Hunt for subprime mess culprits as the blame game gets serious
Wednesday March 19 2008
WHO can we blame for Wall Street's mortgage and banking crisis the nightmare that has seen around €2 trillion wiped off the value of American homes in the past two years?
Who can the one family in every 30 in Stockton, California, blame for losing their home? And to whom should Bear Stearns's shareholders direct their anger after Wall Street's fifth-biggest bank almost went bankrupt on Thursday afternoon?
The culpable are spread across the whole gamut of America's political, economic and banking infrastructure. They trickle down from Capitol Hill with the policies devised at Washington's Federal Reserve Bank and head up the coast to Manhattan's Wall Street chief executives.
Culprits
Downstairs from the chairman's office lie more culprits populating investment bank trading floors, and the maths graduates in front of their Excel spreadsheets, designing ever more complex-structured debt products.
The blameworthy also sit in the credit rating agencies who endorsed the debt and extend wide across America to the network of thousands of mortgage brokers and lenders who sold bad mortgages over the past decade.
Sitting at the top of the blame tree, many look to Alan Greenspan, the former Chairman of the Federal Reserve, America's central bank.
Under Mr Greenspan's leadership, the Fed continued to cut interest rates during the 1990s -- the cheap cost of borrowing helped inflate the housing market, with some states such as Florida and California experiencing doubling house prices over a five-year period.
Cheap money and surging house prices also created fertile ground for mortgage brokers to push home loans that borrowers could ill-afford, in the hope that property values would continue to rise and homeowners could simply remortgage.
Pushing the dream of universal home ownership, was former President Bill Clinton, whose policies helped encourage individuals whose low incomes and poor credit ratings should have prevented them from taking on mortgages at all. Chris Whalen, founder of the Wall Street consultancy Institutional Risk Analytics, also blames Washington for the design of America's mortgage industry.
He said: "The real father of sub-prime is Congress for setting up Fannie Mae and Freddie Mac. Their existence effectively meant that the Government had the monopoly on mortgages.
The banks had to scrabble around with what was left -- and what was left were jumbo loans [big mortgages] and bad credit quality debt."
He explained: "Because of the way the market was structured, the likes of Bank of America and JP Morgan between 2004 and 2005 were so hungry for mortgage assets, they took market share from Fannie Mae and Freddie Mac."
Countrywide and Bank of America, among the US's biggest mortgage lenders, stand accused of predatory mortgage lending, and of being complicit with mortgage brokers, who sold home loans aggressively to boost their commissions.
In order to manage the higher risk associated with either very big or very shaky mortgages, investment banks needed a means of trading the debt on. They devised a means of pooling the loans, paying a credit rating agency to rate them, and the pools -- from which they could sell bonds -- became liquid and tradeable.
In the 1990s Bear Stearns was the best -- now they are perceived as being the worst -- at designing these complex pools of mortgages to sell on. Bear Stearns, under the leadership of James Cayne, who resigned as chief executive earlier this year over the toxic securities, was the King of Sub Prime.
Unlike its Wall Street rivals, Bear Stearns had a cradle to grave model -- they sold their own sub-prime mortgages, through their own retail lending arm. Bear Stearns was the market leader in creating new and ever more complex-structured debt and selling it on through its extensive fixed income sales teams.
Joseph Mason, associate professor of finance at Drexel University, argues: "Bear Stearns was the most innovative, and by innovative I mean 'worst', at creating these complex instruments. They had a cradle to grave mortgage structure. They originated it, pooled it and sold it on."
Professor Mason also explained that it was the likes of Bear Stearns, Lehman Brothers and Citigroup who, in 2001, tried to find ways of splitting out the worst bits of the mortgage pools and securitising them separately. In turn, they split out the worst of the secondary pools into a higher-risk set, then repeated the process into a third pool.
"Bear, Lehman, Citi -- they were big in this space. It meant that they created a way to sell on high risk debt, which was crucial to be able to securitise further. They fed the bubble."
Most of the structured debt products -- known as collateralised debt obligations -- were typically designed by less than five mathematics experts in their twenties at each bank, armed with a spreadsheet, as part of the fixed-income teams.
Professor Mason argues that not only did the likes of James Cayne not understand either the debt products themselves or the risks they posed, but neither did the banks' heads of fixed income. "The heads of fixed income were more interested in whether they could sell the bonds, rather than how risky they were -- whether they would perform."
Yesterday, Roland Arnall, the billionaire founder of Ameriquest, once America's biggest sub-prime mortgage lender rescued by Citigroup, was laid to rest. It may be some time before his legacy draws to a close. (© The Times, London)
- Suzy Jagger in New York
