Wednesday, October 27, 2010

Remember the Mortgage Crisis on Election Day


By Lynn Evans

For anyone planning to vote in the November elections, “The Big Short” by Michael Lewis should be required reading.

Author of “The Blind Side,” on which the Oscar-winning film was based, Lewis went to Wall Street to try to understand the causes of the great Subprime Mortgage Meltdown of 2007-2008 and the resulting government bail-out that has so angered the American public.

As Lewis makes clear, there were few people who understood what was happening inside the world of mortgage investments, but they were not the people in charge of either the investments themselves or the government and ratings oversight agencies that were supposed to protect ordinary consumers.

The story begins with the Shadow Banking Industry that sprang up after banking deregulation during the Reagan years. Local banks no longer hold the mortgages in their communities like Jimmie Stewart’s bank did in “It’s a Wonderful Life.” They sell them to bigger banks based on what money can be expected to be earned in the future, given the credit worthiness of the borrower and the worth of the property. Since ordinary families’ incomes have not kept up with inflation over the past two decades, refinancing to get the equity out of their homes has been the way many Americans have chosen to maintain their standard of living or pay off big expenses. This lending was based on the assumption that housing prices would always go up and Americans would always pay their mortgages. Therefore investing in mortgages was, as the British say, “safe as houses.”

Wall Street investment banks figured out that they could “bundle” these individual mortgages and sell them as big investments, again based on the assumptions that housing prices would always go up and never go down, and that mortgages were based on real worth. The bundled investments were called Mortgage Bonds, and they were highly rated by Moody’s and S&P. The SEC concluded this month that Moody’s, at least, used a flawed ratings model in calculating how safe these mortgage bonds were.

According to Lewis, most of the bond raters had no idea what was even in the mortgage bonds they were rating AA and AAA. They, too, were sold on the notion that the bonds were all “safe as houses.”

Seeing what great money they were making off mortgage bonds, investment banks realized they could create even more bonds by inserting more and more subprime loans into their big bundles of mortgage loans. This sent eager local agents out scurrying for borrowers, resulting in some of the unbelievable stories Lewis relates like the New York nanny with five mortgages. The eventual result was that banks all over the world owned mortgage bonds consisting of more and more subprime mortgages presented as solid investments.

In the end, too few of the investment bankers and hedge fund managers who created the feeding frenzy that led to the subprime meltdown were held accountable for their actions. Under the bail-out program set up by Bush, Treasury Secretary Henry Paulson used money from Congress to prop up the biggest investors in the subprime business, like AIG and Citigroup. And, as we all know now, too many of those institutions turned around and paid huge bonuses to the very employees who either dreamed up the increasingly exotic mortgage instruments or ignored their risk.

The American people need and deserve a federal government that has the enforcement power to make sure everyday people are not made the dupes of the big banks and corporations whose one purpose is to make lots of money. We need to stop blaming government for creating a crisis which was in fact created by a lack of government oversight. And for those who don’t get that yet, the assigned reading is “The Big Short.”
Evans is an activist and writer.
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