Now that we have the job stimulus bill about to be signed, I expect our attention will soon turn to some sort of bank stimulus. Wait a minute, didn’t we already bailout the banks? Indeed we did. The problem is that, even though they received billions of dollars and even though the bankers all gave themselves fat bonuses, it’s still really hard for the average citizen to get credit, i.e. a mortgage or a car loan. The question of course is why? Why won’t these recently replenished banks lend money? They answer they give is that they are lending, but their ability to lend money for mortgages is limited because of a lack of interest in the secondary mortgage market.
The secondary market? What’s that? Well, if we take a step back in time, you recall that when the economy was surging full speed ahead and the Real Estate Ponzi Scheme was in full swing the big U.S. banks had developed a strategy of dealing with high risk mortgages (now called toxic assets). The strategy can be succinctly referred to as “flipping”, mortgages that is. The banks sold these hot potatoes to investors after telling them that they were AAA rated by their buddies in the securities rating game. Of course they should have been ZZZ rated, but that’s just a little detail we can overlook. Right?
Well, these ZZZ mortgages were sliced and diced and sold off by the banks who made up the primary mortgage market to the “savvy” investors who made up what is called the secondary mortgage market. By selling (dumping) these toxic assets immediately, the banks were able to replenish their money supplies and then turn right around and give out some more mortgages! Isn’t that fabulous? The whole economic miracle of the housing boom could go on forever and the original banks had almost no liability!
Then, you may recall, everybody stopped paying their mortgages because they were only planning on flipping their houses anyway. So who got burned? It was the guys holding the ZZZ rated mortgages – the secondary mortgage market. They had their own game going of buying and selling ZZZ securities too. Of course they insured themselves with credit default swaps, but that was a scam because the companies that issued them, like AIG, couldn’t cover the losses if they all defaulted at once. So people got burned, really bad. Sure the big banks took a hit, because they always had some ZZZ rated stuff on their books that they hadn’t unloaded yet, but the secondary guys, the guys we never hear about, our ghost banking system, really took the brunt of the loss – along with the insurance guys who issued the credit default swaps, of course.
So, just who are these people who buy mortgages on the secondary market? Ultimately, they are individual investors and pension funds and so forth who bought Real Estate Investment Trust (REIT) funds and other derivatives. The people who were buying this stuff were ultimately just us! We were scamming the banks by buying houses we couldn’t afford and then the banks were scamming us by selling our own mortgages back to us as AAA rated securities that were actually our own toxic mortgages! That’s called a real estate-based economy.
So, anyway, now we have a problem. The banks have been bailed out by former Secretary Paulson, and they say they want to lend money, but the secondary mortgage market has dried up. They can’t flip any new mortgages and they are not foolish enough to hang onto any mortgages they provides these days, so they’re just not providing mortgages. The solution from Secretary Geithner seems to be that the government will help buy up these “securities”, which is a way of saying that you and I will be paying for our own mortgages again (by our taxes) via the secondary mortgage market. This, of course, is in addition to us making our regular mortgage payments anyway.
The heart of the problem is that our banks don’t hold mortgages any more. They flip them to a ghost banking system that is riddled with misrepresentation and speculation. Ultimately, the ghost banking system is just us, you and me, either via our 401k plans, other investments, or our taxes. We essentially wind up buying our own mortgages! Meanwhile, the big banks make huge profits by being nothing but middlemen! This secondary mortgage market ghost banking system provided the circular linkage that created our worldwide real estate Ponzi scheme. The way to remedy this is simple: make sure the primary banks are well capitalized and then forbid them from reselling mortgages on the secondary market. A bank should be content with making its money from the interest and up front fees it charges for a mortgage and not be allowed to go for quick profits by flipping toxic assets.
Meanwhile, we need to either completely eliminate or very strictly regulate our ghost banking system.