Fed Creates $1 Trillion 'Out of Thin Air"

[TraneWreck]

Wrong. Subprimes were fully fixed 7-08 by Bush with over 300B. I used an example of jacking value from 300K to 3M to show the problem.

I think what he means is that there were plenty of intermediary steps in the leveraging. So you start with a 300k mortgage, sell that to another institution that uses it as collateral to borrow $1 million, and so on, until you've done that 30x.

Part of the problem was that the Fed helped make a lot of those steps legal.

Now I understand what you've said is the common perception, but I believe that when you follow the money, you have to encounter one or more of the three types of illegal behavior I laid out.

Or the classic 4th case: Listing the same asset down more than once.


I'm not saying you are not right - I just haven't seem this argument laid out clearly to show that it doesn't contain fundamentally illegal activity, and I'm having difficulty contriving a way to run the scam without such. Put yourself in the shoes of the scammer, and tell me how you do it without breaking laws.

Part of the difficulty is that the process was 1 part deregulation, 1 part lax oversight, 1 part wholesale fraud, and 20 parts sheer stupid gambling. We talked about this a little before, but insurance institutions never would gamble on those credit default swaps in a vaccuum, it required complicity throughout the financial system all based on the bet that housing prices would go up forever (incidentally, they're still dropping).

So I agree with you 100% that there was fraud and illegal activity on every level, but it's sometimes difficult to distinguish from abject stupidity. I'm hoping that Obama is just trying to stabalize the system before going after all that criminality, but my fear is that it will all be ignored and swept under the rug with the rich-person defense, "mistakes were made in the past but we have to focus on the future...blah, blah, blah..."

 

[Piggy]

Put yourself in the shoes of the scammer, and tell me how you do it without breaking laws.

You're presuming that there was a scam. I don't think there was, at least not at the core of the meltdown.

When you allow exorbitant leverage, then allow folks to extend that leverage even farther by using insurance, don't require the insurance to be backed by liquid assets, allow the securitizing of debt, and allow the securitized debt to then count as an asset base for further leverage, throw in default swaps on all that securitized debt to essentially shackle everyone's legs together, and you have a formula for a global financial meltdown once the underlying bubble (housing) bursts.

Everyone at every point is doing something legal.

It's the system they're in that can't help but produce a house of cards, if each person is acting in their own interest, or in the interest of their company or shareholders.

 

[Piggy]

So I agree with you 100% that there was fraud and illegal activity on every level

I don't, except for deceptive practices at the bottom of the chain in loan origination.

It might turn out to be true that there was lots of fraud going on, like Madoff and Stanford, but that simply made things worse.

It could have happened without any fraud at all, under the circumstances.

 

[oggiesnr]

I think what he means is that there were plenty of intermediary steps in the leveraging. So you start with a 300k mortgage, sell that to another institution that uses it as collateral to borrow $1 million, and so on, until you've done that 30x.

That is the point I was making.

As far as sub-prime being fixed I think the jury is still out.

Steve

 

[mhaze]

I think what he means is that there were plenty of intermediary steps in the leveraging. So you start with a 300k mortgage, sell that to another institution that uses it as collateral to borrow $1 million, and so on, until you've done that 30x.....

That just plain does not work. Not when the intermediate documents are examined, then you find one or more of the illegalities earlier mentioned.

So the defense in court would be what, 30 guys lined up in a row claiming ignorance?

I'd love to see that.

Repeating:

To create a bubble using leveraged instrument basd on morgages requires lying about the income stream since that determine value of the instrument. Several times repeated.

Not focusing on the asset behind, that is, the morgage(s).

So how much did each of these 30 merchants claim their package was worth, and based on what?

 

[TraneWreck]

I don't, except for deceptive practices at the bottom of the chain in loan origination.
QUOTE]

I think that's the key, though. So, for example, they were paying people in FLorida to sign their names to mortgages without ever intending to give them property. Stuff like this went on at a staggering rate.

But every step of the leveraging pyramid you have to claim that the people were either perpetuating the fraud and profiting off of it, or were insanely stupid.

If you're purchasing one of these morgage backed securities, wouldn't check into the underlying mortgage? In order to give those instruments AAA ratings, wouldn't you want to figure out the employment situation of the person all that money depended on?

Giving those assets AAA ratings is either fraud or that process has zero conditions and therefore no meaning, which seems increasingly likely.

 

[mhaze]

Here is something I wrote on 9/23/08.Some of the numbers may have changed. I'm not sure we know/have been told much more than was possible to deduce on 9/23/08.




We already bailed subprime.

Period.

Looking at several sources, total default in subprime:

(1) Subprime defaults = 1.3T x 25% = 325B.
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis

That number in default maybe presumed to be sold at a 20% loss, or 40% to take a wild number. The total economic loss to those who bought packages, derivative products, etc, containing a clear or hidden component of the subprimes then is

(2) 20-40% of (1.3T/4) = 65-130B.

Below cites $300B bailout already in place.

The Housing and Economic Recovery Act of 2008 (Pub.L. 110-289, H.R. 3221) designed primarily to address the subprime mortgage crisis, was passed by the United States Congress on July 24, 2008 and signed by President George W. Bush on July 30, 2008. It authorizes the Federal Housing Administration to guarantee up to $300 billion in new 30-year fixed rate mortgages for subprime borrowers if lenders write-down principal loan balances to 90 percent of current appraisal value. It's intended to restore confidence in Fannie Mae and Freddie Mac by strengthening regulations and injecting capital into the two large U.S. suppliers of mortgage funding. States will be authorized to refinance subprime loans using mortgage revenue bonds. It also establishes the Federal Housing Finance Agency (FHFA) out of the Federal Housing Finance Board (FHFB) and Office of Federal Housing Enterprise Oversight (OFHEO).
http://en.wikipedia.org/wiki/Housing_and_Economic_Recovery_Act_of_2008

Why are the numbers in the bailout discussion of Sept. 23, 2008 10-20 times higher than the actual subprime losses of 65-130B?

Perhaps it represents massive inflation of the value of derivative products as they moved down a successive chain of buyers. But then at the point where a taxpayer bailout occurs it represents, well, basically stealing. The bailout is of imaginary value in the financial market, not a bailout of the actual taxpayers in their subprime housing whatsoever.

After a subprime crash, there should be a market correction in overpriced values. A home that was worth $1M at the peak of the bubble is found to be worth $800 and then $721K as the bubble continues. It might be argued that additional layers of loans "move into the subprime category" as the debt to equity ratios change. It is rational that someone owing $800K with value at $721K might walk away from their morgage. This is a healthy part of the process of correction. A government attempt to shore up values only keeps these people in their morgages longer, and an attempt to extend loan guarantees to these subprime borrowers is effectively an attempt to keep them from walking away from their morgage. In other words, these are efforts to keep overpriced income streams of morgage payments moving to the financial industry - the morgage servicing companies.

If the government "helps us out" at a cost of $1 trillion for a $65-130B base problem, they sure are not doing a very good job of spending our money.

Are the efforts by the government efforts protect the financial health of whole skyscrapers of fools in suits, instead of the average guy on the street?

 

[Piggy]

Repeating:

To create a bubble using leveraged instrument basd on morgages requires lying about the income stream since that determine value of the instrument. Several times repeated.

Repeating: No, it doesn't, when it's all perfectly legal.

 

[Piggy]

Giving those assets AAA ratings is either fraud or that process has zero conditions and therefore no meaning, which seems increasingly likely.

Yeah, the collusion of the ratings agencies is outrageous. Not sure if it was fraudulent. Might be. We'll see.

I'm glad M.Lynch tanked. Wish they'd been scattered to the winds after colluding with Enron to create those paper companies to hide losses. That should have been the end of them and it's a scandal that it wasn't.

 

[oggiesnr]

The problem is that they didn't go to the base. They didn't go to Joe Doe and pay his mortgage (the $325bn part of the problem). They tried to fix at bank level where the leveraging had already kicked in.

Steve

 

[mhaze]

Repeating: No, it doesn't, when it's all perfectly legal.

Repeating vague phrases doesn't make them true. Actually that's only circuituous reasoning.

How can it be done legally?
"It's not illegal because it's legal".

I've asked for a specific method that this could be done legally, being unable personally to come up with it without some in the chain looking at jailtime, and showed several examples of why this seemed to be so.

 

[soylent]

Repeating vague phrases doesn't make them true. Actually that's only circuituous reasoning.

Before the housing bubble reached its peak, foreclosing on a home meant that you took possession of an asset that is both fairly liquid and worth more today than when the mortgage was issued. MBSs and CDOs came with 400-page booklets of incredibly terse reading; almost nobody who bought these things payed any attention to the detailed internal workings so it required no fraud to just roll the recovered cash from selling the forclosed home back into the revenue stream of these instruments.

Most of the prime borrowers and many of the early sub-prime borrowers were infact fine. Lending standards deteriorated over time in order to find ever more new borrowers and attempt to satisfy the insatiable appetite for these securities. If you didn't pay much attention these assets didn't appear to be bad investments at the time they were sold and didn't become really toxic until well after the housing bubble went pop.

 

[mhaze]

Before the housing bubble reached its peak, foreclosing on a home meant that you took possession of an asset that is both fairly liquid and worth more today than when the mortgage was issued. MBSs and CDOs came with 400-page booklets of incredibly terse reading; almost nobody who bought these things payed any attention to the detailed internal workings so it required no fraud to just roll the recovered cash from selling the forclosed home back into the revenue stream of these instruments......

Let's examine that using our prior example. Investment instrument $3M is purchased, actual asset value is one $300,000 house. Market requires yield is 24,000 per year in reality using the market required 8% number. Quick sale of the property after foreclosure, legal expenses, accrued morgage payments not made, repairs, etc let's say 250,000.

So if you sold this instrument with a subprime (IIRC 3% chance of foreclosure) you had the following expectation of income. We'll consider foreclosure in the second year for simplicity:

Year 1: $24,000

And each following year is one of these realities:

2A. Year 2 - n (foreclosure) $250,000 at 3% probability followed by years with no income

2B. Year 2 - n $24,000 at 97% probability

The net present value of this instrument taking 2A and 2B into account is less than if the 24,000/year stream continued for the 30 years. You just cashed out of a 3M investment with a loss of $2,726,000....

Now, how is it considered the salesman presented this deal? How did he present the 8% income stream without criminality? There is no component here where "something is made from nothing".

 

[Piggy]

Repeating vague phrases doesn't make them true. Actually that's only circuituous reasoning.

How can it be done legally?
"It's not illegal because it's legal".

I've asked for a specific method that this could be done legally, being unable personally to come up with it without some in the chain looking at jailtime, and showed several examples of why this seemed to be so.

No, you need to cite the law that's being broken and by whom and at what point in the chain.

I've already explained how it can be done. I've outlined how the circuit worked. None of that is illegal, AFAIK.

If you think a law was broken, then cite it.

It's like you're asking me to prove that it's legal for me to mow my lawn. There's no law I can cite which says it's legal for me to mow my lawn. It's legal b/c there's no law against it.

Again, if you think a law has been broken, then explain which one and by whom and with what action.

Sometimes, mhaze, you are so unbelievably illogical I don't know how you learned to type.

 

[Piggy]

Most of the prime borrowers and many of the early sub-prime borrowers were infact fine. Lending standards deteriorated over time in order to find ever more new borrowers and attempt to satisfy the insatiable appetite for these securities. If you didn't pay much attention these assets didn't appear to be bad investments at the time they were sold and didn't become really toxic until well after the housing bubble went pop.

Exactly. This wasn't the product of lawbreaking. It was the product of a system that created a bubble. You can't point to any specific link in the chain and say, "That was illegal".

Granted, there was probably a lot of fraud going on. There always is when there's lots of money to be made.

But the bubble is explicable by examining what was allowed, not by looking for some illegal activity going on behind the curtain.

 

[mhaze]

No, you need to cite the law that's being broken and by whom and at what point in the chain.

I've already explained how it can be done. I've outlined how the circuit worked. None of that is illegal, AFAIK.

If you think a law was broken, then cite it.

It's like you're asking me to prove that it's legal for me to mow my lawn. There's no law I can cite which says it's legal for me to mow my lawn. It's legal b/c there's no law against it.

Again, if you think a law has been broken, then explain which one and by whom and with what action.

Sometimes, mhaze, you are so unbelievably illogical I don't know how you learned to type.

You refer to this:

When you allow exorbitant leverage, then allow folks to extend that leverage even farther by using insurance, don't require the insurance to be backed by liquid assets, allow the securitizing of debt, and allow the securitized debt to then count as an asset base for further leverage, throw in default swaps on all that securitized debt to essentially shackle everyone's legs together, and you have a formula for a global financial meltdown once the underlying bubble (housing) bursts.
​

Your first sentence, jumbo loans with PMI have allowed low payments for a long time - say 20 years. Nothing new in that except maybe consumers discovered it in larger numbers. A morgage(debt) is an asset and always has been to a bank. Securitize $100k of it, so what? Yes it is an asset and can be loaned against.

Morgages a bank is a storefront for only, they always went out and were packaged.

Where's the multiplier or pyramider? I don't see it legally so far. That takes us to this:

throw in default swaps on all that securitized debt

But you seem to think there was legal "creation of money" all the way back down the chain, not just at the last step?

 

[Piggy]

But you seem to think there was legal "creation of money" all the way back down the chain, not just at the last step?

The problem was that there was no creation of money. There was just compounding of risk, which depended on future payments, which depended on continued economic expansion.

For any one loan, that expectation might not have been unreasonable -- and no matter how high the risk, there was always some chance that the person taking out the loan could pay it off... heck, maybe they'd win the Lotto.

But system-wide, all added up, there was no way in God's green earth it could have all been made good.

IMO, allowing insurers to back so many deals with so few liquid assets of their own should have been illegal. But it wasn't.

ETA: My apologies for the crack at the end of my other post there. Bad day, frustrated, took it out on you. I'm sorry.

 

[mhaze]

The problem was that there was no creation of money. There was just compounding of risk, which depended on future payments, which depended on continued economic expansion.

For any one loan, that expectation might not have been unreasonable -- and no matter how high the risk, there was always some chance that the person taking out the loan could pay it off... heck, maybe they'd win the Lotto.

But system-wide, all added up, there was no way in God's green earth it could have all been made good.

IMO, allowing insurers to back so many deals with so few liquid assets of their own should have been illegal. But it wasn't.

ETA: My apologies for the crack at the end of my other post there. Bad day, frustrated, took it out on you. I'm sorry.

Sure, understood. Total subprime market was 1.3T and by 05-2008 25% defaulted. A $325B mess. These already had insurance (PMI) , but more layers of "weird" insurance were likely sprinkled on the securities to sweeten them up. Value of morgage backed securities is set by the interest rate the market demands and estimation of risk.

Securities aggregate value cannot change more than $325B without a change in demanded interet rate and or risk estimation. Total securities value cannot exceed 1.3T if rate of return on securities is equal to rate of return on morgages. (subprimes only here).

"Expansion of money supply" and or fraud in so doing is not the same or a product of leverage. It is the situation where based on 1.3T of morgages you somehow have >10T of morgage backed securities (they did), which is why we are having this discussion. But the >10T of the products were only so valued because they were alleged to have an income stream supporting that valuation. Who said it came from where?

Follow the money.

http://en.wikipedia.org/wiki/Mortgage_backed_security
http://en.wikipedia.org/wiki/Subprime_mortgage_crisis

 

[Piggy]

"Expansion of money supply" and or fraud in so doing is not the same or a product of leverage. It is the situation where based on 1.3T of morgages you somehow have >10T of morgage backed securities (they did), which is why we are having this discussion.

That's not the way I see it.

I think the specific practice you're referring to here is securitizing on potential.

In other words, I have $100M, and I figure w/ my legal leverage on that plus the extra leverage I can get by buying insurance, I could potentially lend $5B. But the loan market is so saturated, I have no buyers at the moment.

So I bundle and slice, and sell off the $5B in loans which I have the potential to make, and as soon as I do, and the payments start coming in, the buyers of those tranches will receive payments.

Once again, it's betting on other people's future potential to earn and pay... only this time, the people are hypothetical. There's no creation of money, just a gamble on future economic growth allowing more loans to be made and paid.

My understanding is that this was legal, in that there was no law specifically against it.

I could be wrong, but so far, in all my reading on this, I haven't come across anyone citing any such law.

 

[mhaze]

The ability to be loaned money is not an asset on the balance sheet.

• Before borrowing, you have neither the asset or the liability.
• After having borrowed, you have say for real estate, a morgage and a house on the balance sheet.

These cancel each other out more or less if values are equal.

I'm not questioning the classic nature of a speculative bubble in pricing and asset value, or the human tendency to be fooled by such a thing. Further, in the above example, for every loan that the perp takes out, he could pad his asset list further by overstating values.

But you are now saying that he could pad the asset list with imaginary value without any cash, buildings, etc. This would indeed be "creating money". It would as far as I am aware be way, way outside the allowed bounds of GAP (generally accepted accounting principles) and thus would not withstand any accountant's audit. Now I understand well the implications of going from this to a securities issue and raking in the cash, likely without SEC oversight.

But where is the income stream that supports the value? None. So you answer that this is along the lines of an IPO? Now this is way outside the bounds of allowed "fiduciary agent investments", which would disallow any pension funds or banks who hold others' money, and who must make conservative investment decisions, from getting into such a deal because it is de facto risky. The fiduciary agent if taken to court (and they should be) would not fare well with his claim "But they said it was insured!".

I am not aware of any offerings of this sort in the market in question where it was said "We just started this up, have no current profits to show you, but expect a lot of profit, and estimate it at 8% (or 12%)". It seems that if such an offer was placed, the competitive prices bid would be a tiny fraction of the face value due to the obvious risk.

So are you implying that betting on the future when insurance against future losses is in place does in fact fall within the allowable range of activity of a fiduciary agent?

I hope not, yet my view on it would put thousands in jail.