As the Lehman Brothers bankruptcy anniversary passed a couple of weeks ago, a number of articles appeared explaining what went wrong. Most of the stuff that I read missed the point in a couple of important aspects - one, that monetary gain trumps traditional morality and two, that academics do NOT have even the slightest idea of what makes markets move and three, that anybody can criticize anything after it happens ... predicting it before hand is the hard part.
CONTEXT:
I've tried to make the point that the MBS business underwent a very dramatic change that began four or five years ago. Traditionally, a mortgage was the most difficult loan for which to qualify - underwriting guidelines and documentation were established by Freddie Mac, Fannie Mae and HUD - which sponsored Ginnie Mae and administered FHA programs. Because of the strict lending practices, non-FHA/VA mortgages experienced historical default rates of less that 1%. The market had a few hiccups, in the post 1987 stock market crash, a number of S&L's had to be liquidated because they were much too aggressive in using "teaser rate" ARM's - but as a general rule, the market worked quite well. $100's of billions in mortgages were funded each year, and all of this amazing liquidity was provided through the miracle of MBS relying on variations of the CMO (see previous posts) and tapping into previously unimagined amounts of capital.
It is VERY important to note, that Fannie Mae and Freddie Mac, from a credit point of view, were considered to be bullet prof. Between them, they owned over one trillion (that's 1,000 billion folks) dollars in mortgages. To support their balance sheets, they held the paltry sum of roughly $10 billion. Stated another way, they employed leverage of greater than 100 times. In spite of that, they were consistently affirmed by the rating agencies in the highest category - AAA. Hold that thought, because everyone, from members of congress (not the fun kind) to the SEC to the rating agencies to the institutional investors that held Fannie and Freddie paper, were absolutely convinced that nothing could go wrong. Further, in the unlikely scenario that the mortgage default rate would experience a 1% jump, the government would intervene and prevent a Fannie/Freddie failure.
We know what happened, but what events facilitated the collapse? Answer, it's all in previous posts but, in quick summary: 1. congress relaxed the Community Reinvestment Act qualification guidelines, permitted the GSE's to buy CRIA paper, increased the maximum loan amount that the GSE' could buy while decreasing qualification guidelines overall, which permitted, 2. mortgage bankers to go "all in" in the origination of "new mortgage products" like sub prime, no docs, interest only and teaser rate ARM's (the ban on qualifying at teaser rates was lifted some time after it was imposed post S&L crisis) and 3. somehow everyone involved bought in to the argument that the single family housing market would continue to rise in price, regardless of affordability.
FURTHER:
I, a humble and lovable bike shop owner pretty far removed from the financial markets, saw this train wreck coming down the tracks. My 30 years in Wall Street led me to many conclusions. One is, that making money - for those that do - is the single most important aspect of their lives. Further, for true believers, you can never make enough and you, absolutely, deserve every penny and everyone else deserves less. Another is, most folks believe that there is an absolute correlation between making money and being intelligent. A third is, that congress will bow to the will of anyone that has the money to influence policy and that they will use their power to enable those supporters to continue to make money - keeping the circle in tact (if you haven't, you must read Catch 22, e.g., when the company wins, we all win). I could go on, but the point is, most of the people that were involved, from the mortgage originators to the realtors to the builders to the rating agencies to the lawyers to the regulators to the Wall Street types to the economists who bought into the charade, all were either too stupid to know what was happening or knew, but looked the other way. Their decision was, making money was more important than stopping the gravy train and avoiding a depression.
I knew, and I fretted, that if I really screamed about it, people would fear the worst and cause a run on financial institutions and bring about a depression. If I knew, the people involved had to have known. It's as simple as that - they had to have known, and they did it anyhow. They did not care about causing a depression because making money trumps all else and they ALL deserved to be rich - it's the American way!
THE POINT
When viewed under a moral prism, this whole thing stinks to high heaven. I think that most people understand that. What I don't understand though, is how the system is permitted to go on. How can we elect people who are so morally bankrupt? How can we NOT hold accountable the dolts who put us into this hole?
