| Fraud is not an "innovative financial product." |
| The root of the current financial crisis are the "liar loan" and other forms of predatory mortgages that have proliferated the US housing market for the past decade. The final solution to the crisis must begin by addressing this issue.
How did the marketplace become saturated with these insolvent mortgage loans? It all started when the entity that provided the capital and the entity that arranged the terms of the loan became separate entities. Before the current deregulation craze, the entity that arranged the terms of the loan and provided the money for that loan had a vested interest in making sure the borrower could pay the loan back. Lenders spent months examining the borrowers financial condition before handing over the money. But since deregulation, the lending agency is able to arrange for the loan, bundle it with other loans and sell the loans to a separate entity. Now, the lending institution has no vested interest in making sure that the borrower can repay the loan. Their motivation is to generate as many loans as they can. The more loans (and the bigger each loan is) the more their commission. Soon, fly-by-night mortgage agencies were appearing on late night TV commercials hawking mortgages that could be arranged over the phone in 30 minutes. Borrowers of modest means were encouraged to borrow money that they could never afford to pay back. Loan officers encouraged borrowers to submit fraudulent information on their loan applications. (Hence the term "liar loans.") Mortgage agencies established policies that prevented agents from researching the borrowers ability to repay the loans. Agents were actually trained to do whatever it took to increase the size and volume of loans, no matter what the long-term consequences might be. By any definition, this constituted fraud, and it was rampant in the mortgage industry. The mortgage companies then repackaged the loans into mortgage-backed securities. These securities were then submitted to rating agencies. These rating agencies analyzed these securities and assigned a rating according to the level of risk that they posed to potential investors. At this point, the system should have provided a warning to investors that the securities were "toxic" A legitimate rating would have warned investors that these securities carried a substantial risk, because the mortgage agencies had not thoroughly assessed the borrowers ability to repay their loans (to say the least.) But the agencies typically gave these securities a triple-A rating, their highest value. Why did the rating agencies fail to rate these securities honestly? It turns out that the rating agencies were paid (rather handsomely) by the mortgage agencies whose securities they were rating. This is a classic conflict-of-interest. So at this stage, we have the mortgage agencies colluding with the rating agencies to defraud the investors who bought the securities. This is where it gets really convoluted. Many of the institutions that invested in these mortgage backed securities must have had a sense that something was rotten, because they purchased a form of insurance against these securities going bad. Federal regulations require that insurance companies have enough money to pay out claims in case of a loss. In order to evade these regulations, the companies that sold these insurance policies claimed that, rather than insurance policies, they were innovative financial products called "credit default swaps." (One such company was A.I.G.) Since they weren't insurance policies, they weren't covered by federal regulations. But in reality, selling insurance policies with no money to back them up is just plain old garden-variety fraud. And when the securities went bust and the investors filed claims, the insurance companies didn't have the money to reimburse the investors. So the credit markets have frozen up because the market is saturated with securities that are based on mortgage loan portfolios that are essentially fraudulent. These securities have come to be referred to in the popular vernacular as "toxic assets." The current plan is to remove them from the balance sheets of the banks by some sort of public/private purchase. But the reason why this hasn't already been accomplished is because the sellers and the buyers can't agree on their value. Investors insist they're worth no more than 30 cents on the dollar, while the banks insist on receiving at least 60 cents on the dollar. Until the value of these securities is resolved, no resolution to the current crisis can be implemented. There have been a variety of proposals designed to resolve the status of these mortgage backed securities. Because the personal circumstances of each of these mortgages is unique, most practical solutions involve disinterested parties, such as bankruptcy judges, examining each mortgage and imposing an agreement on the lender and borrower. This would have the effect of assigning a value to each mortgage. But what criteria do we use to rewrite these mortgage contracts? Although a close examination of each of these mortgages reveals unique circumstances, in general we find that while some borrowers simply borrowed more than they could ever hope to pay back (often with the encouragement of conniving loan agents) others were steered towards predatory mortgages with deceptive terms such as adjustable "balloon" interest amounts, etc. One solution that has been proposed is to adjust mortgage payments so that they are a specific percentage of the borrowers income. But that is inherently unfair. Should someone who borrowed more than they could afford be rewarded? Most reasonable people (particularly mortgage holders who borrowed within their means) would agree that it is not. Rather than base the criteria on each borrowers circumstances, the playing field should be leveled by restructuring all of these mortgage so that the terms are the same. For example, the standard could be a 30-year mortgage with a fixed interest rate… say 6%. This would provide relief for all of those borrowers who were steered into predatory mortgages. Restructured mortgage terms would allow them to make their payments and stay in their homes. On the other hand, even under these revised contracts, borrowers who were just plain greedy would still find themselves unable to repay their loans and would find themselves in foreclosure. This solution settles the issue of fairness among borrowers. This solution would provide a specific value for the securities that are based on these mortgages, and solve the problem of valuing the much discussed "toxic assets." But for investors who bought those assets, it would have the effect of dramatically devaluing them. These securities were originally valued based on the assumption that borrowers would pay mortgages based on a ballooning payment structure. These securities were rated triple-A by the big rating agencies and purchased in good faith by investors who had nothing to do with these dubious mortgage contracts. Should they bear the brunt of the losses? Again, that is inherently unfair. (At this point, you may be thinking that these investors made risky investments and that they should be prepared to lose their money. But keep in mind that these investors are largely mutual funds, pension funds and 401(K)s, maybe yours!) So who is responsible for the losses? If the borrowers have their loans restructured so they can make their payments, and if the investors receive the full value of the securities they bought in good faith, who makes up the difference? This is where the aspect of fraud comes in. And there is lots of it. To begin with, every loan agent who encouraged a potential borrower to submit a fraudulent income level and signed a fraudulent loan application should be prosecuted. Supervisors who trained agents to submit fraudulent applications should be prosecuted. Companies whose policy it was to falsify loan applications should be prosecuted. Rating agencies who conspired with mortgage agencies to defraud investors by falsifying securities ratings should be prosecuted. And insurance companies who wrote insurance policies (by whatever name) without the wherewithal to pay claims should be prosecuted. Incarcerating these crooks would only place a heavier burden on taxpayers. But a restitution fund could be established and paid into by every individual and company that conspired to defraud both borrowers and investors. That fund could be used to subsidize the renegotiated predatory mortgages. It could also be used to supplant the securities that were based on them. Since much of the money collected by the crooks that propagated this crime has undoubtedly already been spent, it might take time for that fund to accumulate enough money to repay the aggrieved parties. But convictions can result in wages being garnished indefinitely. This would go a long way towards making the defrauded parties whole again. Instead, the current administrators seem to think that the solution is to use taxpayer money to refund this money. But why should taxpayers pay restitution for these crimes? Ultimately the burden of repairing all of the damage to the financial system should be borne by the companies and individuals who perpetrated the fraud. That doesn't constitute "governing out of anger." That constitutes justice. |
No one has submitted a comment on this statement yet.
Be the first and submit your feedback below.
Submit your comment below |