This time it’s different? Yes – far worse!
Before the last financial crisis in 2007/2008 sub-prime mortgages were all the rage. The idea was that if mortgage lenders put a pot-pourri of mortgages in a parcel, the risks attaching to mortgages at the lower end of the security spectrum would, statistically, be offset by those at the higher end, and the package itself would then be euphemistically labelled a “collateralized debt obligation” (CDO) and classified as a tradable security carrying its own rating, between AAA to BBB – anything less than BB being classified as “junk”.
These mortgage packages themselves could be “sliced and diced” and flexibly packaged by lenders to be traded between investment banks and mortgage companies, even including government-backed home loan agencies like Fannie Mae and Fannie Mac, whose guiding movers did not wish to be left out of the party.
The subliminal theme underlying the perception of low risk at the heart of the entire process was: “Who would be crazy enough to risk their home by not keeping up with mortgage payments? Cut down on holidays, entertaining bills maybe, even clothes – but mortgage payments? Never!”
Had anyone been so mistrusting as to open one of these parcels they would have found that a significant number of the mortgage contracts had been written on terms that betrayed a complete absence of basic commercial caution.
A factory worker earning, say, $20,000 a year, might have been granted a mortgage of $700,000 on “teaser” terms that allowed a trifling initial deposit and an opening repayment holiday, or “flexible” terms that permitted suspension of instalments for a 6-month period, or a lower interest charge and hence reduced repayments, if the borrower happened to be in difficulty. Unvarnished defaults led, quite simply to “renegotiated” terms. Anything, to mask the charade.
Had any representative of an investment bank, a rating agency, an auditor, or the Securities and Exchange Commission (SEC) as top financial regulator, bothered to sample a parcel’s contents, it would have been obvious to them that the mortgage broker’s sole motivation was to “sell” the loan!
The marking system operated by credit rating agencies (Standard & Poor’s, Moody’s and Fitch) was inherently suspect since the agencies themselves were conflicted by being paid by the very banks that submitted the poisonous parcels for grading. Even the SEC turned a blind eye on professional relations between its senior staff and banks whose business they were invigilating. Bernie Madoff, erstwhile Chairman of the NASDAQ exchange, was adviser to the SEC on market regulation while operating his own investment house as a giant Ponzi scheme.
Fees and margins were extravagantly lucrative. So much so, that no one wanted to prick the money bubble. Consequently everyone – banks, brokers, rating agencies, auditors – claimed to be relying on each other for the purpose of authenticating the solvency of the rump of mortgage parcels. But none of them actually looked at a single mortgage contract - despite the fact that instalments may have been nine months in arrear.
The wilful blindness that gripped financial markets was nothing short of criminal – on a scale not witnessed since the diabolical escapades of Horatio Bottomly, or even the South Sea Company (which, Parliament believed, had taken over Britain’s national debt). Like those legendary episodes, the ensuing mayhem took a commensurate toll. The demise of Bear Stearns and Lehman Brothers, and several smaller entities like Northern Rock in this country, led to the loss of thousands of jobs, homes, savings and pensions – but very few prison sentences.