A 3,000 to 1 shot, Wall St. took it, collected billions in
bonuses, blew it and you paid for it.
Before 2008, how Too Big to Fail Banks’ hidden
3,000 times leverage rigged the Real Estate market and defrauded EVERY mortgage
borrower and many others…
This article disabuses the notion that “deadbeat borrowers” caused the financial crisis. And offers an answer to the question that still lurks in the mind of every American; whether black, white, native American, asian or Hispanic; whether educated or not; whether English, Spanish, or Mandarin speaking.
Taking a big step back, and looking at it like a business process: “How could so many Americans ALL have made the same ill-advised mortgage borrowing decisions?” The answer lies in what did they ALL have in common…
It was all about leverage
What is leverage?
Leverage is a way to control more of something when you can’t pay for it in full. We do it all the time; when we buy a car – except few of us actually buy the car, we finance it or lease it. We also do it when we buy a house – except almost no one pays cash for a house, we finance the purchase with a loan; it’s secured by a mortgage on the property.
Example of 5 times leverage:
When we buy a house and put 20% down, we buy a house worth 5 times as much as the down payment. If we put $100 thousand down we can buy a house worth $500 thousand. $500 thousand divided by the $100 thousand we put down equals 5 times leverage.
100 times leverage:
By the same calculation ZERO down mortgages were suffice it to say, 100 times leverage, it’s actually more but that’s a discussion for later. Repeat after me, no money down mortgages equal 100 times
(Click for Sharper Image)
Who controlled and approved EVERY leverage decision?
Leverage Approval #1 by:
TBTF Banks (ultimately) approved every one of these loans and bundled thousands of others like them initially into mortgage backed securities (MBS).
Leverage Approval #2 by: [the key, little known fact]
In the past, TBTF Banks used to sell them off (remember that word) to investors like mutual funds, insurance companies and pension plans. In the 2000’s TBTF banks issued almost $17 Trillion of MBS, but did not sell all of them OFF to 3rd parties. They held massive amounts of them to turbo-juice their bonus checks in a 2nd set of books (legally) in OFF balance sheet, special purpose entities. As a refresher Enron did the same type of thing.
In the decades, make that for over 60 years before the 2000’s TBTF banks’ leverage was around 12 times; however when they concealed trillions worth of MBS – their leverage increased to over 30 times.
Remember 5 times leverage? It was based on how much the house was worth right?
And when TBTF banks add more leverage on top of the borrower’s leverage we don’t just add it – we ______? You guessed it – we multiply it.
3,000 times leverage on house prices:
100 times leverage on the borrowers side times 30 times leverage on the TBTF banks’ side is 3,000 times leverage ON house prices.
Lather, rinse and repeat – 100 times 30 equals 3,000 times leverage. Lather, rinse and repeat
100 times 30 equals 3,000 times leverage.
Remember what I first told you about leverage?
Leverage lets you (or TBTF bank) control something that you can’t fully pay for. Well the TBTF
banks’ way of financing them in the Asset Backed Commercial Paper market began to dry up in August 2008, so they couldn’t pay for these assets. This is the direct cause (but not the root) for the Fed and US Treasury to (have to) step in and pay CASH for them in the bailouts of 2008, and again in 2009, and again in 2010 and yet again 2011 via the Fed’s QE trifecta to the tune of over $20 Trillion dollars.
The interactive portion is about to begin:
Is it any surprise that the assets backing the commercial paper were ________? You may have guessed it – MBS.
Is it any surprise that the Fed created a new category to track ABCP in_______? You would be correct if you guessed 2006; just two swift months after Ben Bernanke was appointed chairman of the Federal Reserve by President Bush.
Is it just a random coincidence that almost $17 Trillion of Mortgage Securities were created by TBTF banks from 2001 to 2008?
What was that word I asked you to remember?
Oh, right it was OFF.
When TBTF banks’ CEOs, executives or prop traders got their year end bonus check did we hear reports that anyone said it was OFF (or that it was too much)? Nope.
Yet even the erudite, indeed veritable student of the Great Depression, Chairman of the Federal Reserve, Ben Bernanke in October 2007 was unaware of (just a few days after the stock market peaked at 14,087 as measured by the Dow Jones Industrial Average) what the TBTF Banks were really up to when he entertained the NY Economic Club. See “One year, One Trillion Dollars; the education of Ben Bernanke 2007 to 2008…” Fiduciary in thought and action: One year, one Trillion dollars; the education of Ben Bernanke from 2007 – 2008…(since there appeared no news report that any of the luminaries of the NY Economic Club questioned Mr Bernanke we assume they all understood and agreed with his distinguishing point. I only wonder was that before or after they might have cashed a bonus check based on…LEVERAGE.)
Yup and we paid for it then and continue to pay their salaries, benefits like paid vacations, health care (non-taxable) even now – silly us.
The top 12 reasons + one
TBTF banks, before 2008 created a hidden, secret “market” for MBS:
- As stated above TBTF banks changed from financial intermediaries into speculators via their proprietary (for the house only) trading desks;
- Hiding (the FDIC used the word “concealed”) trillions of MBS off balance sheet;
- Allowing their own internal prop traders to value #2 (legal under the SEC’s 2004 Consolidated Supervised Entity (CSE) program) despite the fact few if any, of #2 had EVER seen the light of any “market” trade as one between arms-length parties;
- Why? To maximize same prop traders’, managers’ and CEOs’ cash bonus checks;
- All based on the assumption (almost a religious belief) that national median home prices had NEVER gone down – true, as you may recall;
- BUT the past was under a 60 times house finance, prudently underwritten leverage regime (20% down payments, verified job, income, assets and 12 times bank balance sheet leverage);
- TBTF Banks’ single handedly created 3,000 times leverage on house prices, the underlying collateral of any MBS, CDO, etc.;
- 3,000 times leverage is the product of Zero down loans; 100 times leverage for the borrower and 30 or more times TBTF bank on and off balance sheet leverage;
- Mr Bass testified to the FCIC in January 2010 that TBTF banks’ leverage at the end of 2007 – yes end
of 2007 (see page 13) shows almost all TBTF Banks were over 30 times, Citigroup at 68 times leverage; meant an adverse swing (in the value of the underlying collateral or obligations) of as little as 1.5% wiped them out completely – insolvent;
- And we know that leverage worsened in 2008…and we know from Goldman Sach’s 2007 to 2008 collateral call dispute with AIG that MBS valuation marks (not even CDO’s) were south of 90;
- It’s not about Fannie or Freddie either; they were downstream of information from the TBTF banks – again TBTF banks held trillions of MBS, in secret OFF balance sheet; I’m not saying it was necessarily illegal but it was fraudulent; as it was knowing, willful and intentional fraud upon the other side to the mortgage – the borrowers. And it only went on as long as it did – BECAUSE they were hidden;
- And we know it’s not about CRA as home ownership peaked in 2004 nor can we blame it on the variant of “homeownership for all” as just a few too many houses were not primary residences but 2nd, 3rd, 4th and 5th homes and condos – each time the loan was approved (ultimately) by TBTF banks;
- Last, 3,000 times leverage on home prices represents a 50 fold increase over the 60 times historical norm; more importantly shows that TBTF Banks’ violated requirements of their banking charters; i.e. to operate according to “safety and soundness”.
*Except borrowers who falsified their loan apps.
How could EVERY American mortgage borrower ALL have made the same mistake?
1) Every mortgage loan was (ultimately) approved by?
2) Every mortgage loan was securitized by?
3) Massive amounts of securitized loans were held for speculation by?
4) Thousands of off balance sheet and or off shore entities were created by?
5) Massive amounts of #3 were held off balance sheet by?
6) The 2004 SEC CSE program was lobbied for by?
7) Models, not markets were used to value off balance sheet holdings by?
8) Hundreds of billions of customers’ money market funds were diverted to affiliated banks known as industrial loan companies by certain?
9) Massive dollar amounts of leverage were employed by?
10) Massive (greatly increased by hidden leverage) bonus checks were paid by?
11) Assets held off balance sheet were not timely, fair valued by?
12) Massive amounts of Fed and US Treasury aid were received by?
13) LSD used by?
* TBTF Banks on LSD indeed; massive amounts of Leverage, Swaps and Derivatives.
A “Financial Crisis” approved, securitized one loan at time and brought to you by your friendly neighborhood TBTF Bank on LSD; one they prefer to still keep secret…
By the way, there was no need to create vast bodies of new laws except to require all securities and derivatives to trade on open, disclosed markets with independent clearing agents; just like stocks have traded on the NYSE for decades.
Chris McConnell AIFA®, Accredited Investment Fiduciary Analyst™ - is an expert on the securities industry and markets with over 28 years experience dealing with accounting, leverage and compensation issues. He has an economics, accounting and fiduciary background. McFid, BFD Expert™ since 2003. To visit his website Fidiciary Forensics.
Author’s Note: 3,000 times leverage is an estimate as not all mortgages were zero down; just several million too many; not to mention “every app was approved” underwriting. But we do know that 60 times leverage (on house price) was the norm for decades; also called safety and soundness; and we also know that TBTF banks’ leverage, assuming their year end 2007 marks were accurate, when the 2007 to 2008 Goldman AIG dispute timeline triangulated with Mr Blankfein’s 2010 testimony to the FCIC suggests otherwise, are understated – correct understated. And we know that marks worsened (and caused leverage ratios to increase in 2008). Again, the pressing need for CASH infusions from the Fed, UST in 2008/9, and kinder, gentler accounting treatment courtesy of the SEC/FASB
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