When is the Next Economic Melt Down
If you look back at the financial meltdown that occurred worldwide and the lack of regulations enacted because of; you can see that we are all still under a huge risk of it occurring again. And you can see that if you had Gold in your portfolio and retirement accounts along with stocks and bonds, you would have made an absolute fortune while the world was in the worst financial crisis since the great depression.Banks closed, parts of major cities were destroyed because of vacant homes, home values plummeted and a record number of people lost their homes and/or filed for bankruptcy.
How could this possibly happen is a pretty naive question once you realize that the financial industry is double the size of the manufacturing industry and that the regulations from the depression era that kept the financial industry honest were basically stripped of their power in 1999.
Contrary to most beliefs, it wasn’t the government that pushed for the 1999 banking DE-regulation. It was the banks and their lobby groups who bullied the politicians into doing it. Of course Washington didn’t have to and they did make a big deal of the bi-partisan measure but frankly, it was the last thing on their minds at the time (remember Monica and Newt?) and would have never occurred if not for the financial lobby groups.
HOW DID IT START?
What started as a reasonable and brilliant idea way back in 1994; spreading lender’s risk among many to free up capital reserves that would have been tied up for existing loans to be used to loan more money, turned into the worst nightmare any bank could imagine. Ironically, J.P. Morgan, who’s “Young Turks” invented the concept got out of it way before any crisis ever developed and actually benefited from the industry meltdown.
The basic idea was that J.P. wanted to use the same hedging techniques the commodity markets use. If they could spread their risk for letters of credit or loans around, they’ll make more money because they’ll be able to lend more money.
The first deal J.P. made was for an Exxon letter of credit because of the Valdez oil spill that occurred in Alaska in 1989. J.P. had a huge amount of capital in reserve for that letter of credit. They found financial institutions willing to invest in some of the risk for a good yield. This enabled J.P. to take much of the capital reserves they held off their books and use it for other deals. It worked well for them and they continued spreading risk on credit for individual companies.
Their next step was to package risk they held from many A-1 companies with great credit and sell some of that risk to investors who got a reasonable return when the A-1 companies paid their obligations. J.P. made money and fees, the investors made money, the A-1 companies got the credit they needed and all was well.
To expand this business, their next move was to package risk from other lenders (J.P. at the time had this market cornered) and sell them to investors which worked well also because they only packaged A-1 companies with great credit and had practically no chance of defaulting.
As word got out in the industry, other banks started doing this and because there were no regulations on this new derivative, this was all done on private exchanges with no one, including government regulators, knowing who was selling what to whom. It was relatively safe because the risk was really safe as only companies with great credit were part of the portfolios.
Wall Street wanted to take this risk spreading to the home mortgage market but was blocked because of the Glass/Stegall regulations enacted after the Great Depression. They and their lobby groups spread millions of dollars around Washington and in 1999, the industry was DE-regulated enough to allow many more different kinds of mortgage products (mostly sub-prime) which resulted in millions of new mortgages and allowed for the packaging and selling of the mortgage portfolios to investors.
Most of the new mortgage products (sub-prime loans) were no interest loans (borrower only paid interest and not principle for a specific amount of time to keep payments low), stated income loans (borrower didn’t have to prove their income), adjustable rate mortgages (when adjustment period ended, interest would increase or borrower took out another adjustable rate mortgage or a fixed rate loan) and countless others. The new mortgage products allowed people who would have never re-financed previously to take out the equity in their homes in cash and start a new mortgage.
And this is how the banking crisis was born. Banks and other lenders learned they could package sub-prime loans with prime loans to increase risk as well as yield and sell as many as they could put together. Backing the risk were the Credit Default Swaps (CDS) and the kingpin in writing (insuring) the loan packages was the insurance company AIG.
Because of the DE-regulations and new loan products as well as the CDS’s, new mortgage brokers opened all over the United States and they specifically targeted people with either poor credit but had equity in their home or people strapped with serious credit card and other debt and had equity in their home.
The selling pitch was easy for the mortgage broker; home values continue to increase so take an adjustable rate mortgage with a low interest rate,lower your payments now and cash in your home equity. Take the cash and pay your bills which will lower your monthly obligations then refinance when the adjustable time period is over into a long term loan.
Even if an adjustable rate mortgage wouldn’t work, they had other mortgage products to use with the end result being, anyone who had equity in their home, no matter their credit rating or income, could get a loan and they were closed in days versus the previous normal time frame of a few weeks to a month.
Once the mortgage broker had a group of sub prime loans, they packaged them into a portfolio and sold them to investors. The investor, usually a bank, would bundle the sub prime loans along with the lower risk loans they had. They would buy a CDS, go to a rating company and get a good rating because it was insured then sell the whole package with a great rating to other investors.
When you sit back and take this all in, it was really brilliant if you don’t consider what would happen if the home values didn’t continue to appreciate (which happened). If you take into consideration what could happen if the appreciation stops, you can see this was basically financial suicide. For the sake of fees and profits for the financial institutions, the world economy went down the financial tubes. Even though this started in the United States, the European banks were heavily invested into sub-prime portfolios too.
One of the first states to realize that this way of mortgage lending must be stopped was Georgia. The governor and other legislatures, to the chagrin of the banking industry who spent millions fighting them, wrote a predatory lending bill to stop sub prime lending and it was written into law in 2002/2003. This was about 3 years before it really hit the fan and ironically, even with the predatory evidence from Georgia, nobody else acted except of course Wall Street, who with help from their lobbying groups backed candidates to run against Gov. Barnes.
With the money they threw into the election, Barnes didn’t have a chance and within 2 weeks of the new governor taking office, the Georgia predatory lending laws were rescinded. The lobby groups used the same argument they used in 1999. Regulation stifles growth and opportunity and must be struck down every time they are enacted.
The sub prime lending was still going strong even with the problems Georgia was having. With slick sales techniques driven by huge commissions and bonuses and the never ending supply of people living beyond their means who still had home equity, the sub prime mortgage lending along with the packaging of mortgages insured with CDS was going as strong as ever.
The worst thing about the Georgia fiasco was the politicians, backed by Wall Street money, publicly stated how the regulations would stifle home ownership, curtail lending and ruin Georgia’s economy. Greed and stupidity has no bounds.
Another problem DE-regulation caused was that the selling of mortgage portfolios were basically private deals and one entity (including regulators) didn’t know what others were doing. J.P. Morgan who invented the derivative wasn’t even using it for mortgages because they knew if the home appreciation stopped, the house of cards would fall faster than it was built.
The other banks didn’t know J.P. was not selling sub-prime portfolios. The only bank who actually spoke out about the danger of sub prime portfolios was Wells Fargo but they owned a subsidy that was doing it too. Did they stop? No, they were making too much money at the time.
The only way to financially protect yourself is by owning Gold.
Home prices were still rising and mortgage portfolio sales were going strong because the European banks started buying them. They were late into this but hit it fast and hard. Ironically, the first bank to go into default was the German bank, IKB.
Starting in 2006, American banks knew they were part of a deal that could collapse at any moment. It didn’t stop them though. They just sold more of the toxic bundles trying to make more money before the bubble burst.
September of 2008 is when it really hit the fan. AIG, one of the world’s largest insurers and who wrote credit default swaps worth an estimated 400 billion dollars got hit with the first tremendous wave of claims from people who invested in the toxic mortgages that they insured. Of course AIG, who took advantage of the regulations and didn’t have enough capital to pay off the insured, came to Washington begging for money to stay afloat. Why they allowed themselves this kind of risk can be answered with one word which is the same word that sunk Wall Street; greed. But of course in the end, Wall Street really didn’t get hurt.
In fact, they’re as strong as ever. They just about single handedly drove the world into bankruptcy and not one criminal case has been filed. There are civil suits and many have paid fines and damages but the U.S. Justice Department has refused to file criminal charges against anyone from Wall Street.
The Justice Department claims they can’t prove without a reasonable doubt that the banks willingly partook in fraudulent or criminal activity. The argument against this: they knowingly continued to sell soon to be worthless mortgage portfolios to get them off their books. Just about all the big Wall Street banks have settled many civil cases and have paid hundreds of millions in fines but have not been prosecuted.
The other argument against the Justice Department not taking action is; any jury anywhere would easily convict the leaders of the financial institutions with the evidence they had. Even the ridiculous foreclosure actions banks have taken have not been prosecuted. Can you imagine not even knowing who owns your mortgage? And facts have come out that even the banks don’t know who owns what (mortgages have been sold so many times and/or combined with other mortgages) which caused them to forge foreclosure paperwork. Most American cities have huge blighted areas with foreclosed homes just sitting there because they can’t do the paperwork to demolish the homes because they can’t figure out who actually owns it.
There is no dispute that the DE-regulation of 1999 and the greed of Wall Street were directly responsible for the economic meltdown. The question is, will anyone learn from this? Our government forgot all about the great depression with the financial DE-regulation in 1999. Our government forgot all about Vietnam (same failure and problems occurring in the Middle East now) in 2003. What will they forget about next?
It’s naive to think you have nothing to worry about.