The Sub-Prime Mortgage Meltdown

The other day I read where Warren Buffett blames the sub-prime mortgage crisis on the banks that made the loans in the first place. Actually, there are quite a few people, organizations and firms that could claim some of the responsibility for the sub-prime mortgage crisis. The banks and the mortgage originators is a good place to start. But, like all good money stories, the way to uncover the whole story is to follow the money (trail). As an amateur historian of sorts, I would just like to point out that there are usually several factors that comprise an historical event involving so many people as the sub-prime mortgage meltdown. So, if we are going to make a serious examination of the facts that lead up to the sub-prime mortgage meltdown, we really should broaden our research beyond the banks and the mortgage originators. Mono-causation when it comes to writing the history of the sub-prime mortgage meltdown will hardly win us any prizes. Let me state at the beginning that I admire and respect Warren Buffett. But on this issue, I feel there are many more players with responsibility than simply the banks and the people that made the mortgages.

But, before we look at all that, let us take a step back and ask a question: who is officiating this game? You think you know where I am going? Yes, let’s take a look at our central bank, the Fed. The Fed, in my humble opinion, should have blown the whistle before the game got out of control. It would have been nice if Congress would have taken some action, but, again in my humble opinion, Congress is usually a day late a dollar short when it comes to regulatory action. The Fed on the other hand, being an independent body, could have taken control of the game from the beginning and blown the whistle when they first saw shoddy play. Unfortunately, the Chairman of the Fed, at the time that the mortgage game got started and really started to heat up, was Alan Greenspan.

Former Chairman Greenspan is of the philosophical point of view that the referee should put his whistle in his pocket and let the players play. Only under extreme situations should the Fed resort to pulling the whistle out of their pocket and calling a foul. So, the mortgage game went on for many years, without anyone officiating and that eventually lead to the game getting out of control. By the time Chairman Bernanke replaced Chairman Greenspan the game was very much out of control and the clock was running down. Within months of his start at the Fed, Chairman Bernanke was to find the sub-prime mortgage game about ready to collapse in on itself.

What I find hard to accept, is the fact that the Fed and the government will be willing to pull solutions to big problems out of you know where, but they will not act when it is the little guy’s butt that is on the line. Everyone with an ounce of brains now says that people were given and encouraged to take mortgages that they had no business getting themselves into in the first place. Where was the oversight?

The number of subprime mortgages that were made was totally out of control and I place some of the blame squarely at the feet of the Federal Reserve Bank. Only when Bear Stearns appears to be going down the tube, and the consequences of such a disaster for Wall Street and the country too big to bear, did the Fed step up to the plate and take control of the situation. My question remains: Why does it take a major brokerage firm to hit the rocks before the Fed moves into action?

So, getting back to Warren Buffett and his assessment of the subprime mortgage debacle, there are plenty of characters at various stages of the process that hold some responsibility for the mortgage meltdown. The question that we all should be asking is: What steps are being taken to prevent another mortgage meltdown from occurring again?

Congress should have provided some oversight as well. The problem with Congress is that they take campaign contribution from Bank PACs. Political Action Committees lobby Congress so Congress will not only not blow the whistle, but will not buy themselves a whistle to blow in the first place. We once had a Glass-Stegal Act, but that disappeared. Well, it did not disappear like a missing person disappears, the act was dismantled by Congress.

Let me make it clear, I am not against mortgaged-backed bonds. Mortgage-backed bonds, like other asset-backed bonds, have a very legitimate place in the world of finance and investing. But like any good car on the road today, besides having safety glass the car has seat belts and airbags. The securities industry needs to redesign asset-backed bonds so that the fatalities are kept to a minimum. And, the redesigning can start with our independent Federal Reserve Bank setting the ground rules. Since the Fed stepped in when the Bear Stearns bankruptcy was about to occur, I think the Fed has earned the right to step in now and redesign the future of mortgage-backed bonds. There are several good ideas floating about that deal with the mortgage originators holding on to a piece of the action so they have their feet to the fire and skin in the game.

If I was going to stop being an amateur historian for a minute, the group that I would gang up on would be the rating agencies. The way I see it, without the rating agencies going along and giving the mortgage bonds their AAA rating, none of this would have ever gotten off the ground. The rating agencies’ AAA rating, in my opinion, was the equivalent of Underwriters Laboratory (UL) approval. Without that approval, no portfolio manager worth his salt was going to plug into unrated mortgage-backed bonds without knowing full well the inherent risk with such a move. Placing the responsibility for the rating disaster at the feet of the rating agencies is only one piece of the puzzle. Ascribing the entire meltdown to the rating agencies, while I think they had a big hand in it, is scapegoating, and that is not good history or a careful analysis of all the facts.

The brokerage firms that brought the bonds to the rating agencies in the first place, knew that they were carrying a corpse. They, the brokerage firms, needed to have more skin in the game from the get go too. Would that have moderated their enthusiasm? Perhaps. The thing to remember about the sub-prime mortgage meltdown is that it was too big to lay at the feet of any one group. This disaster was not an orphan, the sub-prime mortgage crisis had many fathers. Stay Tuned.