The Real (Easy Credit) Bubble Burst: A “Bull’s-Eye” Over Real Estate
In any advanced economy, if one or two homeowners lose their homes, the economy will neither blink an eye, nor miss a beat. However, when you have thousands upon thousands of homeowners turning over their keys to the bank—all at the same time—you might have a problem on your hands buddy. The main thing we have to deal with now is one of fiduciary trust. How do we, as a society, began to put faith and trust back into the financial/banking system? Fact is a potential depositor has to feel that banks can be trusted again—because that’s what banks were originally created for.
21st Century Bank Commericialization and Securitization!
From this 21st century and beyond, commercial banks will have to deal with a major issue of trust as we forge ahead into the fiduciary unknown. Alas, because of this subprime mess, banks will have to strive very hard to revamp its image. Up until now, commercial banks took these subprime mortgages, packaged them up together and sold them to Wall Street as an asset back security. What’s an asset back security? An asset-backed security is a security whose value and income payments are derived from and collateralized (or "backed") by a specified pool of underlying assets. The pool of assets is typically a group of small and illiquid assets that are unable to be sold individually(wikipedia.) For the most part, pooling the assets into financial instruments allows them to be sold to general investors, a process called securitization. It would be this maniacal financial concept of securitization that paved the way for the subprime mess we experienced at the height of the economic panic of 2007-2008.
Securitization--aka, Fidiciary Fraud Nation
What securitization did to an already sullied banking system was shed more light on the fact that banks were now open for bribery at the highest level. Furthermore, banks joined hands with, “The Big Con Game” of Wall Street. By securitizing mortgages, commercial banks knew that they could transfer the risk of subprime mortgages to the individual investor. The use of securitization to transfer risk from the originator (banks) to the investors wasn’t only detrimental to the financial markets but it was a surefire way of allowing a well functioning market economy to become dysfunctional.
From a pure logical point of reference, who cares if a financial asset is backed by a piece of land? That is to say, if the piece of land isn’t worth anything to begin with, then using it to back some future investment is financially dumbfounded: “If a Dr. doesn’t treat himself, then he has fools for patients.” If these subprime loans couldn’t stand alone as single assets; then why should they, all of a sudden, become valuable packaged together? Securitization was, simply, a pretty word for fiduciary fraud! When the 21st century emerged, so too did this idea that we should “securitize” different financial assets: corporate loans, credit card receivables, auto loans and subprime mortgages. Initially, securitization, as a novel financial concept, wasn’t a bad idea, but what could potentially go wrong in the long-term, far exceeded the benefits that it contained in the short-term.
CDOs--aka, Collateralized 'Death' Obligations
What did go wrong in the short-term was the simple fact that subprime mortgages proved hard to securitize. When investors on Wall Street packaged them up, put them into these so called tranches (just like corporate bonds) they then had to be graded on their risk; from this point, they could be sold as CDOs. What are CDOs? Collateralized debt obligations (CDOs) are a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets. CDOs securities are split into different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, and just like bonds, the lower the tranch rating the higher coupon payments.
Collateral Back Asset--bka, "Robbing Peter to Pay Paul"
The very idea that you could take an asset, use it as collateral, then that take collateral backed asset and try to past it on to the another party didn’t make economic sense. Conventional wisdom says that somewhere down the line, you knew someone was going to get the shaft. To the surprise of many, that someone became our macroeconomic engine. When the party on Main Street shifted to an even bigger party on Wall Street, that was a sign that things were getting out of hand. What transpired in this subprime Main Street/Wall Street revelry was that you had bankers trying to sell investor assets that had very little value. To be exact, magicians on Wall Street tried to take a valueless asset, grouped them together and give it value. Also, to make matters worse, the single investor started “robbing Peter to pay Paul” to get a piece of the action; it was complete economic pandemonium!
When it’s all said and done, it all went back to the individual tax payer who—when these same banks folded up—then needed “big gov” to help bail them out. This wasn’t how the system was designed to work. A well tuned economic engine doesn’t have room for subprime mortgages, let alone a watered down version of it: packaged up subprime mortgages was a sign that something was seriously wrong with both the real estate sector and the commercial lending establishment. The ill side-effects of “The Real (Easy Credit) Bubble” is showing us today that what we did yesterday wasn’t suppose to happen—yet it did. If we don’t learn from our mistakes of the past then we can’t fully prepare for our future.
In conclusion, if you play with fire, sometimes you get burned buddy; the problem we now have to solve, as we traverse this never ending landscape of subprime bubble residue, is how to avoid these types of episodes from happening in the future? This said, to incriminate the Fed as the main suspect in this debacle isn’t an overreaching statement: it was the Federal Reserve System that engineered the declination of interest rates that put the first air in the bubble. Alas, history has shown that you can’t have a bubble without “easy credit.” Notwithstanding, you can’t have “easy credit” without government intervention.