It has taken nearly three years since The Market Ticker began publication in April of 2007.
At the time I said:
To control that risk, banks, which used to hold mortgages on their own, started "securitizing" these loans and putting in tricky features to control that risk.
That has allowed the banks to get away with this. See, banks have FEDERAL guidelines they must maintain in terms of loan safety. Why? Because the FDIC has to bail out banks that fail! Remember the S&L crisis? That was caused by S&Ls making risky loans that couldn't be repaid. Banks know all about this stuff, and they're very cognizant (since there was a blowup in their sector among the thrifts) of what happens when you do that.
So to keep their feet out of the frying pan, they figured out a trick - they shoved off the mortgages to the general debt market! Adding to this the mortgage folks figured out that they could take a "bucket" of mortgages, sift them into baskets that were categorized by loan-to-value and FICO score, assign those a risk premium and then sell them in the market as "tranches" of debt - essentially, converting the mortgage to a bond. By doing this the bank is (mostly) insulated from the risk that you won't repay the loan, because once any recourse written into the contract has lapsed, the risk passes to someone else - the bondholder.
And now The New York Times has opined with:
If economists and regulators had recalled the securitizations of the 1920s, they might have realized that the recent boom in real estate securitizations was not what they took it to be: a result of American financial ingenuity that created ways to spread risk to those who could best afford to bear it and in the process made financing more available and less expensive.
It was, instead, the same old speculative enthusiasm, even if it was wearing fancy new clothes. Investors who had seen real estate prices rise thought that trend could not end. Wall Street sharpies thought they had found a way to make lots of money while not bearing the ultimate risk if the game suddenly ended.
As it turned out, the sharpies were wrong. They too got swept up in the carnage — just as their predecessors had in the 1930s.
Uh huh.
Some of us did see this folks. It has taken The New York Times three years to figure it out, but they're the "tout media" - mainstream newspapers who (just like Tout TV) cannot imagine actually thinking about what these "complex" securities really are.
The simple fact of the matter is that complexity isn't good, it's bad. It's bad because it costs money. This means that as complexity increases yield deliverable to the actual buyer of that security - that is, the earnings power of that security, decreases.
The ugly little truth as I have repeatedly pointed out is that in any lending transaction there is a fixed amount of potential profit - that being the spread between what the borrower pays and what a true risk-free transaction entails at that particular moment in time for an identical duration. That's all there is and that's all there will ever be.
All lending transactions that are more complex than two people sitting across a table with one lending the the other money therefore must have a loser. That is, either the borrower must overpay for the money (compared to actual risk) or the lender must be undercompensated for the risk he is taking. In a marketplace where there are many lenders this risk will inexorably fall on the lender because the borrower will shop for the lowest possible price of the money.
The factual and mathematical reality is that if we want stable lending then we should demand an end to securitization. The proponents claim that doing so will instantly implode capital access for those who want to borrow over long periods of time (e.g. real estate loans) but are not in the position to issue their own bonds such as mid-sized and larger corporations can do.
This is a false assertion.
There is nothing preventing a simpler structure from working perfectly well. That is, those who have capital and want to lend it for longer periods of time (so-called "traditional" buyers of MBS and similar instruments) can just as easily buy longer-term bonds issued directly by banks and insurance companies. Those firms can then lend directly to homeowners and commercial property developers and retain the loan on their own books. Since they have the capital from their lender to do so duration matching is not a big deal; if they borrow the money from an investor (by issuing a bond) and their borrower prepays they can then re-deploy that capital to another borrower for the remaining portion of the term.
This, by the way, was why and how lending worked for most of the stable period in our banking system's history after The Depression. Most lenders indeed did hold their own loans - some were sold off, but not all as is the common practice today.
What "de-constructing" securitization does is cap the use of leverage by the banks and other financial institutions to "gear up" their returns, restricting it to the the reserve ratio for banks and other financial firms. This in turn dramatically reduces both the risk of catastrophic losses and removes the fuel necessary to drive speculative asset bubbles.
The entirety of the pronouncements thus far out of Washington DC and Wall Street is aligned with the idea that we must find ways to "re-ignite" the securitization machine. This is not only false it is fanciful. Securitizaton and all the complex BS "financial magic" that surrounded it was the cause of the debt-based credit bubble that enveloped the economy from the 1990s forward and it not only must not be re-ignited it can't be re-ignited as the bad debt has not been cleared from the economy and as such there is simply no more borrowing capacity at below-market rates of interest with which to play this Ponzi game any more.
A return to sound lending - where lenders hold the loan and thus the risk, and those who wish to lend but are not in the position to originate themselves place capital with those who are, is the correct way forward.
Forcing banks to remove proprietary trading from their deposit and lending activity (e.g. "The Volcker Plan") is a good first step, but not sufficient. Glass-Steagall kept the banking system sound for fifty years and it was only when we started tampering with it, first with the S&Ls and then by dropping it entirely, that we had major problems.
We could avoid those major problems if we would enforce the general statutes barring fraud in all its forms, but that, with a captured government and Wall Street fawning all over people like Barney Frank and the entire cadre of Senators has proved to not work. They simply will not demand that the law be enforced and we the people are too soft and willing to be repeatedly violated to rise up and make this the single issue upon which we will demand action - instead we allow ourselves to be divided and diluted with great-sounding issues like abortion and the so-called divide between "left" and "right."
Here's reality folks: Without a fundamentally-sound economy predicated not on speculative excess but rather on honest return-for-risk acceptance and industry none of the other issues matter.
All the pressure groups and indeed the posturing of the Harry Reids, Nancy Pelosis, John McCains and Sarah Palins are designed to do exactly one thing: Keep you from talking about the single issue that has driven corruption in our political and business space for the last thirty years and upon which the entire Ponzi Scheme that we call our "economy" and "government" today rests.
If we the people were to demand and resolve that problem the entire edifice of fraud and corruption would collapse for lack of return on the "investment" of buying politicians. That is, if the penalty for re-confirming Ben Bernanke, who we know for a fact was not only advocating for the bubble economic policies before was appointed to head The Fed (while working for Greenspan's Fed) and who has been wrong in virtually every single economic pronouncement he has made over the last five years was an immediate assembly of 3 million Americans on The Washington Mall (1% of the population) who then refused to leave until every Senator who so voted either resigned or Bernanke stepped down we would see results.
If the result come November was that every Senate seat in contention where that Senator voted for Bernanke's reconfirmation was sent home and replaced, irrespective of all other issues, we would see results.
If the result come November was that every House seat in which a Representative voted for TARP in any of it's forms, again, irrespective of all other issues, was turned over to a new Representative and the old ousted and sent home, we would see immediate results.
We all want our cake and to eat it too. But that's not possible. All Ponzi Schemes must fail due to the fundamental mathematical reality that the so-called "returns" promised can only be achieved by finding a greater and more-gullible sucker who will pay more than you did. Inevitably the supply of suckers must run out as the number of people with capital has a finite supply, and when it does the collapse ensues.
We can either continue trying to re-inflate a popped balloon and live in a world where everyone measures "success" by how many points the DOW went up or down, or we can decide that the only issue that matters to us as Americans is returning to a definition of "success" that excludes Ponzi financial activity explicitly and, if necessary, by force of law, relying instead on industry and production - that is, a return to measurement of success based on mining, growing and manufacturing.
The only "free lunch" on this rock we call Earth is the energy from The Sun, and even that will end, albeit long after we are all dead.
Wake up America.
