December 31, 2011
We’ve repeatedly noted that fraud by the big banks – more than anything done by the little guy – caused the financial crisis.
And we’ve repeatedly noted that excessive leverage helped cause the Great Depression and the current crisis.
Reader McFid – who has been a breach of fiduciary duty expert since 2003 – sent me the following article (edited slightly) which provides a new angle on both themes.
This article disabuses the notion that “deadbeat borrowers” caused the financial crisis. And offers an answer to the question that still lurks in the mind of every American; whether black, white, native American, asian or Hispanic; whether educated or not; whether English, Spanish, or Mandarin speaking.
Taking a big step back, and looking at it like a business process: “How could so many Americans ALL have made the same ill-advised mortgage borrowing decisions?” The answer lies in what did they ALL have in common…
It was all about leverageWhat is leverage?
Leverage is a way to control more of something when you can’t pay for it in full. We do it all the time; when we buy a car — except few of us actually buy the car, we finance it or lease it. We also do it when we buy a house — except almost no one pays cash for a house, we finance the purchase with a loan; it’s secured by a mortgage on the property.
Example of 5 times leverage:
When we buy a house and put 20% down, we buy a house worth 5 times as much as the down payment. If we put $100 thousand down we can buy a house worth $500 thousand. $500 thousand divided by the $100 thousand we put down equals 5 times leverage.
100 times leverage:
By the same calculation ZERO down mortgages were suffice it to say, 100 times leverage, it’s actually more but that’s a discussion for later. Repeat after me, no money down mortgages equal 100 times leverage.
Who controlled and approved EVERY leverage decision?
Leverage Approval #1 by:
TBTF Banks (ultimately) approved every one of these loans and bundled thousands of others like them initially into mortgage backed securities (MBS).
Leverage Approval #2 by: [the key, little known fact]
In the past, TBTF Banks used to sell them off (remember that word) to investors like mutual funds, insurance companies and pension plans. In the 2000′s TBTF banks issued almost $17 Trillion of MBS, but did not sell all of them OFF to 3rd parties. They held massive amounts of them to turbo-juice their bonus checks in a 2nd set of books (legally) in OFF balance sheet, special purpose entities. As a refresher Enron did the same type of thing. In the decades, make that for over 60 years before the 2000′s TBTF banks’ leverage was around 12 times; however when they concealed trillions worth of MBS — their leverage increased to over 30 times. Remember 5 times leverage? It was based on how much the house was worth right? And when TBTF banks add more leverage on top of the borrower’s leverage we don’t just add it — we ______? You guessed it — we multiply it.
3,000 times leverage on house prices:
100 times leverage on the borrowers side times 30 times leverage on the TBTF banks’ side is 3,000 times leverage ON house prices.
Lather, rinse and repeat — 100 times 30 equals 3,000 times leverage. Lather, rinse and repeat.
100 times 30 equals 3,000 times leverage.
Remember what I first told you about leverage?
Leverage lets you (or TBTF bank) control something that you can’t fully pay for. Well the TBTF banks’ way of financing them in the Asset Backed Commercial Paper market began to dry up in August 2008, so they couldn’t pay for these assets. This is the direct cause (but not the root) for the Fed and US Treasury to (have to) step in and pay CASH for them in the bailouts of 2008, and again in 2009, and again in 2010 and yet again 2011 via the Fed’s QE trifecta to the tune of over $20 Trillion dollars.
The interactive portion is about to begin:
Is it any surprise that the assets backing the commercial paper were ________? You may have guessed it — MBS.
Is it any surprise that the Fed created a new category to track ABCP in_______? You would be correct if you guessed 2006; just two swift months after Ben Bernanke was appointed chairman of the Federal Reserve by President Bush.
Is it just a random coincidence that almost $17 Trillion of Mortgage Securitieswere created by TBTF banks from 2001 to 2008?
What was that word I asked you to remember?
Oh, right it was OFF.
When TBTF banks’ CEOs, executives or prop traders got their year end bonus check did we hear reports that anyone said it was OFF (or that it was too much)? Nope.
The top 12 reasons + oneTBTF banks, before 2008 created a hidden, secret “market” for MBS:
[TBTF Banks on LSD indeed; massive amounts of Leverage, Swaps and Derivatives.]
This article was posted: Saturday, December 31, 2011 at 2:55 am