Day 304 – Punters and Touts

Shame on us if we don’t stop the banks from continuing to fleece the country. They will be happy to blame someone else for the problems they created. In fact they’ve already done it. Do Bank of America or Citibank or JP Morgan or Goldman Sachs take any responsibility for the financial crisis? Do they think the Great Recession has anything to do with predatory lending policies and profiteering on unregulated derivatives, or do they want to lay it all at the feet of people who defaulted on their mortgages? 

There is no way that the threat of foreclosures on subprime loans brought the global financial system to its knees. The math doesn’t work. If all the subprime loans that are going to go bad went bad on the same day, the carnage still wouldn’t add up to what we got. What we got was a ridiculous multiple of the actual problem. And the reason we got a ridiculous multiple is the extent to which the banks leveraged their own folly.

The value of all residential mortgages outstanding in mid 2008 was $10.6 trillion. This number includes good mortgages and bad. Of this total 9.2% or just under $1 trillion were either delinquent or in foreclosure in August of 2008, the month before Lehman Brothers collapsed.

Of this amount there was still some residual value in the underlying residential real estate. Average home prices had declined about 20% by that time. If you consider that the homes with delinquent mortgages were probably in worse shape than the average home, the value lost might have been as much as 40%. So the actual losses on mortgages in default in August of 2008 was something like $400 billion. How did this amount devastate the nation’s economy and send our largest banks into a tailspin?

The answer is twofold—leverage and speculation. The five major investment banks (Bear Stearns, Merrill Lynch, Morgan Stanley, JP Morgan, Lehman Bros. and Goldman Sachs) were leveraged between 25- and 32-to-one at the end of 2007. That means for every dollar of assets they had $32 dollars of debt. They were at the limit of their capital requirements, so their leverage played heavily in determining their soundness. Because of the leverage, if a bank had a million dollars of losses in their loan portfolio and took the loss—that is marked their portfolio down to its realizable value—it would have to come up with $25 to $32 million of additional capital. As you can imagine, this is a pretty scary place to be. This is why no one wanted to write their assets down. This is why they invented accounting chicanery and subterfuge to get the bad assets off their books at full value. At this point, not that I would suggest this is what happened, even fraud would have seemed a better alternative to telling the truth. The consequences certainly would have been less onerous—a few hundred million in fines and sanctions against losing the company entirely.

Speculation just made the problem worse. While there were $10 trillion in outstanding U.S. residential mortgages in 2008, there were $47 trillion in nominal value of credit default swaps circulating in the largely unregulated over-the-counter derivatives market. No one really knew how much was outstanding because the market was unregulated. The market was unregulated because Alan Greenspan, Bob Rubin, and Larry Summers decided to keep it unregulated back in the late 90s. Not only that...they saw to it that Brooksley Born, then head of the Commodities Futures Trading Commission, was silenced for daring to suggest that an unregulated market this size might turn out to be a problem.

Today Greenspan at least admits that this was a mistake. Rubin has denied any complicity in the decisions, and in a Herculean revision of history akin to cleaning out the Aegean stables, now claims that he always thought regulation of the derivatives market was a good idea.

Credit default swaps are like insurance contracts put into place to cover the losses should some mortgages stop performing. The derivatives protect the income stream of the investment in the mortgage. If the homeowner defaults, the derivative pays off. The investor, the organization in this case that bought a package of securitized mortgages, is whole. This is the ostensible purpose of CDS, but if this were their real application why in the world would we need $47 trillion of swap contracts to protect us from $400 billion in losses? That is 117.5 times more protection than was needed.

The speculative part of the problem comes in because, in the world of derivative contracts, you don’t have to own a mortgage to insure against mortgages defaulting. These things are traded in banks and brokerage houses, but they would be more at home in betting parlors. They are not investments. They are wagers.

Derivatives are gambling in its purest form. They are perfectly analogous to a pari-mutuel ticket on a horse race. When you bet on a horse race, you do not have a stake in the horse. You have no interest or participation at all in the horse racing industry. Your only interest is in the outcome of the races on which you have bought tickets. Derivatives are the same. You are betting on the outcome of an event. You don’t have to have a stake in the event other than your contract. You don’t care about the owner of the mortgage, or its originator, or the homeowner, or the value of the mortgaged property. You only care if the mortgage stays good or goes bad. One way you win. One way you lose. Whatever else happens is not your concern.

You can buy a contract on anything. This is what our august financial institutions were doing—gambling on outcomes in which they had no stake other than the outcome. Because the market was unregulated and thus hidden from scrutiny, no one had any idea how deeply the problem ran. The banks were betting against their bets against their bets against their bets that mortgages wouldn’t go bad.

Of course the problem was that If a bunch of mortgages went bad, the companies that sold the derivative contracts were going to have to pay off three and four times...or 10...or 117. No one was prepared to do that. No one could. There wasn’t enough real value in the system to allow that to happen. The whole thing was an enormous house of cards that spun off hundreds of millions of dollars of profits over a decade or so, but which was so fragile that it would all come tumbling down in the balmiest zephyr of ill wind. That’s why now we taxpayers are going to have to pay off the losses three times over before we’re out of the woods.

This is crazy. This kind of stuff is no longer about saving the financial system or shoring up the markets against unforeseen volatility. This is about a handful of guys that we trusted because they were supposed to be the smartest guys in the room betraying that trust and using their smarts, their cultural advantages, and their connections, to systematically strip us of the wealth many of us actually worked for…and they’re still at it.

The banks are still lobbying for less regulation, still trying to keep unfettered access to derivative plays, still anxious to package and sell collateralized debt obligations, and still especially vested in remaining too-big-to-fail because that takes all the risk out of the game for them. Staying too-big-to-fail insures that they will be bailed out by the taxpayers whenever their risk models fail. They reap huge profits on inordinate risk, and we back their play. Who wouldn’t want a piece of that action?

For an excellent discussion of the events and failures leading up to the financial crisis you can stream the broadcast of episode 355, titled "The Giant Pool of Money," on This American Life, aired by Public Radio International in May of 2008 in plain English with stunning clarity!

Day 297 – Confessions of a Former Voldemort Republican

          I put a tweet up yesterday in which I referred to myself as a Voldemort Republican. I’m really not anymore—probably I never was—but I still think the concept is incredibly funny. I got it from a t-shirt/bumper sticker ad I saw during the last presidential election, but it seems that the concept actually originated with an online comic strip called Goats, which is written and drawn by Jonathan Rosenberg.

          That the humor has been embraced, one would think mostly by Democrats, speaks volumes about the low esteem in which Republicans were generally held leading up to the election of Barack Obama as president. Voldemort is of course the principal antagonist from the Harry Potter franchise. Voldemort is the embodiment of overarching patrician conservatism suffused with an unrelentingly callous evil. This is pretty much the way a lot of people still talk about George W. Bush.

          I always liked George Bush. I thought he was naïve at times, maybe even a little stupid, but I never regarded him as evil. He’s an affable, down-home kind of goof-ball born with a silver spoon in his mouth. He’s a contradiction and an occasional buffoon, but he is not evil. By the same token I do not think that Barack Obama is a Nigerian Islamic communist. I do not think he has an agenda to take my money and redistribute it to the poor and disadvantaged. I do no think he is pursuing a reverse racist agenda.

I think each of these presidents did or is doing the best they can, given their particular ideological proclivities and extremely difficult circumstances. I’m giving them a break. This doesn’t mean I agree with the policies of either of them. In fact, just the opposite. I think they’ve both made a lot of mistakes. I’m just not about to presuppose that I, or anyone I know or know of for that matter, could do any better.

          I’m tired of the slash and burn rhetoric from both sides of the political equation. I’m tired of congressional votes that divide along party lines. I’m tired of the no-quarter-taken-and-none-given lack of compromise on all sides. Republicans were only too happy to give $1.5 trillion to GM, Chrysler, AIG and 13 banks when they thought the world as we knew it would come to an end if chips fell where they may. Now they don’t want to part with a few paltry billion in unemployment benefits because they’re afraid the world as we know it might come to an end unless the chips fall where they may. If they are truly interested in making the country a better place for its citizens, they have chosen an odd place to draw the line on stimulus.

          Just as bad, the Democrats were determined to pass health care reform just to prove that they could, but they couldn’t be bothered to listen to anyone else’s ideas, so we got reform that isn’t and cost savings that don’t. Is there anyone out there who is interested in actually fixing some of our formidable problems? All our politicians and all our pundits act like fundamentalist evangelists who would rather prove that their own personal interpretation of scripture is correct than to actually lead a soul to salvation.

          A few days ago (August 12) there was an article posted at the Fox Forum by John Lott blaming the Democrats for a recent, and nearly insignificant, spike in unemployment claims. Lott believes, along with a lot of other people apparently, that unemployment benefits create unemployment claims. This theory has been debunked nearly as many times as the flat earth, but still it persists. It persists because people are afraid that someone undeserving is going to end up with some of their money. They are afraid some lay-about like me is going to use extended unemployment benefits to fuel my yacht and stock my liquor cabinet with high dollar single-malt scotch. They are afraid that the Democrats are orchestrating a massive shift of wealth into the hands of the poor who are, after all, poor for a reason.

          A person calling himself ‘webedun’ who commented on Lott’s post put it most succinctly: “It's the ‘CLOWARD & PIVEN STRATEGY’ they've had in the works since the '60's. Google it. Glenn Beck saw this coming something like a year ago. Just look it up and learn. You'll see the Progressive's plan to take down the Government.” Well I did Google it, and I have to say that I don’t think that ‘webedun’ looked it up himself. He just took Glen Beck’s word for what Cloward and Piven were all about, and then he tried to apply it to a case where it doesn’t really fit.

          The Cloward and Piven Strategy was a proposal by two sociologists back in 1966 for a massive registration of qualifying poor people in order to create a welfare crisis and thereby force the Democrat controlled Houses of Congress to pass something like a guaranteed national income. It was folly then, and it remains folly today. Anyone who would posit it as a viable political agenda, a strategy to be either feared or embraced, would necessarily have an IQ hovering around their hat size. It is ridiculous, and yet there it is on the Internet, touted rather seriously as something I need to look up and guard against.

          The irony is that while Glenn Beck and his minions are worried about a massive shift of middle class income to poor, unemployed, illegal Mexican immigrants, shiftless African American welfare cheats, and secret cells of Muslim terrorists, there has in fact been a massive shift of middle class income. It went the other direction. Instead of going to the poor it went to the rich. We watched it happen and we were too dumbstruck to say anything about it.

          It didn’t have anything to do with Democrats or Republicans either…or liberals or conservatives…or George Bush or Barrack Obama. We were fleeced by our banks. Not only that. They’re still at it. Our banks robbed us of our prosperity. They stole our future. They bet our farm, lost, and got reimbursed for the loss…by us. We paid twice. They lost our stuff and then they got us to pay them for losing it. It’s not over either. They’re going to get us to pay for it a third time. All that lost value, all those toxic assets we heard so much about, they’re still there—still secreted on and off the banks’ balance sheets at inflated values. They haven’t taken the losses we already paid them for yet. They are waiting until they have enough profits to offset the unrealized losses on their books.

Where are they going to get these profits? From us. They are going to charge us fees for doing things they ought to do for free. Citibank is talking about charging a fee if you want to talk to a teller. They are going to charge exorbitant interest rates to loan us money that they get for free. The more trouble they get us into, the more they are going to charge us. They will justify this because we are bad credit risks, and we will be getting worse. We will be overextended.

Sadly, I think, if we don't stop them, we will deserve it.