Predictions From the Past #1:The Subprime Crisis!

The Prime Enabler — Ponzzi Paper — Written in 2000

Money can’t be “Printed” if no-one borrows it. The three basic categories for qualification are income, collateral and credit history. The income was the easy one. A few weeks’ pay stubs or a few months’ bank statements (formerly good for only high risk/interest) became the norm in lieu of two years of tax returns.

The collateral is where the miracle was performed: Paper Wealth! The phenomena of the brainwashed majority pumping their weekly and monthly savings through the stock markets, was the tide that raised all wealth boats. Also, the easy profits from the market money pump contributed to additional collateral via rising home prices. Home equity collateral was then expanded by 100-125% mortgages. This was the equivalent of the 10% stock margin leverage of the Twenties, just being collateralized with different security.

The expanding collateral loan base and easy qualifications liquefied the composite credit world so that almost anyone could subsidize income as needed by additional borrowing to service debt. All the folks “Good Credit “history then became the primary factor for loan qualification and for loan solicitation. This third factor has also applied to the whole world of credit cards, not just secured loans. Certainly, the advent of the derivative enabled all this loosening of loan qualification requirements. The thing is, a derivative itself is only as good as the ‘credit’ of its writer. If events cause the bulk of this “insurance” coverage to come due, those same events may include there being no money to pay it.

Now Steve asks “who caused it and what they stood to gain by it?” Before this last 10/12 year period, most mortgages stayed with the original lender. Suddenly, it seemed, mortgages were being sold and resold. Rather then being created for an income stream, mortgages are now most often created to be an instrument to sell at a mark-up. Declining interest rates are what makes this viable. Mortgage paper behaves as bonds do, when interest rates drop, the yield factor increases the asset value of the paper. Notice that the latest rate cuts have not spread into mortgages and other long term paper. As interest nears the bottom, the yield advantage of earlier written paper becomes less likely to hold into the future.

Meanwhile, though, the writers and subsequent sellers of mortgages are “off-the hook” as soon as the paper is out of their hands. Add to that the dominance of the market by large outfits with scores of loan agents only concerned with their commission and putting the most positive of ‘spins’ on loan applications sent to the underwriters, and you have the easiest money in history.

The conservative banker with his eye on the balance sheet has been replaced by Alfred E. Newman, the mortgage salesman saying “What; me worry!”