The Mother of All Rip-offs: "Get ready for a real hosing"
Mike Whitney

Low interest credit and "financial innovation" have proved to be a deadly-combo. They knocked the banking system for a loop, clogged the credit markets with billions of dollars of subprime sludge, and left the real estate market sprawling on the canvas. Still - even though $2 trillion of capitalization has been wiped-out from falling home prices; and even though the financial system is in a terminal state of paralysis - no one has been held accountable. In fact, not one trader, mortgage lender, rating's-agency official, fund manager, or investment banker has been indicted or even charged with criminal wrongdoing.

NOT ONE. The system operates without rules or guard rails. It's the Wild West!

The system is so thoroughly marinated in corruption, that every trace of regulatory-oversight has been removed. The SEC is little more than a public relations sham loaded with business-friendly sycophants who try to sustain the publics confidence while, at the same time, kow-towing to their corporate paymasters. It's a complete hoax. Last week, the Chairman of the SEC, Christopher Cox, gave a speech at the Ronald Reagan Building. He said:

"We've already launched an initiative in this area to investigate possible fraud or breaches of fiduciary duty involving collateralized debt obligations. Among the issues confronting us this year will be determining whether bank holding companies and securities firms made proper disclosure in their filings and public statements of what they knew about their CDO portfolios and their valuations. We'll determine whether brokers carefully followed suitability requirements when they sold complex debt-related derivatives that shortly afterward went bad. And in this area, as elsewhere, we'll be investigating whether unscrupulous insiders used non-public information to bail out of these securities or to sell them short, in violation of the securities laws."

Huh? So, after 6 years of sitting on the sidelines watching the fat-cat investment banks and hedge funds sell dodgy securities, (made up of mortgages from unemployed thrift-store workers with bad credit) Cox has finally decided to "to investigate possible fraud or breaches of fiduciary duty."

What a joke. Trillions of dollars have been lost, the financial system is reeling, and the nation is headed into recession.

We want scalps - not excuses!

Did Cox know that the CDOs, the MBSs, the ABCP and the rest of the alphabet soup of "structured investments" were unalloyed garbage?

Yes, of course, he did. Everyone knew. But they were making so much money selling snake-oil to credulous investors they couldn't help themselves. They went ape. Two week's ago TV investment guru, Jim Cramer, even admitted that he and his business buddies used to call the investors who bought these sketchy "debt pools" "morons" and Bozos". That says it all, doesn't it?

Does Cox still expect us to believe that he and his Keystone Cops at the SEC didn't know what was going on?

Bullshoes!

Here's a video clip from the Daily Show with Jon Stewart with CNN's personal finance editor, Gerri Willis. Willis explains in simple terms how the subprime fiasco evolved. She acknowledges that the loans were made to "people who really couldn't afford to pay them off" and that when "Wall Street saw how successful they were, they decided to sell them as investments all around the world". Good thinking, eh? She even admits that the sellers knew that the investments were rotten but duped their customers by saying "Trust us" . Unfortunately, the naive investors found out later that "they were sold swampland in Texas".

This is a great summary of a how millions of investors were ripped off in broad daylight by crafty junk-bond salesmen while the SEC looked the other way. It's the biggest heist of the century. Trillions of dollars were raked in on complex investments that everyone in the industry knew were worthless. This is fraud on an industrial-scale.

And that's just the beginning. The same gaggle of investment sharpies who cooked up the subprime swindle are putting the final touches on a plan to off-load hundreds of billions of dollars of mortgage-backed slop onto the American taxpayer. If they succeed, the country's biggest GSE's - Fannie Mae and Freddie Mac - will be crushed by their expanded debt-load and probably go belly-up within the year.

Don't believe me?

Bush's new "Stimulus Package will allow Fannie and Freddie to raise their loan limits from $417,000 to $729,750.The idea is to keep interest rates as low as possible on new mortgages in order to revive the moribund California and New York housing markets. Jumbo loans - mortgages that are over $417, 000 - -are nearly impossible to get now that the market for mortgage-backed securities (MBS) has dried up and the banks have tightened up their lending standards. Sales in California have dropped 40% or more for the last 4 months. Price declines are in double digits. It is a housing Depression.

Still, there's no guarantee that the plan will work. After all, Fannie Mae requires a substantial down payment as well as documentation of earnings and a good credit record to secure a loan. The whole lending environment has changed dramatically in the last year. It's gotten a lot tougher and the pool of potential loan applicants has shrunk by more than half. Besides, how many people are going to plunk down $700,000 for a home in a falling market? That same MacMansion might dip to $625,000 by the end of the year. No one wants to lose that kind of money.

More importantly, why should taxpayers have to guarantee a $700,000 loan just so some brandy-swindling tycoon can get a better deal on his mortgage? That's nuts.

Here's how Sean Olender sums it up in an article in the SF Gate:

"Thanks to Congress, junk bond investors will be able to pawn off their bad debt to Fannie and Freddie, instead of suing the big investment houses for ripping them off. This shift will certainly doom Fannie Mae and Freddie Mac, so don't be surprised if we, the taxpayers, have to bail out poor Fannie and Freddie - to the tune of more than $1 trillion....Why more than $1 trillion? If Goldman Sachs is correct in its recent projections that home prices in California are going to drop 35 to 40 percent, the state's losses alone would top $2 trillion, because California has a disproportionate number of jumbo loans."("Stimulus Plan a Scam to Benefit the Rich", Sean Olender)

Olender's right. It'll cost at least a trillion bucks; and for what? To lend a hand to the bond-hucksters who misrepresented themselves so they could pay off their vineyard in Provence? No way. This is all backwards. It was the investment bankers who created this mess with their mortgage-laundering" operation. They're the one's who should be cleaning it up. They don't need a bail out; they need to go to jail.

Besides, as Olender points out, Fannie is already in financial trouble and doesn't need more debt.

"Contrary to popular myth," says Olender, "Fannie holds a lot of subprime debt, option ARM debt and other dodgy securities. Fannie and Freddie owned or guaranteed almost 45% of all mortgages in America last year. BusinessWeek noted in 2007 that Fannie and Freddie have "moved more prominently into low-documentation loans, which require little or no proof of the borrower's income."

Presently, Fannie has nearly $3 trillion mortgages guaranteed, but only $34 billion in capital reserves. If housing prices slide even 10%; Fannie's is under-water and will probably have to file for bankruptcy. So, why take the chance?

This week, CNNMoney.com reported:

"The increased share of housing debt taken on by Freddie Mac and Fannie Mae during the housing slump has put the two government sponsored enterprises at risk." By "buying up mortages on the secondary market that the banks are walking away from" Fannie and Freddie "are reducing risks in the market, but concentrating mortgage risks on themselves. These risks are beginning to take their toll," said James Lockhart, director of the Office of Federal Housing Enterprise Oversight (OFHEO) He spoke Thursday at a Senate Banking committee on regulatory reform.

Get the picture? Wall Street won't buy mortgage-backed securities (MBS) without Fannie's seal of approval. But that just puts Fannie at greater risk of failure. If Fannie and Freddie take a swan dive the effects will be felt through the entire financial system for years to come.

Naturally, the National Association of Realtors (NAR) are jazzed about increasing the conforming loan limits to $729,000. They're even predicting that it will boost sales by 300,000 homes. But that's just more realator-hype. Look: the way we got into this mess was by "artificially stimulating" the market with low interest credit from the Fed. We're not going to get out of it by using the same strategy. The government needs to stop meddling in the markets and let home prices return to the mean. Then the buyers will reappear. The stimulus will only prolong an already-painful contraction.

Of course, Congress has already rubber-stamped the "stimulus travesty" and rushed off to the Senate where it will get a slight face-lift before it's plopped on Bush's desk. Next week, there'll be a signing ceremony in the Rose Garden, where Bush will be surrounded by a small army of smiling bankers, nodding approvingly and patting themselves on the back for sticking it to the American taxpayer one more time. What a triumph.

THE BANKER'S MASTERPLAN: "Dump the mortgage-backed junk on Uncle Sam"

Everyone should be aware of the massive fraud that is about to be perpetrated on the nation to save a few shifty bankers from default. The basic contours of the plan were laid out in an op-ed in the New York Times last week by Howard P. Milstein, chairman of New York Private Bank and Trust. Milstein made his pitch for a bailout in an article titled "Give The Banks Some Credit".

Milstein says:

"The health of the American - and indeed the global - economy depends on having a financial system that is able to extend credit to businesses and consumers. The losses that have been incurred as a result of the excesses in subprime mortgage lending will take years to work their way through the worldwide financial system, as dozens of banks act to replenish their lost capital... Until the banks rebuild their capital, they will not have the wherewithal to lend money and support economic growth. If banks of all sizes could regain their capital immediately and easily, it would be a tremendous benefit to the American economy."

Milstein continues:

"The federal government could make this happen by entering into an arrangement with American banks that hold subprime mortgages, in which homeowners typically pay a low interest rate for two or three years then face much higher payments. Here's how it would work: The government would guarantee the principal of the mortgages for 15 years. And in exchange the banks would agree to leave their "teaser" interest rates on those loans in effect for the entire 15 years. This would instantly give the lending banks new capital."

Wait a minute. If "the government guarantees the principal of the mortgages" then there's no risk for the banks. If that's the case then why should they be paid anything, even the "teaser rates". Investment is risk and risk is investment - Get used to it. What Comrade Milstein is requesting is "nationalizing" the banking system to protect his indolent friends from loss or default. This could have been written by Chairman Mao.

Milstein continues:

"As these mortgages would be guaranteed by the Treasury, they would suddenly be assessed, on bank balance sheets, at their original value - and a significant amount of the banks' lost capital would be restored. Plus, the banks would receive, from most of the homeowners with subprime mortgages, up to 15 years of teaser-rate payments."

Unbelievable! So the bank takes NO risk on the investment but - at the same time - is allowed to add the full value of the mortgage to its capital reserves? And, Milstein doesn't even want to reduce the value of the mortgage to current housing prices. He thinks it should be recorded at its "original value" so it can beef up the bank's dwindling capital.

What kind of mumbo-jumbo is that? Real estate prices have plummeted in the last year and so have subprime "structured investments". The banks assets should reflect those losses. Tough luck, Milstein. Your buddies cooked up this scam. Now take your lumps like a man.

Milstein continues:

"By solving the bank capital crisis immediately, this strategy would ensure that fewer families would lose their homes"...blah, blah, blah. It would "be good for our economy." Blah, blah, blah.

Then Milstein adds this tidbit:

"Under this arrangement, American banks would have an incentive to buy back the subprime debt now being held by foreign banks and other financial institutions. American banks could buy the securities at a discount to face value (reflecting the continued low teaser rates) and then, thanks to the government guarantee, hold them as capital assessed at their full value. That, in turn, would allow the other financial institutions to reinvest in other sectors of our economy."

Ah-ha! So the foreign banks and investors are finally waking up to the fact that they were ripped-off and they want their money back. It's about time. They were defrauded and they deserve restitution. The first article about the impending tidal wave of subprime litigation appeared earlier in the week on FOX Business.com "Lawsuits Begin to Spill Out of Subprime Mess" The subprime boondoggle will play out in courts for years to come.

But, back to Milstein. What does he want? He wants to buy back the subprime debt that was sold to gullible foreign banks "at a discount" and then record it on the banks' balance sheets at full value.

Whoa. Now, there's a neat trick. In other words, he wants to pay a nickel for the "debt", but then record it as a dollar to meet his capital requirements.

Is this really how bankers think?

Oh - and by the way - he also wants the American taxpayer to guarantee the debt in case the nickel loses some of its value. Nice touch, eh? Milstein adheres to the old adage, "Privatize the profits, socialize the losses."

Finally, Milstein adds that his only interest is his "concern for the health of the global financial system."

How sweet. Can you feel the love?

The tragedy of the stimulus charade is that some variation of Milstein's proposal is sure to be enacted. Otherwise it wouldn't have shown up in the NY Times. The Times frequently uses the op-ed page to put up trial balloons for changes in policy. It's the same here. The banking establishment and the administration have finally settled on a 'bail out plan' and "We the People" are going to have to foot the bill. Congress is already on board and Bush is just a swipe-of-the-pen away from another trillion dollar giveaway to big business. The banks and money-lenders always get their pound of flesh while the rest of us get screwed. Some things never change.

Expect Fannie and Freddie to collapse within the year.