Mortgage Brokers And Mortgage Bankers Pushed Subprime Loans To Borrowers Because There Was No Risk To Lenders As Loans Were Sliced Up And Sold Off Quickly

26 12 2008

Subprime depended basically on brokers who did not care whether the borrower could pay his loan because they got paid their commission at closing, on banks that also did not care much whether the borrower could pay since the loan was being sold off, on packagers of loans who cut and sliced the packages of loans so that some could be called AAA rated loans (generally called CMO’s).

http://seekingalpha.com/article/112297-was-subprime-lending-just-as-dishonest-as-madoff?source=email

 

 

Subprime is a specific type of transaction more generally called CMO’s (Collateralized Mortgage Obligations) and CDS (Credit Default Swaps). Subprime depended basically on brokers who did not care whether the borrower could pay his loan because they got paid their commission at closing, on banks that also did not care much whether the borrower could pay since the loan was being sold off, on packagers of loans who cut and sliced the packages of loans so that some could be called AAA rated loans (generally called CMO’s). They paid credit rating companies to put triple A ratings which could not possibly be justified with any analysis of the underlying package of loans. Finally, they paid credit insurance companies to give guarantees (Credit Default Swaps) that they would cover any default when the credit insurance companies did not have the financial ability to pay if called on to pay. To make it even better, everyone seems to have had the idea that real estate prices would always go up. Finally, we even had President Bush saying all this was good because we were increasing housing without looking at the inevitable results.

 

1.     Financial Results: There was never a history of the returns. Financial institutions and their sales representatives told everyone that this was an exceptional investment. They talked about a piece of paper that is “triple A rated “and “guaranteed by insurance through Credit Default Swaps.” While Madoff peddled dishonest results, here banks peddled a dishonest idea without any results.

2.     Public Explanation of the process: Salesmen only explained these were triple AAA rated investments “structured so that they could not fail.” Furthermore, there was an insurance guarantee just in case. When it all fell apart, we naturally got the obvious truth that the so called protection never existed in reality. When the problem was obvious, Merrill Lynch (MER) sold these triple A rated bonds with insurance guarantees for 22 cents on the dollar and most people said the real value for Merrill was only 5 cents on the dollar. Madoff’s explanation was no phonier than the banks explanation of the value of Subprime triple A rated with CDS guarantees.

3.     What kept the fraud going? While Madoff had to pay out early investors, this fraud did not even depend on really paying investors off. The only ones who really collected on this were the bankers who earned bonuses or a percent of the profits (which can be 40% of the transactions’ profits) when these subprime loan packages were sold. The finance community had never made so much money on an idea like this. Who was going to say that it would not work? Here is a clear case that the personal greed of the bankers led to their own demise and that of their investors. Probably anyone that wanted to cut back on the system was probably told to shut up. As a former banker, I know the pressures put on people. “X bank is making all that money. What is wrong with you?” If you try to say it is a bad idea, most people get run over by the system. Years ago, former Fed Chairman Greenspan said that he trusted the bankers to protect their own interests. He recently said in congress that he made a terrible mistake in this assumption. And in this simple mistaken assumption, we see a root cause of the problem.

4.     Professional Opinion: The personal interest of bankers led them to tell all their investors that this is a splendid investment. In this case, the professional bankers did a 20 times greater disservice to themselves and their customers than all of the Madoff salesmen.

 

 

 

 

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