Blame the Victim Rules the Subprime Debacle

Posted by D.D.Grant at 2:04 AM

Anyone get the impression as I do that the scene is being set for placing the blame for the economic crisis on those hapless people who were so inconsiderate as to put everyone at risk by actually taking advantage of what they saw as the opportunity to get their piece of the pie? Yes folks, the reason the wheels of high finance are now gumming up is you or your neighbours utter selfishness in wanting a decent roof over the heads of your families. How thoughtless and unpatriotic of you to throw caution to the wind.

Max Wolff notes the mindlessness that has become a feature of commentary on the financial crisis where mouthing "subprime" a sufficient number of times seems to absolve anyone from actual analysis. The following from Credit Backwash August 21, 2007

"Every day we watch people blame sub-prime. Sub-prime is neither contained nor, is it the essence of present trouble. Discussing sub-prime as the cause of asset re-pricing has become ubiquitous. I would liken this line of explanation to the way that American urban violence is often discussed as "gang related" or "drug related". In short, it is a lazy catch all employed to avoid scratching below the surface. ..."

The truth is it seems that it's not only in the housing mortgage sector that 'liar loans' have been the fashion.

"A huge credit bubble exists and extends far beyond sub prime mortgage distress. The global bubble is enormous and has many sub-component bubblettes. The internationalization, integration and expansion of finance extended and distributed the effects of overly cheap and easy credit. Innovation of new products, thin opaque markets in credit vehicles and voracious appetite for leveraged yield have transformed balance sheets and portfolios. This mountain of gas soaked rags was ignited by the credit concerns in sub prime. Now the credit bubble is burning. Years of euphoria, easy money and asset inflations built to dizzying heights. Massive, cheap and easy debt was taken on to buy houses, currencies, bonds, equities, mortgages, leveraged loans, credit default swaps, real goods and services. Credit burdens were taken lightly, rolled over, bundled and sold. As long as lenders, buyers, ratings agencies and faith held, bubbles formed and swelled. The size, volatility and interconnectedness of international asset inflation was unprecedented. The downturn has been similarly correlated. Sub-prime credits and the collateralized mortgage obligations comprised of them deflated- the match was struck. The fire is never really caused simply or exclusively by the match that lights it.

All these innovative new mortgages were written because there was great money to be made in bundling them into mortgage backed securities (MBS) and collateralized mortgage obligations (CMO). Lenders cashed in on a "originated to distribute" bonanza. All types of finance companies wrote mortgages- and many other types of credit contracts - only to sell them off. A popular final destination was in collateralized obligations. This industry swelled as trillions of dollars in mortgages were written over the past few years. Every obstacle to further lending was innovated around to allow profits to continue to flow. The risks of all this lending were less pressing as mortgages loans were made to be sold- not held. All the available credit bid up house prices and led to the false conclusion that houses were always safe, appreciating assets. Questionable loans and sub-prime mortgages were sold and reconfigured into AAA rated product. Risk vanished from consideration and discussion. Transformed mortgages became credit vehicles and were sold all over the world. Part of the mad dash now involves finding these hidden gems hiding on books and ascertaining their real value."

Meanwhile over at the Pundit's Blog Brent Budowsky tells it to America straight: Gilded Age Crime: Poor Go Homeless, Wealthy Get Bailouts

"Is it right that the new racket on Wall Street is that banks make bad loans, sell them to hedge funds and private equity firms, many of whom are virtually unregulated and untaxed, who then complain about their pain after they foreclose on average Americans for falling a little behind their payments?

It is good that today the Fed cut the prime by 50 points, but it is bad, and terribly wrong and unjust, that in the last week the Fed has essentially used Americans' money to bail out the wealthy who made the profits, while doing zero for the foreclosed and homeless.

When the banks, hedge funds and private equity firms make bad deals, they keep the personal profits, while the corporate profits are protected by bailouts. Meanwhile, when the average Americans in the middle class, or the poor, fall a little behind, they get the boot, they lose their jobs, they are thrown into the street without homes and often without food."

And don't ya just love the reasoning on RESPONSIBILITY that goes with the line of argument that runs, subprime borrowers who made bad decisions based on insufficient knowledge of what they were getting into should BE HELD RESPONSIBLE for those decisions even if this means losing their homes. Who cares if they're on the streets since that won't affect the economy. All they do is produce products services. But investors who made bad decisions based on insufficient knowledge of the real values of their investments should .... NOT BE HELD RESPONSIBLE for their decisions and should be bailed out by the taxpayer. They must at all costs be protected from losses. Their coupon clipping and 'premia' are essential to the economy.

I think this is known as one law for the rich and another for the poor.

Betting the Bank, and then some.....

Posted by D.D.Grant at 10:49 PM

Who hasn't heard stories of inveterate betting men fully alert to the essential truth that everything in life is a wager. It's chilling to think that the progress of the subprime bubble may well depend on the progress of two flies on a window pane, but let's not forget the idea attributed to chaos theory of the connection between the flapping of butterfly wings and the tornado that topples an economy. (A fascinating area in which to see the dissipation of risk based on essentially the same notion is the apparently mundane world of Insurance and Re-Insurance where the losses from disasters are spread in a worldwide market. Mundane until it's recalled that the men in the London coffee-houses were themselves no stiffs when it came to a bet).

The wild frenzy of gambling that now grips the world is not only attested to by the 54 million casino visits made by Americans in 2004 to lose more than $78 billion on the turn of a card or the spinning the slots, in effect sophisticated mechanical flies. James Mackintosh in The unbearable obscurity of exotic hedge funds gives a truly hair-raising listing of the current trend in hedge fund products. These make the sorties into housing speculation of the American homeowner positively parochial. You start to get the flavor of the 'New Economy' on learning from Mackintosh, "As hedge funds move into the mainstream, managers are testing demand for ever-more exotic investments - and finding backers willing to stump up millions of dollars for funds putting cash into everything from football players, wine and art to aircraft leasing and carbon credits."

A telling clue to the unease of large investors in the plain old vanilla securities market can be had from the tendency of big institutions to ensure that their fortunes "will not move in line with shares, bonds and other traditional investments." Following on this in the recent period money has flowed to a range of 'exotic' funds. These include football funds that buy the rights to talented young players in the hope of profiting from transfer fees should these achieve star status; instead of boring old charts investors must assess the risks of injury, drug abuse etc. (American Idol Fund anyone?). Others include fund specialising in sugar, film financing, art and wine.

Ominously, given the level of consumer debt, there are also funds investing in defaulted credit card debts and partnering with collection agencies in recovering the debt. This in an era when some credit card debt carries interest approaching 30% and when the UK for example is beset with problems stemming from the practices of doorstep consumer loan companies. There was a time when this kind of debt was purely a 'family' affair. Perhaps these developments lend a new meaning to the expression 'gangster-capitalism.'

Enter the multiplier, never far behind. Not to be outdone, Orthogonal Partners is launching a fund dedicated to - investing in exotic hedge funds. "There is a wall of money chasing every opportunity in the alternative scene so you really want to be targeting new niches where you still have a scarcity of capital and inefficiencies that can be exploited," says Dan Gore, Orthogonal's co-founder.

A staid voice intrudes; 'Tracy Pearson, head of alternatives at London fund of hedge funds Forsyth Partners, says it is questionable how many of the exotic funds are really hedged. "If it is offshore and they can charge 2 [per cent a year] and 20 [per cent of profits] it is a hedge fund," she says. "We get all sorts of stuff, usually sent from a Yahoo e-mail account."'

Any day now I expect offers from Nigeria to arrive in my inbox; they may even be packaged with the scams offering to make me an instant multi-millionaire in exchange for help with repatriating the fortunes of some hapless tyrant. Hey, I just thought of a great hedge fund idea.

Heebner: "Biggest housing-price decline since the Great Depression."

Posted by D.D.Grant at 12:37 AM

Bloomberg reports an interview with Kenneth Heebner, co-founder of Capital Growth Management, the top-performing real-estate fund. Commenting on the potential effects of the subprime crisis Heebner inferred that U.S. home prices could fall as much as 20% due to rising defaults on high-risk financing. "It will be the biggest housing-price decline since the Great Depression," he is quoted as saying.

Nor will hedge funds be immune from the effects of subprime-loan defaults. Although to a lesser extent, the same goes for mutual funds that invested in Collateralized Debt Obligations (CDOs) and other instruments secured by this type of loan. However investment banks and the brokers who are in the business of packaging and marketing these products will avoid being hurt, having passed on the bulk of the risk to investors. "They know the product is toxic; they're not going to get caught," Heebner said.

These comments by someone who has a consistently successful track record in calling the market should give pause for thought. A 20% drop in prices would undoubtedly affect many more people than the lower rungs of the subprime borrowers. Those with half-million dollar homes who have over-reached in equity backed borrowing could well find themselves walking away from homes with $100,000 of debt following them. I have witnessed just such situations in the Ontario market in the 80's. This is before the knock-on effects in the rest of the economy are even considered.

Many people have been paying attention to the market and conversations about selling are growing in frequency. This is a difficult matter to decide. Those who leave such a decision to the end in the hope of a recovery can end up being disastrously disappointed. On the other hand, at least one commentator not known for optimism has offered the opinion that a slump in prices that he sees as inevitable in mid-year could be followed by an upsurge in the fall when buyers from Asia will be attracted by the property bargains to be had in the US. But the same writer has been issuing a 'sell now' message for at least a year.

No help will come on this question from anyone who has a vested interest in shoring up the market. This includes politicians and mainstream financial 'gurus'. And it is well to bear in mind that your Financial Planning Associate at the local bank is more often than not speaking on the basis of the minimal requirements for offering such advice that holds in most jurisdictions.