The Socialisation of Risk

The Federal Reserve has bought a ‘staggering’ $1.2 trillion of bad debt since the beginning of the sub-prime mortgage and credit crisis of 2008. There is considerable evidence that this bad debt was a direct consequence of faulty, if not outright fraudulent, processes which pervaded the securitisation of this debt during the housing boom:

Faulty underwriting appears to be prevalent across the board, with originators complicit in overvaluing both the lender and the collateral at the point of underwriting — and doing so systematically.

Julian Fisher – How the mortgage mess could spread beyond sub-prime Reuters 22 Oct 10

Under the circumstances, with the failure of Lehman Brothers and the imminent collapse of credit threatening major financial institutions, an injection of public capital seemed prudent, perhaps even inevitable. Yet although these systemic problems were widely suspected there have been virtually no regulatory penalties or criminal prosecutions. In fact the government has simply absorbed the losses on our behalf:

The U.S. government and the Fed had a stark choice: either impose the rule of law and indict and convict hundreds, if not thousands, of people who perpetrated and profited from the systemic fraud and embezzlement at the heart of the mortgage and mortgage-securities industries, or socialize the corrupted, poisoned markets and use taxpayer funds to prop up the wizened shell of a stripmined market and reward the criminals with freedom.

They chose to reward the criminals and prop up a simulacrum market with only one buyer: the Federal Reserve. You can go to the the Fed’s balance sheet and see the $1.2 trillion in mortgage-backed securities it owns.

Charles Hugh Smith – U.S. Financial Markets: The Well Has Been Poisoned Of Two Minds 23 Oct 10

From Karl Denninger’s chart you can see the debt is still there but it is now the taxpayers’ liability. The profits, however, have been retained by the financial institutions with the hope that their solvency will be the first step towards our economic recovery. But what are the consequences for consumers, homeowners and taxpayers?

It is strongly argued that American consumers are responsible for the obligations they accumulated in the last decade, and that defaulting borrowers caused the housing bubble burst and the subsequent decline. That ‘convenient truth’ ignores the determined effort by financial institutions to dramatically increase the debt pool when debt was the hottest and most profitable commodity:

First [the government] let the banksters literally STEAL people’s hopes, dreams, and money by preying on them with knowingly-toxic exploding loans that they knew in advance would NEVER lead to those Americans owning their own home free and clear. These loans came in the form of 2/28s and 3/27s for “less fortunate” borrowers, crafted for the singular purpose of turning a free US citizen into a perpetually enslaved debtor who would never own a damn thing except a payment book.

NEXT, [they] allowed those very same banksters to create exploding “OptionARM” and other similar exotic loans including “NINJA” liar loans – “No Income, No Job, No Assets Required.” Loans with ZERO underwriting, ZERO collateral requirement, ZERO supervision and ZERO truth. A HUD study years ago uncovered the truth and yet it was intentionally ignored within our government.

Finally [they] let these very same banksters misstate the credit quality of batches of these loans, in active cooperation with the “ratings agencies”, thereby deceiving investors worldwide into believing that utter and complete garbage, much of it utterly WORTHLESS, was “AAA” credit paper.

Karl Denninger – Damnit, Stop the Looting NOW! Market Ticker 10 Aug 09

Sadly, these poorly underwritten and misrepresented investments were picked up by 401(k)s and pension funds, further eroding the assets of many well-intentioned citizens. And it is not like we weren’t warned at the time:

Rampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an “epidemic” of financial crimes which, if not curtailed, could become “the next S&L crisis.”

Assistant FBI Director Chris Swecker said the booming mortgage market, fueled by low interest rates and soaring home values, has attracted unscrupulous professionals and criminal groups whose fraudulent activities could cause multibillion-dollar losses to financial institutions.

Terry Frieden – FBI warns of mortgage fraud ‘epidemic’ CNN 27 Sep 04

Needless to say the collapse of the American economy further exacerbates the ability of consumers to service their debt and many Americans now owe more for their homes than they are worth, whether they undertook prudent borrowing or not. In fact it is tempting to suppose that financial opportunism, having completed the asset-stripping of commercial institutions, turned its attention to assets of individual retail consumers as the next lucrative target. Whatever their intentions they seem to have done a pretty thorough job:

From the second quarter of 2007 to the second quarter of 2010, household net worth fell by $12.3 trillion.

Since the first quarter of 2006, household equity in real estate declined from $13.5 trillion to $7.0 trillion, a 48% decline.

From the first to the second quarter of 2010, household assets held in corporate equities and pension fund reserves declined by $910 billion and $650 billion, respectively.

Sherle R Schwenninger and Samuel Sherraden – A Recovery At Risk New America Foundation Oct 2010

The foreclosure fraud crisis has lifted the lid on some of the arguably fraudulent ‘short-cuts’ employed to rapidly transition homeowner debt to corporate profits but so far no prosecutions have ensued, though it is early days yet. However it is clear that the Federal governments of both the Bush and Obama administrations chose to shoulder the losses on our behalf and leave the profits and capital in the hands of the same actors who perpetrated this mess:

The reality here is that what we have is a bunch of piranhas in a tank that have been feasting on Americans for two decades. Now the Americans are down to bare femurs, tibia, fibula and ribcages – they’re out of assets to strip and out of payments to poach.

Karl Denninger – Weekend Roundup: Foreclosuregate Status Market Ticker 23 Oct 10

In subsequent diaries we will have a look at what financial institutions are doing with what was formerly our capital and explore why this is not a partisan issue. In fact, how ‘bread and circuses’ political partisanship seems a distraction while our prosperity and collective assets at the state and municipal level are further eroded for short-term, private profit.