Key 2007 email sums up the mortgage situation. It’s not from Goldman.

Forget the middlemen – the real criminals are those who betray their oaths of office.


Via the Motley Fool, here is an email from someone inside John Paulson’s hedge fund:

It is true that the market is not pricing the subprime RMBS [residential mortgage-backed securities] wipeout scenario. In my opinion this situation is due to the fact that rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action before the losses that one could anticipate based [on] the ‘news’ available everywhere are actually realized.

This guy was on the right track. Incentives are everything when you’re looking for explanations. The only things this guy left out were the role of government and the fact that managers did have the tools (google, for one) to figure out that there was a housing bubble.
Government provided low-interest credit through Fannie and Freddie, which passed off much of the risk here to the taxpayer through their implied (later realized) guarantee. There was also the tremendous moral hazard of “too-big-to-fail,” which was always just a cover story to justify whatever taxpayer theivery the banks wanted to undertake. FDIC is also another massive risk-transfer scheme that encourages reckless lending by both bankers and depositors.
Also key is the fact that the incompetent rating agencies, Moody’s, S&P and Fitch, only got that way after the government made them a cartel and removed market forces from their industry. If all rating agencies were paid by investors (rather than issuers) and had to compete on the basis of their performance, like Egan Jones, they would actually do some analysis.
Goldman is a scapegoat. In the final analysis, they may be untrustworthy (who didn’t know that anyway), but they are just middlemen, and they didn’t force anyone to buy their bonds. They didn’t create the demand for junk credit — interest rates and spreads were very low during the bubble years, and huge institutional buyers with very highly paid managers simply failed to do their job of understanding what they were buying. Without their demand for junk mortgages, there could be no giant bubble. In the case of public pension funds like Calpers, this demand was partly the result of unrealistic promises made to unions which required very high annualized rates of return.
For anyone who had read any economic history, the situation was plain as day (houses were selling for record multiples of incomes and rent, prices were way above trendline, credit was ridiculously easy, and speculation was rampant). If I saw it as a 20-something kid using google, how could the big shots miss it? The reasons are similar those in any mania, with heavy doses of moral hazard, group-think and extreme optimism. It’s all clear in retrospect, but back then only the weirdos, historians and Austrians were removed enough from the zeitgeist to see it.
If you want to single out firms and individuals for retribution, look at those who betrayed their oaths of public service during the bubble and the Heist of ’08: Tim Geithner, Hank Paulson, Ben Bernanke, Alan Greenspan, Chris Dodd, Barnie Frank, Nancy Pelosi, Chris Cox, etc. Forget the middlemen – these are the real criminals, the people who lie into cameras for a living and deploy force against the citizenry (as a taxpayer you are forced under threat of imprisonment to absorb the losses on bad mortgages you neither bought nor created).
The bankers can buy this power, but only because it’s for sale. Bankers don’t even have to violate the law to lock savers into their paper money cartel and pass off risks to the taxpayer — their lackeys have fixed it all for them.

Some real numbers on Fannie and Freddie

Any hard look at the likely costs of this mess will have to include assumptions like Mike Morgan explains here. The numbers he uses are conservative, since it is not just recent vintage mortgages that are in trouble (truth be told, housing was already rising above trend by the late ’90s), and prices will be down a lot more before this is over.

Paint by the Numbers – We don’t need many numbers, but it seems like we have thousands of them bouncing around the media in order to justify one statement or another, or for the traders to have the ability to push the price of the common up, down, up, down, and up, down at will. It’s funny how Paulson went after short sellers in July for supposedly manipulating the markets, but he doesn’t think it is a problem for traders to push markets up when there is no basis for the move, other than number being manipulated . . . and the real numbers being silenced by the Fed. His blank stare at this type of market manipulation will eventually lead to a blow off and a much harder fall, instead of logically and systematically allowing the markets to work. As for the numbers we do need.

1 – $5 Trillion – Mortgages guaranteed by Fannie and Freddie

2 – $1.5 Trillion – Low end of the number for mortgages in Fannie and Freddie’s portfolios

3 – 65%* – Current value of property for mortgages made between 2003 and 2006.

4 – 30%+* – Percentage of Fannie and Freddie mortgages made between 2003 and 2006.

5 – $500 Billion – How much Paulson needs to come up with for Fannie and Freddie to stabilize
the markets.

6 – $5Trillion – How much Paulson needs to come up with for the banks and lenders to solve the problems or we could refer to this as how much was scammed out of the system during the
Housing/Commercial Ponzi Scheme.

*These two are conservative estimates. If we ever want to talk real numbers, these two are much worse, but they will do for this example. When you take apart the portfolios, even giving them the very best of the best, you are staring at a trillion dollar loss on $6.5T in mortgages. That is the very least Paulson needs to come up with to stabilize the Fannie and Freddie problems . . . temporarily.

Quick Fix – Fantasy Numbers – I say temporarily because housing prices are still declining . . . no matter what Case-Schiller (CS) or the National Association of Realtors (NAR) say. In fact, the leading home building analyst, Alex Barron, came out with a report on the Case-Schiller index this week . . . The Case Against Case-Schiller. . .

Case-Schiller does not properly account for foreclosures and new construction. Huh? Yeah, you heard it right. And for those of you still following the bouncing ball, foreclosures and new construction are the two central players in the housing and financial crisis.

I would add that that last estimate of $5 trillion in scammed money / wasted capital is just the real estate component of the debt binge. The actual misallocations are much larger, since debt has been used for virtually everything lately. People buy groceries with debt and pay for worthless educations with debt, and the corporate world came to rely on debt rather than earnings or equity for expansion.

As of last year, the total private debt outstanding in the US was approaching $50 trillion. The question is how much that has gone to money heaven.