS the standard closing costs).
That's the situation millions upon millions of American find themselves in - through (largely) no fault of their own. They are right to be angry about the efforts to bail out the investment banks and insurance firms. [But we can't be too loud about it because these are the same firms that our 401Ks and IRAs and other investment and retirement accounts are invested in. Their downfalls could mean we're all working until we're 90.]
What to do then?
Again, it's been a while since I've said so (since the subject line, to be exact), but I'm no financial wizard and this is just my impression and could be totally off the mark.
The Obama Administration needs to stop concerning itself with the day-to-day will-they-or-won't-they failure options of the large institutions. Only by directing their attention to shoring up the mortgage failure problem itself, can the Administration hope to come out of this a winner.
But before I get to that, let me make a blanket statement about the institutional problem: Credit Default Swaps should be illegal. Period. I simply cannot see how a third party can wager money on an insurance policy for a asset that is, itself, not really an asset but a conglomeration of bits and pieces of smaller assets (in this case, mortgages). In my fucked up world where Mary McDonnell would be nominated for a Best Actress in a Drama for her work on Battlestar Galactica, such notions as Credit Default Swaps would be against the law.
When it comes to the mortgage problem itself - for those in good standing who have been accidental drag-alongs for this depression-in-the-making there's been little solace. And even less help. And, to be honest, this same thing could be said for the banks themselves. Sure the banks made many loans they shouldn't have, but those tend to be larger (national) banks. For smaller banks, they've been hurt by the ripple effect all of these troubles have caused.
It seems to me (again: no financial wizard) that if the government wants to help the banks and help homeowners, they should insist on a few conditions for the spending/acceptance of government funds (such as the $700 billion TARP fund). These are the conditions I think are lacking and could help alleviate some of the problems:
As I've said, I'm not a financial expert, but it seems to me that the continued loss of 600,000 jobs a month means what we've been doing hasn't been working.
The original problem: Banks began lending to people they shouldn't have. The banks saw dollar signs when they should have seen stop signs. It was like a Nat Geo film of a shark feeding frenzy: the banks ignored the risks inherent in lending to those without income or in a sub-prime status because the addictive instinct for these guys is profit. Banks need to make money to be able to lend more money, after all. Yes, it really was that simple.
The deeper problem: Those mortgages are seen as assets (because if you default on your mortgage, they get to keep your house and you get to hurry up and find someone with a large truck to haul your stuff from the curb.) Now the bank has a real problem: they have an empty house, a money-making asset that isn't making any money. As bank-owned properties pile up near each other, the asking prices for the properties drop and the surrounding property values drop, leading to an even greater devaluing of all local properties. There's a tremendous amount of profit the bank has lost on this single mortgage that's gone tits up. Not only has the bank lost out on the gamble for homeownership-by-those-that-shouldn't, but now your home's value has dropped considerably as well. Oh, but it gets worse because...
The problem gets even more fucked up: Granted, to this point, it's sort of a no-brainer in that the banks brought this on themselves by throwing caution to the wind and not lending sensibly. As a nation, we've dealt with these kinds of banking problems before - most recently, the S&L issues of the Reagan years. But the problem is compounded several times in the whiz-bang 21st century era because of the rise of large financial bank-holding companies, hedge funds, large corporate insurance companies, and government chartered mortgage guarantee corporations. All of these their roles to play, but by-and-large what they all did was consolidate your mortgage and my mortgage and your never-employed neighbor's mortgage into something called a mortgage-backed security. These mortgage-backed securities were then sold as even larger assets to investors and banks as solid AAA-rated investments. Then insurance companies, like AIG, and others came along and made bets - they couldn't call it insurance because insurance is regulated by the government - called Credit Default Swaps (CDSs) that insured that these mortgage-backed securities would always make a profit and never lose money. Then there were default swaps on top of default swaps on top of default swaps.
Stop me when this starts to look like a house of cards. Oh, I suppose I should have made that suggestion right after the point where you take a mortgage with Bank A. Well, you know, if I had done that and if the world really worked that, a lot of already-rich guys on Wall Street wouldn't be as rich as they are today.
When The Cards Came Crashing Down: That house of cards began to fall when your unemployed douchebag neighbor walked away from the house he couldn't afford, defaulting on his mortgage. The millions who didn't understand the ramifications of No Down Payment, AltA, and Adjustable Rate Mortgages have made a massive impact as well. I already mentioned the problems that a default on the mortgage causes the bank holding the mortgage... and it doesn't really take a genius to see how that problem ripples upward through the house of cards built on top of those shitty mortgages: While the bank is losing money on the failed mortgage, the investment bank that owns the larger mortgage-backed security that includes that mortgage (or more typically, just a portion of that mortgage) is now taking a loss on the larger asset, which in turn means that investment bank can call up the guys at AIG and cash in on the default swap (that is: unregulated insurance on the mortgage security.)
But the insurance companies like AIG didn't have enough cash to pay out on the trillions - TRILLIONS - of dollars in credit default swaps that they made. If AIG could not make the agreed-to payments to the large banks and other institutions that held the mortgage-backed securities they owed, then those institutions would be in serious trouble of going bankrupt. The bankruptcy of investment houses holding trillions of dollars in mortgage securities would continue a cascading effect that would destroy the already troubled banks.
Ah, their arrogance and greed cuts them off at the knees, you say. Perhaps, but consider the consequences of the problem already: depleted bank reserves and so many defaulted loans brought the credit markets (that is, banks lending to other banks and thus lending to consumers) came to a screeching halt. Without a nearly flawless credit score, it's become nearly impossible to obtain a new mortgage, refinance at today's lower rates, or hell - even get a loan for a new car.
Consider this then: Because Bubba the Jobless down the block lost his home eight months ago and the bank has been unable to sell the property, like countless others, the property values in your neighbor (and many, many others like it) have plummeted. While the house was a great value and investment when you bought it five years ago, suddenly you're what's considered "under water". That is, the value of your home has dropped so much that you now have negative equity (meaning, you now owe more on your mortgage than the home can be valued at). Because of the broader problems in the markets and government intervention (has it really been helpful? For you?), mortgage rates are at a true low... but you can't do a damned thing to reduce your monthly payments because being "under water" means there isn't a bank or institution that would touch you. They aren't going to give you a loan to (re)purchase an asset (your house) at a price greater than it's actual worth (today). That is unless you are willing to pay off the full amount that brings you to current assessed value (PLUS the standard closing costs).
That's the situation millions upon millions of American find themselves in - through (largely) no fault of their own. They are right to be angry about the efforts to bail out the investment banks and insurance firms. [But we can't be too loud about it because these are the same firms that our 401Ks and IRAs and other investment and retirement accounts are invested in. Their downfalls could mean we're all working until we're 90.]
What to do then?
Again, it's been a while since I've said so (since the subject line, to be exact), but I'm no financial wizard and this is just my impression and could be totally off the mark.
The Obama Administration needs to stop concerning itself with the day-to-day will-they-or-won't-they failure options of the large institutions. Only by directing their attention to shoring up the mortgage failure problem itself, can the Administration hope to come out of this a winner.
But before I get to that, let me make a blanket statement about the institutional problem: Credit Default Swaps should be illegal. Period. I simply cannot see how a third party can wager money on an insurance policy for a asset that is, itself, not really an asset but a conglomeration of bits and pieces of smaller assets (in this case, mortgages). In my fucked up world where Mary McDonnell would be nominated for a Best Actress in a Drama for her work on Battlestar Galactica, such notions as Credit Default Swaps would be against the law.
When it comes to the mortgage problem itself - for those in good standing who have been accidental drag-alongs for this depression-in-the-making there's been little solace. And even less help. And, to be honest, this same thing could be said for the banks themselves. Sure the banks made many loans they shouldn't have, but those tend to be larger (national) banks. For smaller banks, they've been hurt by the ripple effect all of these troubles have caused.
It seems to me (again: no financial wizard) that if the government wants to help the banks and help homeowners, they should insist on a few conditions for the spending/acceptance of government funds (such as the $700 billion TARP fund). These are the conditions I think are lacking and could help alleviate some of the problems:
- TARP for Closing Costs: It's prohibitive for far too many in-good-standing homeowners to shell out the $10k or more required out-of-pocket for closing costs to refinance at the today's lower rates. The government could insist that banks accepting TARP funds use a portion of those funds to cover the nonsense that makes up closing costs.
- Closing costs incorporated into mortgage: This was a suggestion from Earl and after thinking about it, it seems pretty reasonable to me. The closing costs could easily be incorporated into the term of the mortgage without adding any truly substantial cost to the loan itself. It MAY require some additional financial expenditure up front by the bank issuing the mortgage, but I don't see how it could be a loss for them considering the length of mortgages.
- Longer term mortgages for "under water" homeowners wishing to refinance: Again - far too many of those wishing to refinance to lower rates (thereby giving themselves possibly several hundred dollars a month... giving them additional spending capacity elsewhere) are unable to do so because they are unable to refinance. Homeowners "under water" should be able to have their mortgage term length adjusted (that is, lengthened) to accommodate a lower rate based on a 30-year-fixed mortgage but have the term extended up to a 50-year period. Such loans would have to include an option to pay off sooner without penalty. Such loans would be for the value of the home at it's original purchase price. The loan could be broken into two parts (or made as two separate loans): The current value of the home at a reasonable current rate for 30 years, with a possibly longer-term no-interest loan (backed by government guarantee) for the outstanding value of the original loan. (Example: You purchased for $400k; today's assessed value is $300k. Under today's rules, you couldn't refinance because you owe more than the property is worth. Under my idea, the bank could allow you to refinance the current value of $300k at today's rate, and allow (based on some scale) for a longer no-interest (government guaranteed) loan for the outstanding $100k in value lost.)
This probably wouldn't work, but hey, I don't hear anyone else - especially the president, his administration, or congress - making any suggestions to help out the homeowners who have played by the rules but been screwed by the financial house of cards.
As I've said, I'm not a financial expert, but it seems to me that the continued loss of 600,000 jobs a month means what we've been doing hasn't been working.
