Sunday, February 22, 2009

How did the crisis, maybe bigger than the Great Depression, start? People to blame. Time.com

Fact Checking Time's List of 25 People to Blame,
but first,
How did the drop in lending standards play out?

Fraud and predatory lending took off. The primary participants of the fraud, the mortgage brokers and mortgage lenders, were not subject to any real regulatory oversight. Consumers went to mortgage brokers, who got bigger upfront fees from steering their customers to subprime mortgages. The loans were issued by mortgage lenders like Countrywide Financial, which then packaged and sold the loans to investment banks. Because there were no protections against predatory lending, consumers got mortgage loans that they could not afford to repay. Loans had teaser rates of 3% for the first two or three years, before the monthly payments doubled or tripled.

Banks relied on AAA ratings and credit default swaps. The subprime mortgage pools were sliced and diced into mortgage securities that were sold to various investors. About 80% of the securities were rated AAA by S&P or Moody's, and a huge chunk of those securities were held by American and European banks. Why? Bankers thought if a bond is rated AAA, they could always sell it at something close to par. Also, residential home values had held up fairly well during the Great Depression. Finally, because of rules related to regulatory capital, the mortgage bonds received a lower weighting on mortgage securities than on ordinary corporate loans.

The real estate bubble burst and bond prices collapsed. Most subprime mortgages were extended for 80% of the appraised value, but many home buyers in California and elsewhere financed 100% of their home purchase.

Because so many people were buying homes they could not afford, market discipline was lost. California, Florida, Nevada and Arizona experienced a real estate bubble. When the bubble collapsed, almost everyone who bought a home in those markets from 2005 onward saw their home equity wiped out.

Three years after private label mortgage securities took off, they started collapsing. Because of the non-standard documentation, the suspicion of underlying fraud, and the difficulty in restructuring the loans with the borrowers, the securities became very difficult to value and market for them dried up.

How did this steady deterioration suddenly become a global financial meltdown? The two-word answer is Hank Paulson.

9/12 2008 Changed Everything.
On September 12, 2008, just as Lehman entered into final negotiations to find a buyer, Hank Paulson announced that the government would not backstop Lehman's solvency. What was the difference between Lehman and Bear Sterns, or between Lehman and the other banks? The prices of mortgage securities had declined since the Bear Stearns bailout, so the level of government support for Lehman would have been higher. Also, Lehman's fiscal quarter ended one month earlier than the other banks, so the magnitude of its problems was disclosed before those of other banks.

Paulson's refusal to support Lehman was extraordinarily reckless, because there was no transparency in the financial markets, given that vast amounts of money tied up in hedge funds and credit default swaps. Markets became destabilized right after Lehman declared bankruptcy on September 15, 2008.

Lehman suddenly defaulted on 900,000 derivatives, hedge fund assets were frozen, and countless hedged positions suddenly became unhedged. Nobody knew who was solvent and who was not. The different capital markets started freezing up in succession: the interbank lending market, money market funds, the commercial paper market. Banks cut back on extending trade letters of credit, thereby slowing down shipping and the trade of raw materials around the world, and further pushing down commodity prices. Global trade declined for the first time since World War II.

Paulson's TARP bait and switch.
To stabilize the markets, Congress forked over $700 billion to Paulson, who then gave the banks another sucker punch on November 12, one week after Obama was elected. Paulson said he would not apply TARP funds to help abate the foreclosure crisis, and the prices of mortgage securities plunged further, effectively forcing the largest banks into insolvency.

http://www.huffingtonpost.com/david-fiderer/emtimeem-rewrote-history_b_168503.html

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