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

Standard and Poors Places United States on Credit Watch

Standard and Poors have placed several United States financial assets on negative credit watch placement. This means the United States will lose its AAA rating if it doesn't resolve the debt ceiling crisis. It also depends on how the debt ceiling is raised.

However, S&P has said it could move "even if a debt-reduction deal is met and the $14.29 trillion federal debt ceiling is raised. S&P has cited $4 trillion in debt reduction as a figure that would be appropriate for keeping the triple-A rating. S&P has also said it wants a credible agreement, meaning one that has bipartisan support."

Americans could have their homes foreclosed upon, if the Treasury Department cannot make bond payments for Fannie Mae or Freddie Mac. S&P has also place a negative credit watch on subsidized public housing and mortgage-backed securities. The federral government took more bad mortgages to bailout banks. This is many homeowners at potential risk.

Remember...

Bow in reverence to the dogma of free market capitalism. Society will be safe and more prosperous when the government stays out of the market, because there's certainly no regulation needed here.

At JPMorgan Chase & Company, they were derided as “Burger King kids” — walk-in hires who were so inexperienced they barely knew what a mortgage was.

At Citigroup and GMAC, dotting the i’s and crossing the t’s on home foreclosures was outsourced to frazzled workers who sometimes tossed the paperwork into the garbage.

And at Litton Loan Servicing, an arm of Goldman Sachs, employees processed foreclosure documents so quickly that they barely had time to see what they were signing.

“I don’t know the ins and outs of the loan,” a Litton employee said in a deposition last year. “I’m not a loan officer.”

Nope, no regulation needed here.

Known as "Burger King kids" at some banks, the new hires were brought on and tasked with dealing with foreclosure paperwork—a 250-step process—with little training or understanding of the housing industry. Other banks outsourced to firms who were outsourcing, having employees in Guam and the Philippines process paperwork. The result was "chaos." "The girls would come out on the floor not knowing what they were doing," one former employee said. "Mortgages would get placed in different files. They would get thrown out. There was just no real organization when it came to the original documents."

The system is perfect, and everything is fine.


See? Now just toodle along please, communist scum -- but not before you give us another bailout, becasue we need that. And we don't need regulations. Thank you.

The Plan for what, exactly?

[Since this post is rather critical of the president, let me preface this with "Speaking only for myself" - tas]

From the Treasury Department:

To address the challenge of legacy assets, Treasury – in conjunction with the Federal Deposit Insurance Corporation and the Federal Reserve – is announcing the Public-Private Investment Program as part of its efforts to repair balance sheets throughout our financial system and ensure that credit is available to the households and businesses, large and small, that will help drive us toward recovery.

The italics are mine. Let me translate this: Nobody in their right mind will invest in banks with their own money right now because the banks are broke. But the country needs banks to start lending again if we expect our economy to get better.

With that in mind, here's the jist of Geithner's plan: The Government begs private investors to front a minimal amount of capital to bid on toxic mortgage assets by saying, "Hey, we'll pay you $6 for every $1 you spend on mortgage debt." This takes bad debt off bank balance sheets, investors are then willing to place more money in banks again because they'll be able to start making loans again.

Theoretically. Unfortunately, this plan raises a lot more questions than it answers.

Wall Street loves it, as evidenced by stocks shooting up today. And why shouldn't they? The Obama administration just told them, "Hey guys, great news! We don't intend to break apart the huge mega banks that got us into this mess, and we're going to give you billions -- possibly a trillion -- in taxpayer dollars!" This people are all for preserving status quo since it makes them rich, and no matter how hard they fuck us they won't be reprimanded.

But the plan might not even work. Currently, it's slated to purchase $500 billion in toxic assets; possibly rising to $1 trillion. This is supposed to clear bad debt off banks' balance sheets, thus allowing investors to place money in banks again since they'll be solvent, thus allowing banks to make loans, etc. But as I've mentioned here before, just with Fannie Mae and Freddie Mac we see, at most, $5.4 trillion in bad mortgage debt. So does the plan address this debt or just the debt from banks that the government didn't have to gobble up, like Citibank and Bank of America? If the plan doesn't address the Fannie/Freddie debt, what will? Additionally, discounting the Fannie/Freddie debt, just how much toxic mortgage debt are we looking at with Citibank and Bank of America?

To give you an idea of the scope of that last question, as of December 2008, Bank of America's total liabilities were over $1.6 trillion; and Citibank's liabilities are almost $1.8 trillion. Will $1 trillion from the Fed/FDIC -- much less $500 billion -- be enough to convince investors to place money in these institutions again? It would certainly be great to know just how much of that $3.4 trillion in liabilities is bad.

The part of this plan that I really find galling, though, is that the government is willing to fork over hundreds of billions to Wall Street to get them to purchase mortgage debt. This is our money, and essentially our money is being used to pay off mortgages -- but by giving it to investors who can afford to put up a few million to pay for them. These investors can then turn around and ask home owners to pay up on mortgages that their tax dollars just bought.

If this is the case (and I could be reading the plan wrong, but...), what's with the middle man? If the government intends to pay for these mortgages, why not just forgive them? Why not just give banks 85% of what the mortgages are worth -- which they should very well be happy with -- and everyone goes on their merry way?

While some will rightly point out that people would get free houses under such a scenario, which they certainly don't deserve, under this plan the business school rejects who placed the economy in hot water are now being rewarded by having the government give money to banks to pay off these mortgages, and turning around to give these mortgages to the business school rejects with instructions to squeeze as much profit out of it as they can. In short, the business school rejects have the potential to reap huge profits off home owners since they paid $1 for every $6 the Obama administration would give them to buy their mortgage.

And you know, I don't think these assholes deserve the money.

The more I think about it, the more unsure I am of exactly what this plan is supposed to accomplish. Do Obama and Geithner (shamefully) intend to give Wall Street what's maybe the biggest bonus in history? But if so, how can this plan deliver such when it may not accurately address all the bad debt that exists? In the former scenario, normal Americans -- you and I -- bend over and take it; but in the latter the plan just doesn't work.

Here's an idea for a plan that could work: restructure the mortgages so their value reflects the median value of a home based on its value from 2005 to the present; adjust interest rates so they are lower; then spend enough money on job creation (like infrastructure repairs) which give people jobs, kickstarting the economy and giving everyone money to pay down their debt. But that plan doesn't give Wall Street a big fat check, now does it?

Makes me wonder what's really important to the Obama administration right now.

The $5.4 trillion we'll pay if the stimulus package doesn't work

A major sticking point with the bailout discussion is cost. Republicans have blared endless about just how much a trillion dollars is -- a stack of $100 totaling a trillion could reach Pluto or something, go around the globe at the equator eight zillion times, etc. One facet of the stimulus package story that nobody is discussing, though, is how much the government will pay (with our money) if the package doesn't work. A cursory glance at the details of our country's budget problems makes $1 trillion look like a bargain.

Last month, Harper's Magazine had a cover story that I wish they would make available online because the link would go viral, and you would get better pictures of the graphs in it then crappy ones I take with my cell phone camera. Anyway, the story is titled "The $10 Trillion Hangover" and it details the money added to our national debt by the Bush administration. $10 trillion is actually a conservative estimate -- the debt could balloon to $13-15 trillion. Why? Ask Freddie and Fannie.

I made a photocopy of the article (and went at it with a highlighter, which I may not have done if I knew I would post a photo of it online in the future), and to your right is a crappy picture I took showing one part of one graph in the article -- the mortgage back securities debt part. The full graph itself is called "The Bill" and it succulently details all the debt added to the government over the past eight years. Now the graph attributes $.1.6 trillion to the government taking over Fannie and Freddie, but that's a low estimate. This blurb from the article shows why the mortgage debt is a real wild card:

When the federal government took over these failing residential mortgage giants, it also assumed their $5.4 trillion in mortgage-backed securities and outstanding debt.

Cutting straight to the point, that $1.6 trillion the government is responsible for now will balloon -- potentially to $5.4 trillion -- depending on the amount of home foreclosures in the future. Those are costs the government will have to account for. And whose money will they use? You guessed it, yours.

This makes current discussions on the cost of the stimulus bill silly. $1 trillion? Pshaw! Try $5.4 trillion if the stimulus bill doesn't work. A trillion has now become pocket change.

The choice for the Obama administration is simple: get real stimulus done. If this means hopping off the bipartisan pony ride and even, if necessary, brutally bludgeoning that pony to death, do it -- or we all suffer the consequences. And what are those consequences? It could be a repeat of the 1930s... Do you want to find out? You shouldn't. I certainly don't.