The Lie of Our Lives
I teach mythology to my students- Greek, Chinese, Arabian, etc. as part of their literary and cultural education. Myths are fun; except when they are believed. Then you have priests ripping people's still beating hearts out of their chests to appease the gods to send rain. Then myths are bad. The problem with believing in myths such as these is that they lead people to believe in false solutions to real problems. When the "problem" is that we are mortal, and the "solution" is to pretend that we are not, this is relatively harmless. (Except when it isn't, but I have spent enough time on that one.) But when the problem is a lack of precipitation and the "solution" is human sacrifice, that is more worrisome.
We live under a similar myth in this country, a myth that offers a false solution to a real problem. The problem is the hijacking of our national interests by a small cabal of financial criminals. The false solution that many continue to believe is that there is a damn thing our elected representatives can do, or want to do, about it.
Financial Magic Tricks
This is an extremely complex problem that I can only begin to touch on in a few blog posts. However, if you care at all about your own future security, or that of your children, or of our nation and society at large, you would be remiss if you did not read Matt Taibbi's Griftopia. A large part of what I have to say here is explained at greater length in that book.
I will, however, try to retain some measure of focus on the above problem and false solution. Thus, we shall begin with the problem. Most people in this country are vaguely aware that over the past decade or so, something not quite right was has been going on over on Wall St., leading up to the financial crisis of 2008. But many of these people wish to persist with the idea that what occurred was merely bad decision making on the part of several large banks, fueled by a perhaps larger than usual dose of greed. Retaining this belief helps these people feel better about themselves, since no one likes to admit that they are a sucker. Others are slightly more cognizant of the situation, having some notion that the stunts that Wall St. pulled were actually fairly deliberate. But even this doesn't begin to touch on the truth of what has occurred in this country over the last several decades, and continues, with no sign of stopping, to this day.
The reason for our collective ignorance of the the crimes that are being perpetrated against us is simple- the crimes themselves are fairly complex. Learning exactly why credit default swaps, interest rate swaps, collateralized debt obligations and commodity futures are such incredibly destructive financial instruments in the hands of the wrong people is a lot of work. Wall St. counts on this. Even now, while we are being robbed blind on our mortgages and pensions, and at the supermarket and the pump, we still don't bother to learn. Instead, we take it from talking heads on the radio and infotainment news that our current financial situation is the result of too many Mexican lawnmowers and too many black welfare recipients trying to buy quarter-million dollar homes. While there was certainly some of this going on, the real question is; Why?
Why were real-estate agents pushing McMansion's on illiterate laborers making $9 an hour? In what upside-down world do banks want people to default on their mortgages? Bankers aren't stupid. It used to be that when someone defaulted on their mortgage, that was bad for the bank, because even though they now held the deed and whatever payments you had already made, they still had to get someone into that house paying interest on the loan, which meant lost revenue as long as the house sat empty. A few defaults here and there could be profitable, but obviously, if everyone is defaulting, the price of real estate is going down, and the deeds they are holding are less valuable than when they had loaned out the mortgage in the first place. So how did it come to be that banks were actually rooting for people to default?
The answer lies in credit default swaps and collateralized debt obligations. Credit default swaps are relatively simple. It is basically a twisted form of insurance in which anyone, called the speculator, can take out to gamble on someone else failing to pay back a loan. They were originally designed as a way for smaller banks to take out insurance with larger banks against loans that the smaller banks had lent out. It gave smaller banks and credit unions security in lending out mortgages and small business loans, because they were backed by AAA rated banks. However, this was before the repeal of provisions of Glass-Steagall by the Gramm-Leach-Bliley Act in 1999. Glass-Steagall was the law passed in 1933 which established the FDIC, but more importantly for our purposes, forbid the merger of Wall St. investment banks and depository banks like the one you have a checking account, and possibly a mortgage, with. It was this provision of Glass-Steagall that Gramm-Leach-Bliley repealed.
It shouldn't be hard to see where this is going. Glass-Steagall was designed to prevent the conflict of interests that arise when investment banks and depository banks merge. As I pointed out earlier, it is not in your mortgage lender's interest, generally, for you to default on your mortgage. So how did it get to be so? If a depository bank sells sub-prime loans, i.e. loans to people with weak credit who are likely to default, and then their parent bank, an investment bank, is able to hide the risk of the loan, pass that mortgage on to another bank, they can then turn around and take out a credit default swap on that mortgage against yet another bank, now as a speculator with inside information, and make free money when the homeowner defaults on the mortgage. To take out a credit default swap, a CDS, as a speculator, you have to pay the bank a periodic fee, and you get paid out if and only if the homeowner defaults on his or her loan. So, to maximize your profit, you want that homeowner to default as fast as possible after you have passed of the mortgage, because this minimizes the fees you pay, and you get your payout sooner. So, if you were wondering exactly what "predatory lending" would look like, there you have it.
But if bankers are so smart, why on earth would other banks take on these risky mortgages? The answer to that lies in a much more complex financial derivative called collateralized debt obligations. CDO's are a means to spread out the risk on a package of loans. The quick version is this. You take a bunch of loans, say a thousand mortgages and you package them into a CDO. You then look for investors in the CDO, parties who are willing to take on some of the risk for a share of the profit on the interest of these loans. You then break the CDO into three tiers, called "tranches." The first tranche is referred to as "senior" and is a AAA rated investment. (AAA means that investing in this product carries almost no risk.) The rate of return on this investment is low, but it is highly secure because as money comes back into the CDO, the senior tranche is payed out first. The next tranche is the "mezzanine" tier, which gets paid out after the senior, and was generally rated BBB, which means a decent risk, but a better rate of return. This tranche is where all the problems started, so we will return to it in a minute. The bottom tier, which gets paid out last, is called the "junior" tranche, carried a high risk but a huge rate of return. Now, the CDO issuing banks themselves generally held onto the senior tranche, and had little trouble finding buyers for the junior tranche, because other banks were willing to gamble on junior shares, since they didn't cost a whole lot, and so long as too many of those thousand homeowners didn't default on those mortgages, they stood to gain a lot of money.
The trick was finding buyers for the mezzanine tranche, since it didn't pay out as well as the junior tranche, but cost more, and on the other end, wasn't as secure as the senior tranche. This is where the bankers got really "smart" (if you want to call it that). They took a bunch of mezzanine tranches from a bunch of CDOs and repackaged those into new CDOs. CDOs of CDOs. Now they had a bunch of new "AAA" rated senior tranches to sell, and finding buyers for AAA products is never hard. The problem was, these weren't really AAA at all, because they were actually composed of mountains of BBB-rated investments. So which dumb fools ended up buying this toxic crap? If you have a pension fund, you did. By law, pension funds are only supposed to be invested in AAA-rated products. If you are the manager of the pension funds of tens of thousands of state or private employees, and a big bank comes to you offering a AAA investment which promises a better rate of return than the usual, boring percentages offered on Treasury Bills, you are going to jump on it. You just made all those people whose retirements you are vested with a lot of money, didn't you? Well, unless that investment wasn't actually AAA to being with, in which case you, and everyone else whose future was in your hands, just got seriously screwed.
Things Fall Apart
Even at this point, things shouldn't have been been that bad, so long as too many people didn't default. But of course, that is exactly what happened. We have already touched on one of the major reasons, that banks were pushing mortgages on people who they knew couldn't make payments on the loan, simply so they could pass that loan off and then make money against another bank when it defaulted. But this was only a small part of the problem. While some people are uneducated enough or materialistic enough to think they should be living in a $250k house while working as a janitor, this group of borrowers was actually a small percentage of the total. Most of the people who took out these mortgages fell into one of two other camps. Either they were responsible people with decent credit who deserved a prime loan, or they themselves were gamblers who were trying to make money by "flipping" houses in this crazy market.
As for the first group, these were regular, hard-working Americans who walked into their local bank looking to buy a house and live the American Dream. However, to their agents, they were simply "marks." Because the big investment banks could make a lot more money on sub-prime mortgages, even people whose credit was good enough to warrant a traditional fixed-rate interest rate loan were being sold variable-rate mortgages as sub-prime loans because the agents were paid bigger bonuses for selling sub-prime loans than prime loans. This con was pulled off in various ways. Some mortgages lenders, like Countrywide, seemed to simply lie to their customers who went home thinking that their mortgage payment would be stable for the 30-year life of the loan, only to find out a few months later that it had gone up several percent, or several hundred dollars per month. I know many very intelligent, hard-working people who fell into this trap.
The other group is more culpable. Many people saw the direction the market was heading and decided to get in on the action. This group bought homes with no intention of occupying them and took out mortgages where they could make monthly interest-deferred payments, so that they were actually paying less per month than was accruing in interest. But since they only intended to ride the wave for a little while before flipping the house for a lot more than they paid, their profit would cover the greater interest that had accrued.
Until the market ran out of buyers. And then values started dropping. And then these gamblers were sitting on homes they'd bought for 400k, hoping to sell for 500k, which were now worth 300k. Rather than taking the 100k hit, defaulting was a lot easier. And the well started to dry up.
The contagion quickly spread. As home owners defaulted, banks started losing money. There are actually several more steps involved here, including some truly boneheaded, or cynical, moves by clowns named Joe Cassano and, ironically, Win Neuger at AIG. The stunts these a-holes pulled are too complex to get into in great detail here, but we can have a quick look. Essentially, these guys were both up to different versions of the same thing. They were both gambling big-time with AIG's assets in an extreme version of fractional-reserve banking. Fractional-reserve banking is standard practice in our economy, and refers to the fact that banks only need to actually hold a fraction of the cash, or it's equivalent, AAA investments (which will become the problem) in order to lend money out. There used to be stricter limits on what fraction a bank needed to hold onto, but like everything else since the '80s onward, this has been deregulated.
What Cassano did was relatively straight forward. His department at AIG basically sold insurance on bonds. For a tenth of a percentage point of the interest you were making on a bond, you could go to Cassano's department and get credit-default swap insurance, which meant that if the bond failed you were covered and AIG took the hit. Now, if you were holding onto a bond that was paying five-tenths of a percentage point, like the CDOs described above, and you could insure it for one-tenth of a percentage point, what do you have? You have four-tenths of a percentage point of absolutely, completely and totally risk-free income.
It wasn't long before the other banks figured this out and started buying this insurance, hundreds of millions of dollars of it, against CDOs that they knew are eventually going to fail. Further, it seems that a lot of this was purchased with the personal incomes of the executives of these banks through their firm's proprietary trading desks. Why not? It was the deal of the century, and some other sucker was going to take the hit.
Except he wasn't. Cassano had no intention of paying out on these credit-default swaps. When everything started imploding, and the other big banks came collecting, it quickly became apparent that AIG didn't have the funds to cover what they had pledged. It looked like the suckers were going to be the big banks after all. Cassano, incidentally retired with $280 million in personal compensation and lives in a three-story villa in London. Of course, the Justice Department has decided not to prosecute him.
If AIG had defaulted on these credit-default swaps, they would have ended up raiding all of their subsidiary holdings, i.e. smaller, mom-and-pop type insurance companies in order to cover their own asses. This would have led to these subsidiary firms defaulting on life, home and auto-insurance that they issue to people like you and me. The states, Texas in particular, saw this coming and declared that they would seize the assets of these firms before they could be raided, in order to keep their citizens insured.
This would have been bad enough, except AIG had been playing an equally stupid game out of another department. This was Neuger's department. The game he had been playing was securities lending. A massive insurance company like AIG takes the money you pay in as a premium and turns around and invests it, a lot of it, in the market. So AIG held tons of stocks. If you wanted, you could go to Neuger's department and "borrow" stocks you think are going to decrease in value, put up the equivalent value in cash with Neuger as collateral, then sell the stocks. You now are holding onto the same amount of cash you put up as collateral. You wait a while for the stocks to depreciate, buy back an equivalent amount, but at a lower price, return Neuger his stocks, plus a small percentage as a fee, and you keep the difference. You and Neuger win, someone somewhere else loses.
Now, this is supposed to be easy money for the securities lender. All he or she does is happen to have a crap-load of stocks, lend them out, make 1-2% on each transaction, take the collateral and invest it somewhere very safe, like a T-bill (Treasury Bill), something AAA-rated (you can probably see where this is going) and keep that percentage as well. That is what should have happened, but it didn't, because Win Neuger is a greedy moron. Instead, he invested the collateral in residential mortgage-backed securities, the same toxic CDOs that started this whole mess.
Back to the crisis with Cassano's credit-default swap department. Around 2005, AIG's name started taking a hit. Then-New York Attorney General Eliot Spitzer noticed some accounting irregularities at AIG and charged AIG's then-CEO Hank Greenberg, who was forced to step down. This led the major credit-rating agencies to downgrade AIG's rating, for the first time ever, from AAA to AA. This downgrade triggered a bunch of clauses in Cassano's contracts that required AIG to put up collateral to prove they could cover what they had insured.
There were several more incidents like this leading up to late 2007, with other banks demanding collateral from AIG as it became clearer that things at AIG weren't what they seemed, even though Cassano and AIG both kept insisting publicly that they were. At this point, AIG was posting quarterly losses in the 5-10 billion dollar range. The apocalypse had begun.
But even at this point it was only truly bad for AIG and the banks that had insured with Cassano all of these toxic so-called AAA crap CDOs that they themselves had created. This was still worrisome enough for the government to step in during September 2008. On the 13th and 14th of that month, the Treasury and the Fed met with AIG and some of their counter parties, people they owed money to, particularly Goldman Sachs.
As may be recalled, since Cassano was basically giving away the deal of the century, a lot of the executives of the big banks had poured a lot of their own personal fortunes into his scam. When they met with AIG and the government to try and recoup their losses, one bank, one executive in particular, Lloyd Blankfein, CEO of Goldman Sachs, was particularly determined to get his money back, at any cost.
The trick Lloyd had up his sleeve was this; since his company was playing this game with AIG on both ends, he was holding a mountain of stocks Goldman had borrowed from Neuger's department. The way securities lending works, Goldman had the right to return those stocks at any time for the collateral they had posted in the first place. Since AIG was a beached whale at this point, and didn't even have the money to cover Cassano's stupidity/greed, they certainly didn't have the cash to cover Neuger as well, since he had in the meanwhile, lost billions of dollars of the collateral he had been given, because the housing market was imploding.
If Goldman returned Neuger's stocks, and demanded its collateral back, and it becomes apparent that AIG no longer has it, this triggers a run on AIG, with all the other banks trying to get their hands on whatever AIG has left, which leads to a crisis on Main Street, as people like you and me learn that the insurance policies we have been paying into our whole lives our worthless. Since all of the big banks are all tied together in this gigantic cluster-f&%$, this is basically the collapse of the financial universe.
The stocks Goldman was holding were still good stocks, valuable holdings, and there was no reason for Lloyd to be trying to throw them back in AIG's face, except for one reason. He was bull-shit pissed at being ripped off by Joe Cassano and he wanted his "f&%$ing money back." So he basically held a torch to the economy of the entire world and said, "I will burn this f&%$ing thing to the ground if I don't get what's mine."
And Henry Paulson at the Treasury and Ben Bernanke at the Fed blinked. Then they did what they do best; they printed more money, $200 billion dollars of new money, which they then gave to AIG to cover the greed and stupidity of a couple of buffoons.
In the end, Lloyd, Goldman Sachs and all of the other banks got their money back. They also got to keep the AAA tranches of the CDOs which were still paying off well. So who lost?
We, the American taxpayer, did, of course, and in more ways than one.
First of all, when the Fed prints money, pretty much everyone loses, except the people they hand it to, of course. Because when there is more money in circulation, the money you have, in savings, in investments, in your home, in your pension, is worth less due to inflation.
Second, we lost because we, the tax payers (though our children more than us), who are ultimately on the hook for everything the Fed does, were forced to purchase, without representation or consent, all of those toxic residential mortgage backed securities that AIG and the other banks were holding. They kept the senior tranches, the truly AAA stuff, we got the garbage.
Third, our homes lost a ton of value. Especially if you bought a house during this period, you are going to be paying these same banks tens of thousands of dollars on a mortgage that costs significantly more that your house is actually worth now. Since for real people their house is the biggest investment they ever make, this is a huge blow. Just to give you an idea of how big an effect this is having on our economy, here are some numbers.
Every day, 8,500 homeowners default on their mortgage.
Every day, American homes lose $13 million dollars in total value.
Every day, Americans make $750 million dollars worth of payments on non-existent value that their homes lost when the market crashed.
And where does all that money go? Right back to the same people who created this mess in the first place. We are projected to ultimately spend up to $13 trillion (trillion!) on the bailouts, including cash outlaid plus value lost on those toxic securities. Just to give you a hint of what we could have done with 13 trillion dollars, a mere $1.4 trillion, if given to the homeowners instead of directly to the banks, would not only have paid off the mortgages of every single person in this country, it would have bought a house for every single adult who didn't have one. Of course, the banks would get the money eventually, but instead of scrambling every month to avoid being put on the street (by these same banks) every single American in the country would be pouring every penny they now spend on their mortgages back into the economy. That would be an actual stimulus package.
Would this be socialism? Yeah, it really would be. Would it be stealing from our own children? It would definitely be that as well. But if you have a problem with those things, as I do, then consider that we did exactly the same thing, except the money all went to a few already incredibly wealthy individuals, instead of the American people who have nothing to show for it, except a ton of debt, an over-valued mortgage, and a devalued pension.
And the picture gets even better, when we start talking about being forced to buy health insurance that won't pay out when you need it, allowing these same banks and their foreign investors to manipulate the prices of the same essential commodities, food and fuel, that they sell to us, making a double profit on both the speculation and the artificially inflated prices, and finally, these same banks selling of bits of our national sovereignty to our sworn enemies. That will be the next post. Oh yeah, it just gets better and better.