Theory ­ Weblog Articles ­ The Bombsite

I was going to call this article “Conspiracy Theory” but, whenever that phrase comes up, ears go deaf and eyes go blind. What I am about to recount is something you have all been living through and will continue to live through for some time to come. It is completely factual so I have little reason to call it “Theory” other than the future predictions, but one wonders how much “Conspiracy” is involved and whether it could be proved, so that these people can be hung up by the balls for putting us all through a certain amount of misery and hardship.

In the past banks used to fund their mortgage lending by using the monies deposited as savings by their customers. This effectively limited the amount of money that a bank could lend for mortgages. That being the case the banks would do certain checks on the property valuation and borrower’s income to satisfy themselves that the loan was likely to be repaid and, in the event of default, that the property value would cover it, Not a bad thing you might think and I would agree. In recent years however, banks have started selling on these mortgages to the bond market which has enabled them to raise more money to fund additional borrowing. What one needs to look at here is what kind of additional borrowing did the banks decide to fund because, without the incentive to carefully check out their borrowers as they did in the past, the system was open to abuse and you just know that there are plenty of greedy buggers out there eager to abuse the system up to the hilt.

Enter the “sub-prime mortgage market”. If you don’t know already the sub-prime market consists of borrowers who are a little “risky” to put it mildly. That is to say that they are far more likely to default on their mortgage payments than the, up ‘till now, usual “prime” borrower.

Now over the last 5 years or so the private sector has dramatically expanded it’s role in the mortgage bond market. They started to specialise in new types of mortgages, such as sub-prime lending to borrowers with poor credit histories and weak documentation of income, who were normally shunned by the “prime” lenders.

Two things to consider here. First, these bonds were being marketed as “AAA” bonds, that is to say that they were supposedly the best bonds you could get with very little or no chance of them losing money. Second, and maybe a little harder to grasp, is that in the past sub-prime lending was an extremely small part of the mortgage market and it would be to the “top end” of the sub-prime sector in order to keep the risk of default to a minimum. This meant that the historical figures for sub-prime lending suggested about a 1.2% default rate and this figure was stupidly used to predict the future default rate in a vastly expanded sub-prime market.

So how did they manage to market these bonds as “AAA” investments when they clearly weren’t? With a certain amount of trickery of course. There are 3 basic types of investor: there is the type who doesn’t like to take any risk; there is the type who doesn’t mind a small risk; there is the type who loves a big gamble – the get-rich-quick type. The bonds were sold with 3 levels of “charge”. The first charge would go to the “no risk” investor. If there was anything left the second charge would go to the “small risk taker”. If there was still anything left the third charge would go to the “big gambler”. Very clever.

Anyway the banks found that they were starting to make a lot of money because they were getting a fee for each mortgage that they sold on and naturally, as banks are greedy buggers at the best of times, they urged mortgage brokers to sell more and more of these mortgages. It is estimated that 20% of all mortgages are sub-prime.

As to the mortgages themselves. These were sold at low interest rates to the unsuspecting borrower who were deliberately “kept in the dark” about the fact that after 2 years these mortgages would “reset” and this would normally result in a doubling of the interest rate and thus very sharp increases in the monthly repayment amounts. If you consider the type of person to whom these mortgages were sold that would be a very, very, very sharp rise. So sharp that they simply couldn’t afford to pay up.

Bang!!

That 1.2% I mentioned earlier suddenly turned into a 6% default rate almost overnight and that will probably go up. It is estimated that some 2 million families could face repossession. To make matters worse the glut of repossessed homes has forced house prices down so that in many cases the value of repossessed homes no longer covers the amount of the mortgage secured on them.

This is very bad news both for the banks, who have lost billions, and also to the mortgage bond holders, many of whom are pension funds. Now I wonder who is going to end up suffering here? OK, we aren’t having our homes repossessed, but we are going to suffer none-the-less. The banks, because they have lost out, are being very, very cagey about who they lend to and I don’t just mean mortgages, I mean any lending of any sort. Further, your pension fund probably isn’t as big as it should be because it bought into mortgage bonds which aren’t the great investment that they were fraudulently made out to be. Remember those “AAA” bonds?

There are, however, a large number of people who haven’t lost out in this farce. Indeed they have made £millions out of selling these “AAA” bonds and are currently sunning themselves in the Caribbean in extremely expensive resorts, lodges, hotels, yachts and the like. The kind of places you couldn’t even dream about. They really don’t give a damn about the problems that you and I are faced with in this mess that they had no small part in creating. They have no morals. They only have greed. They will be back. As the so-called “credit crunch” starts to take hold you can expect share prices to drop and small/medium sized businesses to falter or even fail. When that starts to happen these greedy bastards will use all that money they made to buy up stocks and businesses at bargain-basement prices. Then, as things start to correct themselves, they will be able to make even more money as the value of their purchases starts to rise. Doesn’t it just want to make you puke?

In the mean time governments are trying to come up with ways to ease the problem. In Britain, The Bank of England has put forward proposals to swap mortgage-backed securities for government-backed bonds for between one and three years but at a discounted rate and only on mortgages existing before the beginning of this year (2008). This would require government approval but it would seem that our “prudent” Mr. Brown is all for it providing that the banks continue to offer mortgages to first-time buyers.

Now forgive me for looking at this from a different angle but doesn’t that mean that you and I, “the taxpayer”, are going to be bailing these banks out of the hole they’ve dug for themselves? Banks that are actually “private” companies? And what do we get out of it in return? We get all those pretty bloody worthless mortgage securities for maybe up to 3 years. So what happens at the end of the 3 years if the banks can’t pay up? Do we get to repossess them? Oh I think not. Oh no, no, no, no, no. Some bright spark will think up another ruse to help them out, again at our cost. When it comes to “big money” a way will always be found.

On a positive front however, The Royal Bank of Scotland (which includes NatWest) look like they are going to be having a Rights issue in order to try and raise a couple of £billion or so. Now that is the right way to do it if you will forgive the unintended pun. A private company raising much-needed funds via the shareholders instead of relying on the taxpayer. This is the route many of the US banks have taken. Good luck to them say I.

Anyway, think on this for a minute. As you go through life with it’s ups and downs it is probably the greedy, rich, immoral bastards that are the cause of those downs. They certainly won’t be the cause of your ups because they can’t make any money out of ups. When you think about who it is who controls your life don’t think about yourself or your local council or the government, think about those greedy, rich, immoral bastards instead. And when you hear about a conspiracy theory in the future you might at least take some time out to listen to or read it. You might be surprised about how much truth is actually in it. More on that in another article.