by Bill Koenig

Rob Cyran and Edward Chancellor in their Wall Street article, “Thanks Greenspan,” stated:

Alan Greenspan was an ideal central banker — at least, as far as investment banks were concerned. Whenever their profitability was threatened, the former Federal Reserve chairman rode to the rescue.

Mr. Greenspan assisted investment banks in many ways. His general opposition to financial regulation made life easier for hedge funds, which became a major source of profits. When investment banks got into hot water after the tech bubble burst, the Fed chief had little to say about their abuse of conflicts of interest.

Even more important for the banks’ profits was Mr. Greenspan’s policy of boosting the economy by keeping short-term rates well below long-term yields. This “carry trade” became a license to print money for the investment banks’ proprietary trading desks and fixed-income departments.

Wall Street may fondly remember Mr. Greenspan. But did he really serve its long-term interests? The markets are being shaken by subprime defaults, and overly indebted hedge funds are unwinding their positions. Yet the housing bubble, unregulated hedge funds and opaque financial markets are part of Mr. Greenspan’s legacy.

John Mauldin of Dallas wrote:

To say the credit markets are frozen is an understatement. Talking to any number of people who have been in the markets for decades, this is the worst in their memory. Ironically, it is the 100-year anniversary of the Panic of 1907, when one banker (J. P. Morgan) stepped in and provided liquidity to the markets. The central banks of the world are providing liquidity; but as we will see, it is not mere liquidity that is needed.

You cannot explain the problems with just one or two items. A perfect storm of this sort takes a number of factors all coming together to work its mischief. Bad mortgage underwriting practices, bad rating agency practices, a destruction of confidence, excessive leverage and then the withdrawal of that leverage, the need for yield, greed, and complacency becomes paralyzing fear — all play their part.

Residential Mortgage Backed Security (RMBS)

A Residential Mortgage-Backed Security (RMBS) is a securitized interest in a pool of residential mortgages. It is structured as a bond. Instead of paying investors fixed coupon rate and principal, it pays out of the cash flows from the mortgage pool. The simplest form of mortgage-backed security is a mortgage pass-through. With this structure, all principal and interest payments (less a servicing fee) from the mortgage pool are passed to the investors each month.

The Participants in the Subprime Chaos

The subprime mortgage boom has had many players. Many have profited, but there are also many who are now feeling the consequences of ill-advised lending — not to mention the up to 2 million loans that may be at risk in the United States.

Here are the participants and their roles:

Major U.S. Banks: They close residential loans and make money on fees and points. They sell their loans to Wall Street firms who pool the mortgages together (securitize them) in bonds. Next, a major rating service rates the risk, and the bonds are then placed with investors/hedge funds.

Mortgage Companies: They close residential loans and make money on fees and points. They sell their loans to Wall Street firms who pool the mortgages together (securitize them) in bonds. Next, a major rating service rates the risk, and the bonds are then placed with investors/hedge funds.

Mortgage Brokers: Mortgage brokers originate about half of the loans made to borrowers with good credit. Their presence is even greater in other segments of the mortgage market where defaults are increasing. Brokers originate about three-quarters of subprime mortgages made to borrowers with bad credit, according to Wholesale Access. They also originate 70 percent of so-called Alt-A mortgages, a gray area that falls between prime and subprime.

Wall Street Investment Banks: Wall Street firms pool the residential loans (securitize them) into a bond. They place them with investors/hedge funds and international hedge funds for a fee and management fee.

Rating Firms (Moody’s, Standard & Poor’s and Fitch ratings): Ratings firms rate the securitized mortgage pools, which impacts the purchases of the loans based on their investment risk. They underwrite the loans with arm-length consultation with Wall Street firms.

SEC Oversight: Oversees the rating firms’ compliance.

Hedge Funds: Want safe assets that return gains — many with higher risk.

Asian and European Banks: Asian and European banks were the most aggressive buyers of mortgage-backed securities and other structured portfolios.

Real Estate Agents: Pitch the investment potential and the appreciation upside of a new home. Many times, they also refer the buyer to a mortgage broker.

Borrowers: It is estimated by the IRS that 60 percent of the subprime borrowers misstated their income in loan applications, which wasn’t checked in low-document loans.

First-Time Borrowers: Many borrowers were misled by realtors who pitched rapid appreciation potential and were led into risky loans by mortgage brokers.

IRS: They will come into the loop if there is debt forgiven by lenders at time of foreclosure. Debt forgiveness is treated as ordinary income in the year of the foreclosure, which will lead to tax due.

Law Firms: Some major law firms are preparing to file suit against the well-funded rating services on the basis that their ratings mislead investors, which influenced their investment decisions.

Congress: The Senate is preparing for fall hearings with an emphasis on rating services responsibility.

Anatomy of the Subprime Disaster: Many Original Traps

Trap: A family had little money for a down payment and chose a loan that would hold their monthly payments down for the first two years, after which the loan was supposed to be “reset” to a higher level.

Trap: Loans were made based on a person’s ability to pay the mortgage (which had reduced interest rates) on the first two years of the loan, not on the next 28 years. These were called 2/28 loans.

Trap: Realtor pitched the appreciation potential of a new home purchase to the prospective borrower — and in many cases found a mortgage broker to fund the purchase.

Trap: Mortgage broker many times attempted to assure the home buyer they would be able to refinance in a couple of years to keep their payments affordable, and that they might even be able to refinance — pulling money out of the house due to home appreciation.

Trap: The refinancing option for many subprime borrowers now looks impossible since loan balances may exceed the value of their home due to home value depreciation.

Trap: When the mortgage money dries up, housing values fall even further.

Trap: The lenders who were offering risky loan offers are now enforcing much stricter standards, putting the borrower into a deeper trap and the risk of foreclosure.

Trap: If the homeowner can find a buyer for their home at a reduced price, they have to go to the closing with money to make up the difference between the original purchase price/loan amount and the deflated sales price. (Equity isn’t likely, since most of these borrowers didn’t have equity to put into their homes originally.)

Trap: Without new financing or money to pay at closing (in the event the home can be sold), the home will be foreclosed with an increased likelihood of bankruptcy, leading to the family’s personal and financial life being totally disrupted for many years to come.

Trap: Debt canceled upon foreclosure is subject to federal income taxes.

WASH—Friday, August 17, 2007 —Below are some of the key areas of concern that I am focusing on for my presidential campaign.

Federal Debt

The federal debt is nearing $9 trillion. It was $5.6 trillion in 2000.

Overall, at this time, intergovernmental holdings account for more than $3.79 trillion of the total debt. The public, including foreign entities, has purchased the remaining $5.04 trillion or so.

At the end of 2006, foreign holdings of Treasury debt were $2.223 trillion, which was 44 percent of the total debt, held by the public. Foreign central banks owned 64 percent of the federal debt held by foreign residents; private investors owned nearly all the rest. (Figures are from Analytical Perspectives of the 2006 U.S. Budget, p. 257, and the U.S. Treasury web site.)

Japan and China are the largest foreign owners of U.S. Treasury securities, with 20 percent of our non-governmental debt. Japan sold a net $2.9 billion in July, bringing holdings to $612.3 billion in the last month.

China, the second-largest holder, reduced its holdings for a third straight month in July, from $407.4 billion to $405.1 billion. China’s share of all Treasury holdings abroad has risen to 18.3 percent this year, from 8.6 percent five years ago. China has reduced its Treasury holdings for three straight months by a record amount of $14.7 billion, the longest period of selling by China since November 2000. (Bloomberg)

Federal Government Size

The federal government continues to expand. The United States Federal budget for 2008 (submitted in 2007 by President Bush) is $2.9 trillion. President Bush’s first budget for 2002 (submitted in 2001) was $2 trillion. This is almost a 50 percent increase in government size in seven fiscal years.

The U.S. Gross Domestic Product (GDP) was $10.1 trillion in 2001 and is expected to reach $14 trillion by the end of 2007. I would venture to say a lot of the GDP increase was in housing; the war on terror; energy, insurance and health care costs; and spending initiated by the tax break.

Corporate and Personal Greed

Based on my estimates corporate and personal greed has cost Americans an additional $4 trillion in costs and expenses above and beyond 2001 costs by the end of 2006. This major money transfer has benefited companies in energy, health care, insurance, pharmaceuticals, banks and investment banks.

Thirty-seven of the 50 most profitable U.S. companies are in these business categories. These companies also spend the most money on Washington lobbyists, who influence Congress to craft legislation to benefit them.    

Health care costs in 2006 were $2 trillion — or an average cost of $6,300 for every man, woman and child in America. I estimate 20 to 25 percent of that amount, or $400 to $500 billion annually, is overpayment due to greed, mismanagement, inefficiencies, excess costs, unneeded tests, pharmaceutical costs and fraud.      

Personal Debt

Americans’ personal debt has increased significantly in the past six years to $900 billion of credit card debt and $1.5 trillion revolving debt — cars, boats, etc. and home mortgages — now totaling $10.9 trillion (up from $4.5 trillion in 2001). These are all-time record levels.

Subprime Fiasco

Dr. James P. Gaines a research economist with the Real Estate Center at Texas A&M University stated:

The private sector found a way to make loans to low-credit, previously unfinanceable households so that they could own homes. While this effort was spurred by profit, not altruism, the effect on homeownership throughout the country was nevertheless profound.

The fraud, predatory lending practices, purposeful misrepresentations and other illegal practices employed by unscrupulous lenders must be stopped. This may not be easy because many of the practices are hard to clearly categorize as proper or improper, much less legal versus illegal.

The Federal Reserve injecting $17 billion Thursday into the U.S. banking system to ease a credit crunch triggered by fears over the ailing mortgage market. The central bank has pumped a total $88 billion dollars into the financial markets in the past week to stop the country’s banking system from hemorrhaging.

Subprime loans totaled $1.8 trillion from 2001 to 2006.

This percentage of loss to GDP is less than the percentage the Savings and Loan crisis produced in the mid- to late ’80s. At this point, there isn’t a major crisis concern; but that could change if housing prices drop considerably more, putting more homeowners at risk.

WASH—Monday, August 13, 2007 —I’m very encouraged by the response we’ve had to our presidential exploratory committee efforts over the past few weeks. Thousands of people have visited the william2008.com web site, we’ve received many encouraging emails, and I’ve spoken to audiences of more than 3,000 people. Americans are delighted and thankful to learn there’s an outspoken Christian with a solid platform in the presidential race.

WASH—Thursday, August 9, 2007 —The United States is playing a dangerous game in the Middle East by penning agreement on a Saudi Arabian peace plan to curry Arab help in stabilizing Iraq. This turn of events began earlier this year when the US State Department signaled that the 2002 Arab Peace Initiative was an acceptable framework for beginning peace negotiations with Israel and establishing a Palestinian state. Now Secretary of State Condoleezza Rice has actually put her signature on the plan forwarded by the Arab league, all nations who are sworn enemies of Israel.

The plan is being promoted in the media as one that is reasonable calling for an end to Israeli occupation of the land won in the 1967 war, in which Israel pre-empted a massive attack by Arab nations against the tiny Jewish nation. The plan, however, also calls for Israel to give up East Jerusalem to be the capitol of a new Palestinian state.

The Arab Peace Initiative essentially says give up Jerusalem, the strategic Golan Heights, the West Bank (which are the traditional Jewish lands of Judea and Samaria), allow the Palestinians complete repopulation of the sovereign nation of Israel, and the establishment of a Palestinian State.

In return, Israel receives recognition of its right to exist and a guarantee of peace from Arab nations.