The blame game

By E.P. Unum | October 8, 2008

It’s hard not to be familiar with the story by now. A mountain of illiquid mortgage backed securities is currently wreaking havoc on our capital markets and our broader economy. Washington is telling us that our best option is to get this paper off the market as soon as possible. The idea, they say, is that by gobbling up these complicated and little understood securities for God only knows what price, we will free up the credit we need to help save our economy from further damage. Nobody else with enough clout has stepped forward to offer a more credible plan. So we’re going to swallow this. We’re going to throw hundreds of billions of our hard earned dollars at the folks who purchased these securities without any clear notion of their real value so that these folks will have enough of our money to, and here’s where I get a headache, lend our money back to us. We’re going to take it on faith that once they have our money, they won’t just pay the next creditor in line, or, if they’re more fortunate, cut and run. We’re going to take it on faith that later, when things calm down, some bottom feeder will buy this garbage from us for something more than nothing. In Paulson We Trust.

How did this happen? Who’s to blame? Wall Street and the subprime lenders who sold and underwrote the high risk loans that were used as collateral for these unregulated securities are taking most of the arrows. And rightfully so. In some cases, these investment banks owned all or part of the subprime lender, lent money to the captive lender in order to underwrite the home loans it sold, bought back all of these loans to use as collateral for the mortgage backed securities it was packaging, and then sold these risky securities to investors to whom it was, you guessed it, lending money to facilitate the sale! At every step in the process, the investment bank had its sizable nose in the trough sucking up every last penny it could. The only problem, and it was a big one, was that any hiccup in the housing market would tank such an absurdly leveraged scheme very quickly. So, in a very real sense, in hindsight, it wasn’t a matter of if but rather a matter of when this house of unregulated cards was going to topple. Not surprisingly, many of these institutions, large and small, are history. But not before the folks who ran them into the ground gorged themselves repeatedly and often. It’s hard to swallow the notion that they didn’t have any sense of what they were up to.

Our politicians and regulators are also taking a lot of heat. Even though these risky securities and the subprime loans that were used as collateral to create them were and remain largely unregulated and poorly understood, the well publicized travails of Fannie and Freddie should have resulted in a closer examination of what was going on earlier than it did. The few who did have qualms and spoke up were either shouted down or ignored. But until the problem became obvious to all concerned, it’s perhaps all too predicable that very few politicians or regulators would, without the benefit of hindsight, publicly question a process that was making it possible for so many more of us to buy a home. Moreover, it was a process that was driving home values through the roof. Everybody involved was more than a little giddy. Why think about the hangover while the party is still going on?

The culprit that nobody wants to point a finger at are the millions of us who took the money in the first place. It was all just too good to be true. Cheap money. Little or no due diligence. Loans that financed the full price of the home. Sometimes more than the full price. Payment options that made it possible to borrow far more money than we could realistically afford. Is it any wonder that so many of us who lacked the means still jumped in against our better judgment, or worse, understood the game for what is was and are now walking away. Walking away not because we can’t make the payment but because we no longer like the bargain we made. In the end, millions of us bought these loans. From the beginning of 2004 to the end of 2007 alone, $2.4 trillion dollars of subprime loans were written. More than a quarter of these loans are now in some form of default. These are the loans that were used as the collateral for the securities that are gumming up our economy.

The common denominator, of course, is no big secret. It’s the vice that fuels any free market economy. Greed. Greed has no political affiliation. Greed is an equal opportunity corruptor that knows no ethnic, racial or gender barrier. It’s your realtor, who wanted to sell you as expensive a house as possible because his fee was based on the price. Your lender, whose fees were based on the amount of money you were willing to borrow. The appraisers, whose business prospects were all too often predicated on their willingness to see things the lenders way. The investment bankers, intoxicated by the size of the mortgage market and the opportunity to invent ever more exotic securities that they could sell for a profit. The purchasers of these securities, not content with the more modest returns they could get from less risky, better understood investments. The private credit rating agencies, whose lax underwriting standards were influenced by their desire to maintain profitable relationships with the investment banks who were creating these securities. And yes, at the very outset of the process, all of us who cast moderation and common sense to the winds and took the easy money.

The overwhelming majority of us who took this easy money did so with our eyes wide open. The politicians who tell us that we’re blameless are more interested in directing our anger than in addressing the root cause of this latest economic crisis. Our government failed to properly regulate the greed that created this mess. But because we’re the people who elected them, we’re also the only ones who can ensure that this doesn’t happen again. It’s our government. During the last two decades, we’ve seen two poorly regulated bubbles burst right in our faces. When we reflect on what happened, will we be inclined to point fingers at someone other than ourselves? I hope not. Because, if we do, we’ll continue to get the government we deserve.