THE SUBPRIME MESS: WHY WHAT “THEY” SOLD YOU WASN’T AND STILL ISN’T WHAT YOU NEED
“They” are the giants of Wall Street. “They” are the folks who pumped billions of dollars of bonds backed by subprime mortgage obligations into the hands of unsuspecting investors like you. These loans are called subprime because they were made to people who were likely to be unable to repay them. Subprime loans were made to borrowers who had low credit scores, a history of late payments, or even recent bankruptcies. These subprime loans were then bundled and “repackaged” by financial institutions into securities with impressive names such as collateralized debt obligations (CDOs) that were snapped up by banks, traders, and hedge funds in the United States and throughout the world. “They” meaning brokerage firms, might have even foisted CDOs on you in bond mutual funds your broker told you were a safe place to stash money you weren’t willing to risk in the stock market.
Things began to fall apart in the world of CDOs when the housing bubble burst in 2006-2007. Subprime borrowers simply couldn’t repay their loans, particularly as interest rates rose and those with adjustable rate mortgages or low teaser rates owed more money each month. Houses went into foreclosure and home prices dropped. Mortgage lending institutions filed for bankruptcy. Suddenly people who should have known it all along were forced to acknowledge that all those repackaged subprime loans weren’t worth much. In fact, they became almost worthless since nobody wanted to buy them, and nobody really knew how to value them on financial statements. Astoundingly, most of the major investment banking houses got caught holding substantial blocks of their own toxic subprime paper. By the end of 2007, these firms took staggering writedowns based upon their subprime exposure:
1) Citigroup: $18 billion
2) UBS: $13.5 billion
3) Morgan Stanley: $9.4 billion
4) Merrill Lynch: $8 billion
5) Bear Stearns: $3.2 billion
A billion here, a billion there, and before long the subprime virus had contaminated markets throughout the entire world, resulting in January 2008’s free fall of share prices in European and Asian markets, not to mention devastating losses by U.S. institutional and individual investors.
There are lots of people to blame for the sub-prime crisis. Certainly banks and mortgage brokers who gave loans to people who didn’t deserve them, and deftly limited the risk of default by selling those loans to others, bear much of the blame. As just as certainly, the investment houses that repackaged trash loans and the rating agencies who gave them their seals of approval, are worthy of condemnation. And goodness knows, brokerage firms like Morgan Keegan that sold subprime-tainted funds to investors like you need to and can be held accountable,
But then again, it’s not surprising when predators act like predators. The important question for purposes of shaping policy is where were the regulators whose job is to oversee the integrity of the US markets? More specifically, where was the SEC? The answer appears to be that it was fighting for its life against people (more Wall Street “theys”) who preach the gospel that any government regulation is the enemy of economic growth. According to a recent House of Financial Services Committee Report, the current administration has allocated the SEC so little money that, since 2005, the agency’s staffing levels have been reduced by close to 11% in terms of actual positions lost, despite major increases in market activity and the number of entities under the agency’s oversight. Fewer cops equals more crime. It’s equally true in the streets and in the suites.
At the same time that the SEC was getting by on reduced rations, business interests and their political flacks in both parties were vigorously proposing “reform measures” designed to “enhance US global competitiveness.” To be blunt, these measures “ they” were and still are pushing are designed to make it a lot easier to commit fraud without having to pay consequences. Some of these proposals include: (a) cutting back on legislation such as the Sarbanes – Oxley Act enacted in the wake of the Enron and WorldCom financial scandals; (b) reducing the ability of state regulators to enforce securities law; and (c) limiting private remedies available to individuals who have been injured by Wall Street fraud.
Make no mistake about it, the campaign to gut reforms designed to protect investors and enhance corporate responsibility will continue unabated in the coming months. Deceiving investors is a multi-billion dollar industry, and those who reap its rewards are not going to skulk away in shame for the financial havoc they have created. Instead, they will be lobbying hard to “help” the securities markets “recover” by reducing regulation and remedies for people like you. Don’t listen to the fox that tells you how to protect your chickens or when he tries to convince you that it’s somehow wrong to allow you to recover for the chickens he already stole.
Copyright 2008 by Brian N. Smiley
