SUB-PRIME DEBACLE

Think About It
Confused about all the fuss over the “sub-prime mortgage slime” and its ramifications? Give me 10 minutes and we will try to make sense of it and see how and why it turned the financial world upside down.
The Federal Reserve, which is really a pseudo-government organization owned by its member banks, controls the interest rates in this country. After the tech stock crash of 2000, and the event of 9/11/2001, they kept the Fed Funds rate as low as 1% for an extended period of time during 2003 and 2004. This was good for all of us who needed to borrow money for sensible purposes. But the people who had big money to lend were going crazy at such low returns. They said to the money brokers of New York, “We don’t care how you do it, just find us a way to make 8-11% on our money, and we will buy it all.” The money brokers, ever anxious to oblige (and make a fee) came up with the answer.
They invented SIV/s (structured investment vehicles) to buy CDO/s (collateralized debt obligations), and CMO/s (collateralized mortgage obligations) and they put together a lot of good and potentially bad mortgages into packages, and sold tranches (slices) to eager, money-hungry investors. You could pick the amount of risk and return you wanted, but it all appeared to be rated AAA. Some SIV/s even borrowed money short term, with asset backed commercial paper (ABCP), to buy long- term 30 year CDO/s. It’s like borrowing on your credit card to purchase someone’s home mortgage.
When word got out as to how bad some of these high interest mortgages were, the ABCP market completely dried up. Without the ability to refinance their short term debts, the SIV/s would have to sell their long term CDO/s, but there was no market and no one could even determine their value. To the rescue comes the Fed. Being the lender of last resort (they print money at will), they offered to lend to banks at their discount window, and even said they would take this bad paper as collateral for a short time, but longer than usually allowed.
Next, the Treasury Secretary encouraged the three largest banks to form an MLEC, (Master Liquidity Enhancement Conduit---or a huge pool of money) to buy securities from those SIV/s who could not sell to anyone else, and did not even know what they were worth. This keeps the SIV problems totally separate from the bankers, who were their creators.
Thus proves the old saw—if you borrow $1,000 and can’t pay, you are in trouble. But if you borrow $100 million and can’t pay, someone is going to help you out. We can’t afford to upset the money world. Someone should have learned a lesson from 1964, and LBJ. He told the Federal Housing Administration, until then one of the government’s only success stories, to quit lending based on credit worthiness, and to make their decisions based on what seemed to be “reasonable risks”. Within a few years, those borrowers who should not have been given loans defaulted, the lenders repossessed; and FHA, who had insured the loans, ended up with the houses; losing thousands of dollars on each one, when they resold them. Who lost? We did, because we are the government. Now, housing prices are going to be depressed for probably several years, and we lose again. Any time a boom is created by unreasonably low interest rates, a bust will follow in about 5-7 years. The Fed seems to enjoy ignoring history.