Reading through the reviews of the mortgage credit meltdown this past two weeks I’ve come across any number of culprits that are said to be responsible for this fiasco.
First, there is the HOMEOWNER. I really can’t get behind the notion that someone who was unfortunate enough to buy a home with little or no money in the past few years is responsible for this crisis. It is the “American Dream” as President Bush so proudly trumpeted in his State of the Union address. He and his administration were taking credit for the high 60+% number of Americans being homeowners. Who can blame the new homeowner for grabbing part of the Dream as best they could? Others may be speaking not of homeowners but of SPECULATORS. That’s a concept I understand. Speculators were playing musical chairs with houses. Buying sight unseen pre-construction with huge leverage in a market that had already risen to new highs. That’s risky and in my opinion this is what precipitated some of the crisis starting over a year ago.
MORTGAGE BROKERS and LENDERS are another commonly maligned group. And yes, we have our share of unscrupulous individuals. But, lenders and brokers were selling the products that were made available to them. And yes, buyers were demanding these products, even those who should have never considered being a buyer as well as the realtors who wanted the deal to close. Let’s face it – not everyone is cut out to be a homeowner.
So, where did all those crazy mortgage products originate? On Wall Street with investment bankers and hedge funds. Conduits, which are the methods by which mortgages are created and turned into securities and sold to investors, grew at an unheralded pace over the past five years. Billions and billions of dollars changed hands and created a host of new products for the bankers to sell at a profit.
How does all this fit together? There are really two commonalities:
GREED and LEVERAGE
We all have heard how greed corrupts. A nasty habit. But it was leverage that brought the credit markets to a screeching halt. It was considered a “no risk” trade to borrow yen and invest it in mortgage backed securities (MBS) or Collateralized Debt Obligations (CDOs). There was a free spread of anywhere from 3 to 7 percent or more. And if you could do it with cash, why not do it with borrowed funds and really jack up your yield. “We can borrow at a ratio of 10 to 1 and we can’t miss.” Until the music stops. And the beat started slowing when some homeowners were forced to sell at lower prices. The volume dropped when lenders gave funds to bad prospects. When speculators just walked away from their empty, unsold investments you could barley hear the music. And finally, when lenders and hedge funds had margin calls against the declining value of wall street investments it stopped and so did the bids for certain mortgage products. Mortgage rates rose in the face of declining yields on treasury bonds.
Greed and leverage, they rarely coexist for long together.