"underwater" mortgages

[richlevy]

ARMs were always a most risky thing. Long ago, banks held the mortgages. Therefore bankers shared in the risk and would not make deals that were risky and so stupid. With new financial games (ie mortgage backed securities and CDOs), bankers no longer held risk. They could lie and be believed because once banks were responsible. Once banks did calculate risk and determine who could qualify for loans. No longer. Bankers no longer determined what was and was not a risky loan. He would simply sell that loan to others. And reap rewards by no longer doing what was his job.

I have to agree with TW on the principal of his statement if not on the actual objection to ARMS. This whole mess that we have gotten ourselves into is because of hyper-capitalism. If I collect a bet from you for a horse, our relationship is not investor and broker, it is gambler and bookie. We are not investing in the horse and directly supplying it's owner with capital. While securitization, hedges, and other methods were useful in spreading risk, they were never intended to be primary investments. In the insurance industry, there is also a concept called reinsurance, where an insurance company sells some of their risk in, say oceanfront Maryland properties and takes on earthquake risk in California. This is so that a single catastrophe could not bring down a company. Hedges and the securitization of mortgages were similar in that they allowed spreading risk or betting 'for' risk. Southwest Airlines famously did this by buying fuel hedges. When the price went up, the profits from the hedges offset rising fuel costs.

Banks, however, took it too far. They oversold, securitized, and re-securitized to the point where no bank kept any appreciable risk from any mortgage. This removed their incentive to apply due diligence. Loan officers and brokers, who have a legal obligation to borrowers and lenders, were either untrained or committed actual fraud when dealing with borrowers. Yes, if borrowers lied and knew they were lying, then they were accomplices. But in these dealings the people brokering the loans were the experts.

ARM's serve a legitimate purpose. Interest-only mortgages, however, and some of the more exotic offshoots, are more like rent than mortgages. I can't believe the IRS allows mortgage deductions for them.

Broker: How much did you make last year?
Borrower: Well, I got paid $45,000, but my aunt died and left me $15,000.
Broker: I see. Income $60,000.
Borrower: But I only got the last $15,000 because my aunt died. What am I going to do next year?
Broker: You have other relatives, don't you?

[tw]

Originally Posted by richlevy

Banks, however, took it too far. They oversold, securitized, and re-securitized to the point where no bank kept any appreciable risk from any mortgage. This removed their incentive to apply due diligence. Loan officers and brokers, who have a legal obligation to borrowers and lenders, were either untrained or committed actual fraud when dealing with borrowers. Yes, if borrowers lied and knew they were lying, then they were accomplices. But in these dealings the people brokering the loans were the experts.

Risk is a concept that international banking standards such as Basel 1 and Basel 2 were designed to address. The US simply refused to accept these standards. And then watered them down to enrich the finance industry at the expense of America and other nation's economies. For example, investment banks including Lehman, Bear Stearns, Morgan Stanley, etc were exempt from Basel standards so that their debt to equity ratios could exceed 30 to 1.

We have finally finished with health care reform. Coming is the next and absolutely necessary regulation of financial industries. The same naysayer will attack it for the same political agenda reasons. Finance industry foolishly claims the purpose of a company is profits. Same philosophy behind the mafia. The product (service to an economy) be damned.

Key is long overdue regulation due to LTCM 12 years ago (hidden risk that could not happen on open markets), Enron accounting (that was made so legal in 2001 as to be called REPO 105 in Lehman Bros), and insurance (AIG wrote thousand page insurance policies to remain exempt from insurance regulations and to hide risks that even top management could not understand).

Overt fraud is so widespread in the American financial economy so that stock brokers (salesmen) routinely reap $250,000 plus (not including bonuses). The senior VP in Merrill Lynch was fired for warning about what would happen years later. Board of Directors in AT&T remained completely uninformed when AT&T was only 3 months from default. Major bankers were told they had eight hours to save the entire American economy. We all learned later that is was that bad.

Coming is the next and necessary fight. To heavily regulate an industry ripe with corruption. With people so grossly overpaid because they actually believe they deserve it. Risk is simply a major part of a massive problem directly traceable to profits reaped without any responsibility for the consequences. ARMs are just a little part of that larger problem.

Essential to risk markets is complete transparency. ARMs are quite risky. And only one example of the larger problem. That battle looms.