"Sub-Prime Mortgage" crisis - PLEASE READ!

Something always seemed strange to me...The housing sector is but a small part of the overall economy of the nation. "Sub-Prime" mortgages are a smaller part of that. And, homeowners who are defaulting on those loans, are an even samller part than that. So, how come this small segment can cause such havoc on the rest of the economy? Apparently, we haven't been told the whole truth. The REAL cause of the crisis is a hidden part of the economy.

A relatively new, investment vehicle, created by the banking industry called, "Credit Derivatives", otherwise known as "Credit Default Swaps", "OTC Securities" or "Assest Backed Securites" is the real cause of the problem. This type of "investment" is essentially a "bet" on any number of various legitimate, financial indicators. For example, in a traditional investment, investors purchase stocks or bonds and in return they "own" a portion of the investment - for example, Intel stock. In credit derivatives, you don't purchase the stock of Intel, but rather, you BET money on whether or not you think that Intel stock will go up , or down, in value during the next quarter. Others bet in the opposite direction - some won and some lost. Credit derviatives were sold for just about any financial indices that you can imagine, although they were heavily sold on the housing market, because, historically, the housing market had been a sure thing. MILLIONS were made by BETTING that subprime mortgages would be defaulted on...Seems like a dangerous conflict of interest! These Credit Derivatives grew streadily in the 90s and beginning in 2000, a series of legislation was introduced, and passed, that gradually eroded the oversight of the banking industry, making these investment vehicles really take off. Historically, a major distinction was made between "Depository Banks" and "Investment Banks", in order to protect the average Joe from having his savings used in "risky" investments. This distinction had been in place since the great depression, when the Stock Market was new and people were still unsure of it's safety. Depository banks are heavily regulated and insured. Investment banks are not. Well, when those bills that I mentioned (I can't recall their names offhand), were passed and the lines were blurred between Depository Banks and Investment Banks, the oversight and regulation that the typical mortgage lender had, was lost. Depository Banks - the mortgage lenders - were free to dabble in unregulated, uninsured, investments. Most thought that this was a great idea, since most believed that the housing market was a "sure thing" and the banks made money, hand over fist, in large fees, for selling these credit derivatives. Individual banks no longer cared if a mortgage could be paid back, since credit derivatives arose that bundled loans and resold them, time and time again. New homwowners could typically expect their loan to be bundled and sold to another bank, within 6 months of purchase! Soon, banks created ever increasing loan products, designed to maximize fees. This spurred increasing sales of credit derivative bets on the housing markets (new build quantities, construction times, etc.). The most important fact about these credit derivatives, is the fact that they weren't on the accounting books of the banks, since they were simply fees! They weren't real "products"...they were uninsured and unregulated. The "deregulation" legislation that did the most damage in 2000, was backed by Phil Gram (who happens to be chief financial advisor to John McCain). All 2,000 pages of this bill was added as a rider, to an 11,000 page budget legislative document. I doubt any of our congressmen/women even read it, let alone understood it.

Our culture and economy rewards speculation. Speculative investing spurred the dot-com boom and bust. Buying and selling of anything - including real estate - is psychological. Hell, in recent years, as my husband and I watched our home value climb, every month, and we were delighted. We literally clipped the housing values listing per zip code from the paper each week and put it on the fridge. We saw the resale value of our house climb from $190K...to $230K...to $250K...and eventually to $360K in 8 monrths! During that time, we, like SO many others, contemplated pulling $100K in equity out of the house and purchasing another home for a rental. Millions did this and told those who didn't, that we were nuts to miss out. Neighbors starting acting as if you must have bad credit if you DIDN'T purchase investment property. Everyone mentally kicked themselves for not buying property "way out here", 20 years ago! In the South East Valley, people couldn't buy homes fast enough, as the stores, open air mall in Gilbert and the new stretch of the 202 took shape fast! TONS of investors bought houses for rentals. People had to camp out overnight in parking lots in Gilbert, just to be able to put money down on a new home lot! Everyone embraced the creative loan products to finance these investments. And the banks force fed us to rake in those fees from these "Assest Backed Securities". Like every psychologically driven, social phenonmenon, there was a tipping point.

Warren Buffet, fell victim to the Credit Default Swaps as well, when he unwittingly bought an investment company that was heavily involved in these credit derivatives. Again, they were unregulated and they weren't on the books, so people simply didn't know how fragile some company's were as so much of their money was tied to these "bets". When Warren Buffet was burned, there were calls to regulate this hidden economy and many professors and economists started screaming about the dangers, but the banking industry was desperate to keep their mistakes hidden. Most say that this is the tip of the iceberg as credit derivatives were also heavily sold for credit card loans, car loans and student loans. Lobbists worked 24/7 to pass additional legislation to exempt the banks from regulation. They hit all of the hot buttons about "big government" and pointed to "progressive" Europe and the fact that England had half of the regulation that the US had. But, the talk died quickly when the major bank of England nearly went under because of these credit derivatives, in 2007. The country literally had a classic bank run and closed their doors, with people lined up to withdraw their money - money that was no longer there. The British government had to purchase the bank to prevent disaster. Ironically, the effort to prevent too much regulation, resulted in more government owner and run banks! But, this barely made the news in the US. Oh sure, it was covered in the NY Times, etc. but the small, local news remained oblivious to it.

None of the millions made from these bets, filtered back into the economy, the way it does with stocks (companies are started or expanded, people are hired, products are sold, etc.). When the psychological tide turned, over extended banks, lost millions, paying on these investments - Loses that they suddenly needed to put back on the books. Investment companies began reporting loses...investors to purchase these "bets" dried up and the millions in fees that the ran the banks before, were gone. The dominoes began to fall. The government began to see that they had no choice, but to bail out these banks.

THIS is what is meant by the "sub-prime mortgage crisis", NOT the small percentage of homeowners who are being characterized as "irresponsible". In fact, most of the sub-prime loans in default, are in fact owned by over extended, real estate, speculative investors. They are not, for the most part, our neighbors.

I can't do justice to this topic. I merely attempted a summary of what I recently learned. It's appalling. I urge everyone to go to NPR.com and listen to the interview with Michael Greenberger, professor of law at the University of Maryland, who was recently interviewed and explained what "Credit Derivatives are". I'm sure that there's more that I missed.

Remember when the financial powers that be, blamed EVERYTHING on "911"..."Katrina"..."El Nino"...we must be more skeptical of what we accept. Sigh...but, damn, I'm a working mother and wife - how was I supposed to read that 11,000+2,000 page legislative proposal??????? Ugh!

"Only a life lived for others, is the life worthwhile" - Albert Einstein