Thursday, October 14, 2010
A simple word that means so much today. I've been trying to wrap my brain around the complexities of the issue. Much has been written on the subject of late but there is a much more sinister motivation even now that issue has become a drag on the economy. Banks, those one time bastions of stability have become about as trusting as your local used car salesman. At this point the salesman may have more credibility. But I was wondering if after such a meltdown whether or how the banks were fairing. After all they posted handsome profits and this year are rewarding their corporate overlords with record bonuses.
Backing up a bit to 2005 the first inklings of cracks in the system started showing up. If you watched the TV ads at the time you didn't need to be an Einstein to figure something was starting to go awry. There was 125% mortgages, no interest, no money down loans that would make a loan shark blush. Everybody was getting into real estate. Fix a house and flip it for big bucks fast. And in mortgage banking soon even pizza delivery guys were processing loans. It was the tone or attitude that kept the good times rolling. Don't have the income to afford a mortgage? No problem. They'd just fudge the numbers and count your deposits to the Christmas saving club as income. Anything to close the loan and make the commission and fees.
Then the bubble started deflating and housing prices started dropping. Many loans were adjustable. When they adjusted the buyer no longer could afford payments. Did the banks lose? Nope. They cranked up the foreclosure machine and took back the asset again creating fees. The Fed seeing a lack of faith in the system threw money at the problem. Did the banks really need all that loot? Again Nope. Simply put if there is a difference between what is owed and the value of the asset then the bank can add that to the bill. The buyer even though he's walked away from the house can still be on the hook for the difference. It's called a deficiency judgment. Plus the banks get to add all the fees and legal expenses. Sounds pretty profitable to me.
But when the poop was hitting the fan how were the banks able to show a profit to their shareholders? That was simple too. They slid their garbage loans into a 501c. That's a tax exempt fund that need not show up on a quarterly report and is not counted on the profit loss sheets. Pretty sneaky eh?
But I forgot to mention a few other revenue streams for the banks at the time. They took a bunch of those subprime loans and sold them to investors as MBSs (mortgage backed securities) and REITS (real estate investment trusts). They also sold insurance to cover losses. The only problem there was that there wasn't enough money in the pool to cover many losses, it was underfunded.
So the banks are laughing all the way to the bank so to speak.
They made money on the initial mortgage.
Made money selling MBS
Made money selling insurance
Make money servicing loans
Got free money from government
Are making money from foreclosures
Saw their stock shares go up
It does get a bit more complicated than this but I thought you might like a thumbnail sketch.