Many contributed to financial crisis

I believe that the reason why the nation’s economic problems have reached epic proportions is due to the vast number of people who contributed to them. We’ve all heard about the speculators who bought homes with as little money as possible and then sold them for thousands of dollars more. Their house flipping was a key factor in driving up prices at lightning speeds.

We’ve also heard about the unethical deals struck by some of the subprime lenders and their clients. In these cases, the borrowers took out mortgages they couldn’t afford, thanks sometimes to deceitful practices of both lenders and borrowers.

Well, there’s plentiful information about the other contributors. I came across it while reading Paul Muolo’s book called “$700 Billion Bailout: The Emergency Economic Stabilization Act and What It Means to You, Your Money, Your Mortgage, and Your Taxes.”

Muolo, executive editor of National Mortgage News, said that when the wheelers and dealers from Wall Street got involved in the action, the money being staked on risky mortgages grew exponentially.

Investment banking firms such as Bear Stearns, Merrill Lynch and Lehman Brothers have profited in the past by creating bonds backed by low-risk mortgages. As part of this process, the firms made money by selling those bonds to institutional investors in the United States and overseas. However, in recent years, these investment houses and other Wall Street firms started looking for ways to increase their income.

The solution they adopted was to add subprime mortgages to the process. These riskier mortgages carried a higher interest rate and therefore a larger yield.

Muolo explained that once this practice began, there were investors who bought the new bonds without knowing exactly what they were buying. So, he said, the investment firms bought bond insurance to make them feel more secure.

At the same time, Wall Street firms and insurance companies sold investors a product called “credit default swaps.” These were insurance contracts, Muolo said, “where an investor makes a bet against the value of a bond.”

Since there can be more than one contract issued against the same bond, the consequences for policy issuers, if you will, could be staggering. These contracts can be made for any type of bond, and a huge number of them have been created.

Although no one knows what percentage of existing contracts is for mortgage-backed bonds, the shocking picture that emerges when contracts are compared to mortgages might be revealing.

According to the estimates that Muolo provided, there is an astounding $44 trillion worth of credit default swaps in the United States. In stark contrast, his figures indicate that the entire amount owed on all mortgages now stands at about $9.6 trillion. The portion of this amount that is attributable to subprime mortgages is $1 trillion.

The roll call of contributors to the financial crisis doesn’t stop here. Credit rating agencies gave excellent ratings to the risky subprime mortgage-backed bonds. These agencies considered the bonds safe because they were insured. On the other hand, the government made no effort to regulate the gigantic credit default swaps market.

For example, it didn’t mandate that the firms that sold credit default swaps keep enough money in reserve to cover their contracts.

Not surprisingly, when borrowers started defaulting on their subprime mortgages, the entire financial system ground to a halt. The institutions that owned bonds based on subprime mortgages not only lost income, but also their bonds decreased in value.

These bond owners were typically Wall Street firms, insurance companies, banks, pension funds and governments at the state and city levels.

The bond insurance companies involved were caught unprepared for the high 30 percent default rate and were consequently unable to pay off on all their insurance policies.

Investment firms that had sold credit default swaps for mortgage-backed bonds were in the same predicament.

A credit crisis developed as bankers tried to figure out how many more mortgages were going to fail and which institutions would suffer severely because of them. As the banks attempted to play it safe by holding onto their money, they denied the requests of businesses and individual consumers who were in need of loans.

Clearly, by the time this happened, a lot of the contributors referred to earlier had already made a ton of money. But I didn’t see any of them offering their money to help the nation get its finances back on track. On the contrary, the government asked taxpayers for $700 billion to bail the financial industry out.

This may have been necessary at the time, and I hope it works. However, I also want the people who were responsible for getting the nation in this mess to pay restitution.

Source:- thesouthendnews.com