Sunday, November 16, 2008

Let the Revisionist History Begin

And of course, Rush to judgement Limbuagh is already calling this the Obama recession.


Down the Republican Rabbit Hole

Sun Nov 16, 2008 at 07:00:03 AM PST

History may be written by the winners, but that doesn't stop the losers from wasting a lot of ink in the attempt. This time, it's the GOP revanchists who are busy trying to come up with a reason -- any reason -- for the economic crisis that doesn't point directly to their conservative ideology and the greedy green horse of the Apocalypse, deregulation.

There are dozens of letters percolating through Republican chain mail, and a matching number of posts on right wing blogs, all trying to spread the same message: Democrats loaned money to black people!

Here's an example plucked from my own mailbox.

We're on the brink of an economic disaster and another Great Depression. This was not caused by Republicans. This was caused solely by Democrats.

In 1977 Democratic President Jimmy Carter passed the Community Reinvestment Act to provide housing to poor people. In the 1990s Bill Clinton had Attorney General Janet Reno threaten banks under red lining rules into giving loans to people who could not afford them. Then in the last 8 years, the leftist group ACORN, which has ties to Barack Obama, went to banks and threatened them to relax their rules again. Banks had to give loans to people who had no jobs or no identification.

You have to hand it to them. In terms of bringing together the maximum number of Republican demons -- Carter, Clinton, Reno, Obama -- with the smallest amount of connecting narrative, this is a keeper.

It's a satisfying bedtime story for the right. They can snooze and dream of revenge, when the wonders of True Conservatism will pave the streets with a mixture of gold and liberal bones. Unfortunately for them, it's not only simplistic, not only demonstrative of deep prejudice, it's also dead wrong.

The Community Reinvestment Act and other red lining laws weren't passed to force banks to make loans to African-Americans and other minorities. They were there to make the rules consistent. Previous to the passage of the CRA, minorities were often required to have better credit, and make larger down payments to get loans equivalent to those awarded whites. Nothing in these laws required that banks lower their lending standards, only that they be fair, consistent, and operate in a "safe and secure" way. There was no evidence then, and no evidence now, that minorities with the same initial credit rating as whites tend to default on their loans at any greater rate.

Want proof? Mortgage failure rate in 2000: 1%. 2001: 1%. 2002, 2003, 2004, 2005, 2006? One (1) as in ONE percent. But wait! Everything that Carter, Reno, and Clinton could do was already in there. The nefarious community organizers of ACORN had already grown their little oak trees of pressure. Carter's poor people had been sitting in their new homes so long, that many of those initial mortgages were paid off and gone.

What does legislation passed 31 years ago have to do with problems today? Nothing. Neither do tweaks Clinton made to that legislation in the mid 90s. The real culprits require a much shorter trip down memory lane.

Subprime mortgages (and all mortgages, really) are a fraction of the current problem. The bailout would have been enough to buy out every subprime mortgage in foreclosure across the country. In fact, it was enough to do that several times over. So why not do that?

The reason is that the purpose of the bailout (at least as Treasury Secretary Paulson sees it) isn't to stop mortgage foreclosures, but to save the banks. And the banks have some self-inflicted problems that make those mortgages an afterthought.

For example, the wonderful credit default swap. In essence, credit default swaps are (or were) nothing but insurance policies for loans. And yet in 2007 the total number of credit default swaps traded far exceeded the value of all loans. In fact, it may have touched $70 trillion dollars, which puts it above the gross domestic product of the entire planet.

How is that possible? Come with me back to the primitive world of 1999, when SUVs ruled the roads and cell phones did not yet shoot video, and let's see how this clumsy bit of fiscal jargon conquered the planet.

The Evolution of the Credit Default Swap

Stage 1 (Perturbo mutans) 
You have just made a loan to someone, and now you're nervous that this scoundrel might not pay. What to do, what to do? Ah, but you need not worry! I happen to have assets on hand that can easily cover your petty loan. What's more, for a small monthly fee, I'll be happy to provide you with insurance of a sort. Should the person to whom you've extended a loan prove unreliable, I'll shoulder the burden -- so long as you keep up the payments. Let's call this insurance a... credit default swap.

In 1999, these credit default swaps already existed, but they were a niche product. Only a fraction of banks employed them and then only on a fraction of loans. Without some knock to the system, swaps would probably have remained a relatively small player.

Stage 2 (Perturbo furtiva) 
Knock, knock. In 2000 Republican economic hero, Phil Gramm, with the assistance of a small legion of lobbyists, created the Commodity Futures Modernization Act. Along with ushering in the Enron disaster, this bill provided the one thing that credit default swaps needed to grow and mutate -- invisibility. Thanks to the CFMA, not only were credit default swaps unregulated, they were impossible to observe directly. Like black holes in deep space, you could only spot swaps by looking at how other things acted nearby.

So, now you've made a loan to someone, and you're worried about it. I want to offer you a credit default swap so I can collect the fee. Trouble is, I don't have the assets to cover your loan. So how can I... hold on, credit default swaps are so unregulated that no one says I actually have to be able to deliver on my promise.  Hey, over here! Have I got a swap for you, and it's a bargain.

So now the CDS is a means of moving the risk, but the risk is still as high (or higher, since the original lender might have been better able to cover the loss). In fact, credit default swaps have gone from being a risk mitigator, to a risk magnifier.

Stage 3 (Peturbo veloxicresco) 
You have a loan you're worried about. That's good, because lots of people want to offer you swaps. After all, you don't have to have any assets to issue a swap. The investment bank of First Me and The Change I Found In the Couch Cushions can offer swaps for all the debt at Morgan Stanley, and that's okay. I get free money for issuing the swaps, and the swaps have value on the books. So both me and my pal Mr. Stanley have values that are inflating faster than a tick in a blood bank.

Now you can get a swap for any loan you want, and with all the competition, the cost of these swaps is lower, and lower, and lower. Here's an idea: why not go out and make more loans, riskier loans. Why not offer anyone you can collar on the street a loan, no matter whether or not they can pay it off, not because some 30 year old law makes you do it, but because your friend the credit swap makes it perfectly safe!

So many people are offering these things that you could give a loan to Saddam while the bombs are falling without a care in the world. You can always get a swap.

Stage 4 (Fatum casus) 
I have a swap. I really, really want someone to take my swap. Only even with every incentive I can offer, not enough people are loaning. Sure, there's a record amount of hypothetical money sloshing around the system thanks to me and my swaps, but it's still not enough. So what can I...

Wait a second. Swaps are unregulated. No one says I have to have enough resources to cover the swap, and even better, no one says I have to offer the swap to the person who actually made the loan! Hey buddy, see that loan over there? You may think it's iffy, but I think it'll hold up. In fact, I'm so sure it will, I'll sell you a credit default swap on it that pays off if it fails. You don't make the loan, you don't have to pay off on the loan, you don't have anything to do with the loan. You just pay me the fee. And if that guy loses his money, you collect. How sweet is that!

This mutation is enormous (see how the genera changed up there?). At this point, credit default swaps have become completely divorced from the original function. A single loan can be covered by multiple swaps. There's a complicated fiscal term for this. It's called gambling, and at this stage, that's all that remains of those little "insurance" policies. They no longer protect anyone from anything, they just offer a chance to place enormous overlapping side bets on everything.

Stage 5 (Fatum insanus) 
I have swaps! Get your swaps here! Want a swap on a loan you made? Okay. Want to bet that the bozo in the next cube is making bad loans? We can do that. Want to bundle up some loans and bet on those? Buddy we can do better than that. I can give you a swap on the value of other swaps. Now we're really in business.

Who owns the original loan? Don't know, don't care. Who's actually responsible for the money if that loan should fail? Ehhh, can't really say. Has anyone noticed that a single bad loan could cause a cascade of swap calls that bounce around the system like a rocket-power pinball? Shut up.

Isn't anyone worried that this is the most massive house of cards ever constructed in human history? Lookit, what part of "we took 120 billion in bonuses out of this place in the last five years" are you missing?

Stage 6 (Fatum exicelebritas) 
Hey, my loan went bad. Can I have my money from that swap, please?

Stage 7 (Fatum cerus) 
Oh shit.

Now that people are paying attention, it turns out that the value of most credit default swaps is not just bupkis, it's Bupkis Plus. More computer power went into modeling these things than has been invested in predicting climate change, but everyone overlooked the giant "and then a miracle occurs" at the center of all the equations that allowed credit default swaps to generate revenue ex nihilo.

Trying to blame the 1977 Community Reinvestment Act for the current fiscal crisis is like blaming a spot on your windshield for engine failure while ignoring the gaping wound in you head gasket. Republicans are scribbling hard to create their new version of reality, and you never know what's going to sell. After all, people bought a "Book of Virtues" authored by Bill Bennet.

But in this case, even the Mock Turtle and the March Hare think the GOP line is too outlandish.

  • ::

No comments: