Mike Whitney

Information Clearing House

February 25, 2008

“The SEC probe of the securitization of subprime mortgages into collateralized debt obligations (CDOs), announced last summer, has yielded no official enforcement cases….SEC chief, Christopher Cox, along with other top-level administration officials, has cautioned against quick-fire regulatory or enforcement responses to the worsening credit crisis, noting that the market instead should be left to work it out.” Nicholas Rummel, “SEC Drift Said to Prevent Action on Credit Crunch”, Financial Week

That’s right. The biggest economic scandal in the last half century, the subprime fiasco, and the “business friendly” stooges at the SEC are still sitting on their hands reciting passages from Milton Friedman instead of dragging crooked banksters off to the hoosegow in leg-irons. Go figure? SEC Chairman, Christopher Cox, has come under withering attack from Senator Christopher Dodd who chairs the Banking Committee and who accuses the SEC of being “asleep at the switch”.

Dodd said the SEC “needs to help restore investor confidence in the markets by more vigorous enforcement, by more comprehensive regulation of credit rating agencies, and increased accountability and transparency of publicly traded companies.” (Financial Week)

“Accountability…transparency” in Bushworld? Nice try, Dodd, but its a losing cause. The Bush administration is not just philosophically opposed to oversight; they’ve handed over the entire financial system to a cabal of banking scalawags who’ve turned it into their personal fiefdom. This same cast of fraudsters engineered the subprime swindle and ripped off trillions of dollars from investors around the world. And, don’t kid yourself; Bush is proud of the damage he’s done by taking a wrecking ball the SEC. For him, it’s like a good day at the races. He has no intention of reigning in the crooks or restoring the publics’ confidence.

New York Governor Elliot Spitzer has joined Dodd in criticizing the so-called “regulatory agencies” for failing to determine whether any securities laws were broken. In a Washington Post article, Spitzer blasted the SEC’s inaction saying that the Bush Administration would be judged by history as a “willing accomplice” to the subprime collapse.

But Spitzer and Dodd are wasting their breath. The culture of corruption from 7 years of Bush misrule has spread like Kudzu to every jag and eddy in Washington. If we were really a nation of laws rather than nincompoops, federal agents would be busy rounding up every investment banker and hedge fund sharpie on Wall Street so they could get to the bottom of the subprime boondoggle. Regulators still haven’t even decided whether it was a case of overzealous marketing of dodgy securities or downright fraud. That should be “job one” for the SEC.

The reason all this talk about “regulation” is so important now is that the same banking giants who cooked up the subprime scam have just presented the Bush administration with a $739 billion bailout package they plan to unload on the American taxpayer. According to Sunday’s New York Times:

“As losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion. A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble. The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes. To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.”

What Bank of America is proposing is that the US government guarantee the shoddy mortgages that the banks issued to “unemployed shoe-clerks with bad credit” so they could peddle them as Triple A “securities” to unsuspecting investors. Now that subprimes are blowing up at a record pace, the banks need a government bailout before their balance sheets are reduced to cinders.

But what does the poor taxpayer get out of the deal besides soaring inflation, bulging fiscal deficits, and the “warm and fuzzy” feeling that he’s helped some tasseled-shoed charlatan keep his larder in the Hamptons full of Dom Perignon and crab cakes?

The reason we’re in this mess is because financial innovation and deregulation have driven the markets off a cliff. And that started with the bankers. Financial innovation has nothing to do with the efficient deployment of capital for productive activity. No way. In fact, it is the exact opposite. The financial innovations of the last decade have primarily focused on transforming the liabilities of dubious mortgage applicants into complex debt-instruments which are enhanced with massive amounts of leverage and exotically-named derivatives. The investments banks and brokerage houses fought hard to establish the present system which they call “structured finance”. They spent over $100,000 million lobbying congress to remove the legislative firewall which kept investment and commercial banks separate. Those laws, particularly Glass Steagall, made sure that the public was protected from the Ponzi-scams which proliferated just prior to the Great Depression. But, now, 30 years later, the same scams are back with a vengeance. The cult of free market orthodoxy and Reagan-era flim-flam has put us on track for another stock market crash ala 1929. That’s why Bank of America and their buddies in the industry have turned to the administration for a way out. Their flagging balance sheets can’t take another year of rising foreclosures and dwindling assets. They need Big Brother to cover their debts and rebuild their capital-base. Otherwise its curtains.

Other versions of the so-called “Rescue Bill” have been floating around Washington for the last three weeks, but they all follow the same basic guidelines. Under one of the plans, 600,000 subprime mortgage-holders, many of whom are already delinquent on their payments or in some stage of foreclosure, would be able to refinance their loans under the Federal Housing Authority (FHA) which would federally guarantee the mortgage in the event of default.

Great idea, eh? So, now the taxpayer is going to have to pay for the people who lied on their applications (and who really can’t afford the homes they’re in) so the banks can recoup their losses. This plan doesn’t make sense.

Why on earth would the taxpayer want to buy 600,000 subprime mortgages at “current value” when housing prices are falling, inventory is soaring, sales are sagging, foreclosures are at historic highs, and millions of homeowners are expected to simply “walkaway” from their loans?

No thanks. Let the banks go under. They created this mess. Besides, all we’re doing is rewarding the people who deliberately destroyed the system. They can fend for themselves. The first order of business should be to restore public confidence; not bail out crooks. “Credibility” matters in a market-based system; especially one that relies so heavily on the hocus-pocus of fractional banking. When trust is lost; the system crashes. End of story. That means it’s time to clean house at the SEC. Give everyone a pink slip, two weeks pay and send them home. Then scour the countryside like Diogenes for a few honest men.

Second, people in positions of authority have to be held accountable for their crimes. Millions of investors have lost their life savings or retirement in the subprime/securitzation debacle. Someone’s got to go to jail. Apologies just don’t cut it. So far, not one CEO has been led off to the Paddy-wagon in handcuffs. It has all been swept under the rug by an administration that has filled every regulatory position in Washington with industry lobbyists, business-friendly tycoons and corporate “yes-men”. The results are just what any sane person would expect; disaster. The financial markets are completely unsupervised; the SEC is just a subsidiary of the multi-national corporations. It has no teeth. If it was really independent; then Cox and his goons would be storming the investment banks with tasers and truncheons. Instead, he spends most his time explaining why he won’t enforce the laws and prosecute cases.

And there should be no doubt about who is really responsible for the subprime woes. The investment banks employ some of the country’s “best and brightest”. These are sharp guys who have studied at some of our finest colleges and universities. Does anyone really believe that a Harvard MBA—who understands all the fine-points of high-finance–really thought that ignoring all of the standard criteria for prudent lending, and issuing trillions of dollars in loans to applicants who had no job, no collateral, bad credit, and were unable to come up with a few thousand dollars for a down-payment—was a great idea?

Of course not. It was a swindle from the get-go. The reason the banks looked the other way and issued these shaky mortgages was because they didn’t really think there was any risk involved. After all, it wasn’t their money. They simply repackaged the loans into bonds and sold them off to someone else. No worries. But, does that make them any less guilty?

Consider this: If the banks didn’t know that the mortgages were bogus, than why are all the various types of mortgages; including Alt-As, piggybacks, home equity loans, ARMs, prime, and “interest only”—defaulting at the same time? It is not just subprime mortgages that are failing; it runs the gamut.

The reason is obvious; it’s because the banks were making windfall profits and didn’t want to rock the boat. They knew they were peddling garbage. How could they not know? The banker’s primary task in life is to figure out who can pay him back “with interest”. And they’re pretty good at it, too. So why did they start handing out hundreds of billions of dollars to anyone who could fog a mirror? In fact, it got so out-of-hand that (according to The New York State Commission of Investigation) “a homeless woman earning $10 an hour was recently approved for a $470,000 adjustable rate mortgage”. In a similar incident, two Hispanic migrant workers in Bakersfield, California, who made roughly $45,000 in combined income, were approved for a mortgage on a home valued at $725,000.

These aren’t innocent mistakes. They’re part of a broader pattern to fudge the paperwork so unqualified “high-risk” loan applicants would look like J. Paul Getty and secure a mortgage. That way, the banks could continue to rake in lavish origination fees and maximize their profits.

But then the plan hit a rough patch and the Gravy-train tipped over into the ditch. When the credit storm hit the markets in August, the mortgage securitization went into deep freeze and the easy money from Wall Street dried up. The banks got stuck holding billions of their own bad paper. Now every foreclosure eats into their capital so, they’ve turned to the government for a handout. Of course, they don’t want the public to know what’s really going on so they’ve asked the Bush administration to help them pull the wool over everyone’s eyes. According to the New York Times one banking official summed it up like this:

“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market.”

Really? So, on top of everything else, the banks want the Bush administration to organize a public relations campaign that will make the multi-billion bailout look like it was designed to help struggling homeowners instead of crafty bankers. Unbelievable. No doubt Team Bush will do whatever they can to help out.

Bank of America’s proposed $739 billion bailout is just the first of many hyper-inflationary, economy-busting trial-balloons we can expect to see in the near future. The banking system is in terminal distress; collapsing from hundreds of billions in worthless assets, bad bets, and poor decision-making. Their capital impairment problems were all brought on by themselves. And they should be forced to pay the consequences, whatever that may be. They managed to take a simple, revenue-generating activity like mortgage lending, and turn it into a textbook case of grand larceny. It’s pathetic.

In their present condition, many of the banks will be back for another handout in a matter of months. Next will be commercial real estate (CRE) which is already slumping and on its way down. Then it’ll be the $160 billion in private equity deals and leveraged buyouts (LBOs) which need refinancing. Then it’ll be the maxed-out credit cards, and delinquent student loans and defaulting car loans all of which are failing at a faster and faster pace. It is not just the “structured investment” market that’s unraveling now; it’s the whole speculative paradigm of hyper-inflated assets, toxic bonds, over-priced equities and bizarre-sounding derivatives which are crashing down in one great debt waterfall. The investment banks are at the very center of the problems. They’ve played it fast and loose from the very beginning and now they’ve come up snake-eyes. Tough luck. Only they shouldn’t count on a $700 billion freebie from Uncle Sam to make up for their own bad judgment.

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