Revisiting the Financial Crisis: Mortgage-Backed Securities

This is the start of a series of the financial crisis. The purpose of this series is to prove that there were several indications of an oncoming financial crisis that the federal government chose to ignore.

This Federal Reserve report published in June of 2008 indicates that the Fed realized that there was serious problems with subprime mortgages. In 2007, the S&P/Case-Shiller house price index released a report that indicated the largest drop in home prices since the Great Depression. Part of this was the market adjusting to the housing bubble. What goes up eventually comes down. Home prices went into free well into 2008. Below is a CNN graph of the S&P Case-Shiller National Home Price index numbers for the final quarter of 2008.

Bloomberg News reported on December 7, 2006 that Ownit Mortgage Solutions Inc. laid off 800 workers. The Los Angeles Times reported that Ownit could not meet its financial obligations. Ownit blamed Merrill Lynch & Co. for letting the company die. Former Ownit employee Kevin Panet told this to Bloomberg News about what management told him about Ownit's relationship with Merrill Lynch. The result was a disaster. Mortgages eventually depreciate in value. The housing bubble popped. Yet the major investment banks tried to keep riding the housing wave.

``There were meetings with top management late in the day on Monday saying, `Look, we're having some problems with our partners and brace yourselves,''' Panet said. ``It's a lousy market right now, and it's heading down not up.''

Here is how Ownit worked. Merrill Lynch & Co., JPMorgan Chase & Co., Credit Suisse First Boston were providing funding to Ownit to sell subprime mortgages to people with bad credit. These investment institutions would then buy the subprime mortgages and bundle them up into mortgage-backed securities. Merrill Lynch, and JPMorgan Chase bailed when the housing bubble popped. Ownit filed for Chapter 11 bankruptcy on December 28, 2006.

In 2004, Erick Bergquist reported half of its $4 billion worth of production to Merrill Lynch.

A Merrill spokesman confirmed that it had bought a stake in the wholesaler. "Merrill Lynch is active in the mortgage-backed securities market in many areas.

We are always looking to establish strategic relationships with quality firms," a Merrill spokesman said.

Merrill Lynch and other investment banks started losing billions in 2007. In good part to mortgage-backed securities. Merrill Lynch CEO E. Stanley O'Neal was forced to step down.

In pure destructive power, the subprime mess has become Wall Street's version of Hurricane Katrina. It has wreaked havoc on the nation's iconic brokerage firm, Merrill Lynch (Charts, Fortune 500), and biggest bank, Citigroup (Charts, Fortune 500), which have announced billions of dollars in losses and parted ways with their celebrated CEOs, E. Stanley O'Neal and Charles Prince. Banks, brokerages, and lenders have announced thousands of layoffs, and more are sure to come.

The blow to shareholder wealth is staggering. Since June 29, Citi's share price has dropped 35%, from $51 to $33, while Merrill's stock has slid from $84 to $54, a 36% swoon. In the same period, the dozen biggest Wall Street firms and the commercial banks with the largest investment arms - a list that includes Bank of America (Charts, Fortune 500), J.P. Morgan Chase (Charts, Fortune 500), and Credit Suisse (Charts) - have lost more than $240 billion in market value. Dozens of smaller companies in the mortgage business have suffered huge losses or folded completely.

To be continued.

Profits and Balance Sheet Developments at U.S. Commercial Banks in 2007 by Michael Robert Hussey