Who can pretend to know everything about the housing meltdown? The complicated intricacies of this backroom dealing seem to unfold everyday, baffling even the savviest of market watchers. Perhaps, as the financial titans look for ways of covering their tracks, hiding their losses and hoping that, by the time this incident completely reveals just how badly these investors/lenders/borrowers acted, we will have been too confused to point fingers at any one person.
One of the most telling announcements that we are in trouble from every angle came from the White House recently. They have partnered with eleven of largest mortgage services companies. You know them as the enablers; the folks who lent money to anyone with a heartbeat and five bucks to their name.
This partnership is an effort to get more fixed rate mortgages to the ten percent, yes, that’s right, the one in ten people who may have been eligible for a fixed rate mortgage when they first applied but who had instead, opted for something subprime, to borrow their way out of the problem.
Those ten percent had gambled with their otherwise pristine credit, bought a house that may have been larger or more investment worthy than they may have afforded otherwise and now they need help. Some of the simplest solutions, any Monday morning quarterback can clearly see were overlooked or flat out avoided by those same mortgage service providers when the loans were first generated. Offering to fix some of those rates once the problem of foreclosure seemed unavoidable could have created a good deal of organic empathy for this bunch of rascal-ly characters. But they didn’t.
Instead, faced with the opportunity to turn at least a portion of the meltdown around, they decided to head in the opposite direction and modified only one percent of the mortgages whose low initial interest rates or teasers as the industry calls them were about to expire.
Now, those teaser rates are about to expire on a much larger group: the investors who bought those mortgage backed securities. Until recently, these lenders, which essentially is what a bondholder is, were still receiving their monthly payment. These investors, who bought low-rated bonds called collateral debt obligations, purchased them because of the much higher yield offered over their better-rated counterparts. Higher yields for increased risk.
But now, those higher rated bonds are also suspect. As the underlying problems with poorly rated C.D.O.s, which stems from possibility of mortgage holders defaulting on their loans, make their way off the books ($20 billion have been written off so far), the owners of better rated debt obligations are beginning to worry. And with good reason.
That concern has created the need for a confidence booster, a bailout of sorts. Unsold C.D.O.s still exist. Banks are still holding mortgage-backed securities and are finding no buyers for them. But to hear these financial institutions tell it, these C.D.O.s are rather pristine with no real danger of subprime mortgages suddenly surfacing once they are sold. “No need to look under the hood, son,” the salesman said, “it runs like a charm.” No bad loans hidden under the seat. “Clean as a whistle!”
Two things are wrong with that pitch. First, there is the level of trust needed to take someone at their word and secondly, the belief that there is no one’s interest but yours at stake when the offer is made. But banks aren’t all that honest, even with themselves and worse, they aren’t all that sure what the other hand is doing or even holding.
That said the banks have hatched a plan. Why not form a group where these C.D.O.s of questionable make-up can be bought and finance it with borrowed money? Brilliant. And where do you borrow that kind of money? From the Treasury. And where does the Treasury get its cash? You.
Government debt is now barely worth the paper it is printed on as investors across the globe, fearing the trusted word of the banks, have piled in looking for some safe haven. This has pushed prices higher and that has brought the yield down on one-month government bills to under 3.5%.
The result of all that concern is now called the Master Liquidity Enhancement Conduit, a coalition of three banks – Citigroup, JP Morgan and Bank of America, headed by Henry Paulson, the Treasury Secretary created with the hope that this will be enough to keep the financial markets afloat.
This group, using borrowed cash, as I mentioned before, will buy Structured Investment Vehicles or S.I.V.s. Many of those S.I.V.s, which bear a remarkable resemblance to SUV.s with the same potential for unexpected rollovers and sudden fiery events. S.I.V.s, which is simply a fund holding numerous C.D.O.s, have the all of the same underlying problems: unknown risk, slowly unfolding defaults and the potential of several trillion dollars worth of losses.
In other words, the worst is still ahead of us and the solutions so far have not been adequate enough to stem that rising tide. The froth that Greenspan referred to the mortgage markets as possessing just a few short years ago has turned into an overflow of suds in a tub with the water running, metaphorically speaking.
Foreclosures take time to work their way through the system and they have only just begun. That slow process could take many more segments of the economy down with it in the next several years. But not to worry. As Mr. Paulson might say, “no need to look under the hood, son. It runs like a charm. Clean as a whistle!”