As featured on p. 218 of "Bloggers on the Bus," under the name "a MyDD blogger."

Monday, December 03, 2007

The Subprime Scam

It's indeed shocking that up to 55 percent of all subprime mortgage borrowers had credit scores high enough to get conventional loans. But not when you consider that lenders have financial incentive to do so in the form of yield spread premiums.

The yield spread premium (YSP) is the cash rebate paid to a mortgage broker based on selling an interest rate above the wholesale par rate that the borrower qualifies for.

Yes, that's legal. Brokers are paid money to screw their customers.

And this insatiable greed is now causing a fundamental financial crisis, mainly because the professionals in the industry don't even know what they're dealing with:

How bad is it? Well, I’ve never seen financial insiders this spooked — not even during the Asian crisis of 1997-98, when economic dominoes seemed to be falling all around the world.

This time, market players seem truly horrified — because they’ve suddenly realized that they don’t understand the complex financial system they created [...]

“What we are witnessing,” says Bill Gross of the bond manager Pimco, “is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August.”

The bottom line is that credit has dried up and businesses can't generate needed capital. The collapse of home prices ended up turning all these bonds backed by mortgages into jelly. All these newfangled ways to hide risk have been exposed.

But the innovations of recent years — the alphabet soup of C.D.O.’s and S.I.V.’s, R.M.B.S. and A.B.C.P. — were sold on false pretenses. They were promoted as ways to spread risk, making investment safer. What they did instead — aside from making their creators a lot of money, which they didn’t have to repay when it all went bust — was to spread confusion, luring investors into taking on more risk than they realized.

Why was this allowed to happen? At a deep level, I believe that the problem was ideological: policy makers, committed to the view that the market is always right, simply ignored the warning signs. We know, in particular, that Alan Greenspan brushed aside warnings from Edward Gramlich, who was a member of the Federal Reserve Board, about a potential subprime crisis [...]

The bottom line is that policy makers left the financial industry free to innovate — and what it did was to innovate itself, and the rest of us, into a big, nasty mess.

This should put a nail in the coffin of the legacy of Alan Greenspan, who recklessly encouraged these kinds of free market principles run amok and then got credit for reining them in after a lot of people got hurt (in effect being, as Patrick Artus said last week, "the arsonist and the fireman"). And it should put an end to this regulatory-free nirvana that the business community pushed for years. But instead, they're looking to get in their last bit of fun before their allies in Congress take a powder.

Business lobbyists, nervously anticipating Democratic gains in next year’s elections, are racing to secure final approval for a wide range of health, safety, labor and economic rules, in the belief that they can get better deals from the Bush administration than from its successor.

Hoping to lock in policies backed by a pro-business administration, poultry farmers are seeking an exemption for the smelly fumes produced by tons of chicken manure. Businesses are lobbying the Bush administration to roll back rules that let employees take time off for family needs and medical problems. And electric power companies are pushing the government to relax pollution-control requirements.

“There’s a growing sense, a growing probability, that the next administration could be Democratic,” said Craig L. Fuller, executive vice president of Apco Worldwide, a lobbying and public relations firm, who was a White House official in the Reagan administration. “Corporate executives, trade associations and lobbying firms have begun to recalibrate their strategies.”

And now we know that what is good for global business is frequently bad for America at the same time.

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