March 27, 2010

All quiet on the financial front

The Black Swan arrived in the form of the "subprime mortgage crisis," so named because a species of massive, gigantic, unprecendented fraud, based on the housing industry, became Wall Street's standard operating procedure. The big investment banks (Merrill Lynch, Bear Stearns, Lehman Brothers, Goldman Sachs, Deutsche Bank, numerous others) became the huge vacuum cleaners for every piece of marketable mortgage debt which New Century and a hundred other loan originators (now almost all defunct) could scrounge up from America's vast crapscape of modular ticky-tack, particularly in California, Arizona, Nevada and Florida. And when the mortgage companies could not produce the raw material fast enough (the subprime and Alt-A loans), a number of the banks, such as Bear Stearns and Merrill, went directly into the mortgage business themselves so they could produce their own fraud-fodder. Ah, what days those were! They could take hundreds of loans, such as the five that one Vegas stripper took out in order to buy five houses in one week, moosh them altogether into tranches, perform some alchemy, take them over to Standard & Poor or Moody's, and voila!, Grade Triple A "investments" which could be sold to insurance companies, pension funds, hedge funds and credit unions, all around the world, generating enormous commissions and fees.

It was all fraudulent and it was the biggest business in America. During the boom years the FIRE (finance, insurance and real estate) sectors of the economy generated over 40% of all corporate profits in the United States, and an enormous proportion of the money made was based on the quintessentially fraudulent business of packaging crap loans into bonds and calling them gold. That's stunning when you think about it. An entire economy based on lying and cheating, and to date virtually no one has been prosecuted for securities fraud (a couple of guys at Bear Stearns running a hedge fund were prosecuted and found not guilty). There were two ways to get rich during the subprime heyday: to defraud the general public by selling all the shitty loans to them, or by betting against the shitty loans by means of credit default swaps written by stupid (and greedy) companies like the Financial Products division of AIG. Or, in the case of companies like Goldman Sachs, by selling shitty loans to investors on the basis of fraudulent misrepresentation that the paper was Triple-A, while simultaneously betting against the same shit by means of credit default swaps. And then when the loans inevitably collapsed, by having the payor on the credit default swaps (AIG), which became insolvent by writing insurance on loans vastly in excess of its reserves, bailed out by the Treasury Secretary, who just happened to be the former Chairman of Goldman Sachs, who used to be a big mucky-muck in the securitization-of-shitty loans business.

Interesting, huh? That's actually the America we live in. All of that really happened. Even though all of the Wall Street banks, and many standard commerical banks as well, were engaged in massive, systematic fraud, all of the big ones (the Too Big to Fails) were bailed out, on a selective basis, so that particular favorites of the Bush and Obama Administrations (Goldman Sachs and JP Morgan Chase) could emerge with their old competitors (Lehman Brothers, Bear Stearns, Merrill Lynch) either destroyed or dissolved by digestion in the alimentary canals of other Too Big to Fails.

So now the federal government controls about 80% of the mortgage business, such as it is. The pole-axed GSE's, Fannie Mae & Freddie Mac, have been placed on federal life support, with their $5 or $6 trillion in liabilities explicitly entered on the government's ledger sheets (adding about 1/3 to the national debt, but in a quiet, ambiguous way). The feds felt they had no choice, because so many of Fan & Fred's "agency debts" were owned by our Commie payday lender, the People's Republic of China, and the Reds were none-too-happy about getting fleeced in the first place. The Federal Reserve itself went on a buying binge of Fan & Fred mortgage-backed securities and agency debt to the tune of about $1.3 trillion, along with another $300 billion in Treasuries of various maturity durations, as part of its "quantitative easing" (money printing).

Now, in four days, the Fed's QE program comes to a close. No more buying of mortgage-backed securities. No more "support" for the federal bond market. The housing business is "on its own" now, because Bernanke has stabilized the economy and the recovery is well underway.

So a question which you, as a thinking person, might ask at this point: but where did all the debt go? Didn't the economy tank because trillions in unpayable debt were issued by fraudulent loan originators, on the basis of fraudulent loan applications, packaged by fraudulent securitizers and fraudulent investment banks, and then sold by fraudulent bond salesmen? And all of this insured by the fraudulent writers of fraudulent credit default swaps? And since the housing market has not "reinflated," doesn't this mean that all the loans that were bad are still bad, and all of that debt, on someone's books, still has to be out there? The former residential occupants of the Desert View Mesa subdivision in Toiletcrap, Nevada, may have abandoned their 4-br (incl mast ste), 3-ba, fam rm, pool, 3-car ga, 3k sq ft haciendas in favor of the local trailer park, so that the debt is certainly off their books - but it went somewhere, right? Someone made a cash investment in those houses to the full extent of the mortgage. Maybe it was a Norwegian teachers pension fund, or maybe it was CalPers, but somebody somewhere is holding that debt, and is out a lot of money as a result, are they not?

That's why we're not out of this, not by a long shot. The Federal Reserve's load of this unpayable debt increased its balance sheet from $800 billion to $2.3 trillion, and that only represents a fraction of the loss. There's plenty more where that came from, and foreclosures and the shadow inventory push more debt down the line like the Conveyor Belt from Hell. Banks keep failing, every Friday like clockwork, and every time the FDIC takes over, they find the banks have substantially understated just how far underwater they really were, by playing the game of "extend and pretend," where banks hold zombie loans on their books which haven't been paid in a year, but if they haven't foreclosed, and no one says anything - hey, the loan might still be good, right? There might be a sudden 100% inflation in the housing market, couldn't there? Haven't stranger things happened? (Not really, but nice try.)

Through all this, the Fed has prided itself on its ZIRP (zero interest rate policy), which means that Americans who want to do the prudent thing with their money and save it receive absolutely no reward for their virtue. ZIRP is necessary because the vast Himalayas of debt which the U.S. took on to salvage the mortgage business, and rescue the states, and bail out the Wall Street firms with good Administration connections, and "stimulate" the economy, cannot be managed unless interest rates are kept at artificially, unreasonably low, rates.

And now a few disturbing signs are appearing that this fantasy is also about to melt, as Prospero said, "into air, into thin air." The Wall Street Journal reports today that Treasury auctions over the last week have been weak, with the bidding down and the interest rate required in order to sell all the scrip creeping up. Right as the Fed tries to drop out (Bernanke: "Every time I try to get out, they pull me back in...") of the shill business, the Chinese (whom we are stupidly provoking at precisely the moment we can't afford to) and other "indirect buyers" are losing interest in our tincupmanship. It's hard to overstate how ominous this development is. We really are just getting started on financing all of this debt the USA has taken on over the last couple of years. We have to sell $150 billion in Treasuries a month just to service the current budget deficit, let alone meet all the rollover debt that keeps maturing because of the desperate attempt to keep durations short to keep interest rates down.

So not so long after the last Black Swan dropped a huge whitish-gray load of goop right on top of our heads, here comes Rodan with another pantload, and this one might cover D.C. to the top of the Washington Monument

1 comment:

  1. Anonymous12:53 PM

    Great reality check on Spin City coverage of financial crisis. But putting it all on the banks, without any mention of successive government policies that started back in the Carter administration and pushed the banks to loosen up lending requirements, is in itself a bit misleading. Remember, banking is one of the most heavily regulated industries that we have.

    Susan Lloyd
    Reno, NV