bazarmedia.ca/bazar_288_Monthly/index.html?pageNumber=25 First Published in Bazar issue 288 - page 25- Sep. 2014 SUBPRIME MARKET & ATTRACTIVE INVESTMENT OPPORTUNITIES WOLVES OF WALL STREET & THE GREED BUBBLES- Part 5 Dr. Kia Rashidan, August 2014 THE INCREDIBLE SUBPRIME MARKET A mortgage is called subprime if it is made to those with a less than prime credit history. Before we go further, let’s define the differences between tradition mortgage model and the subprime mortgage securitization model. The traditional structure of mortgages is very simple, Mr. X needs a house he goes to Bank A and applies for a mortgage. If bank is convinced that Mr. X is reliable and can afford the payments he will receive the loan to purchase the property. Mr. X will start the repayment process and bank will receive the capital plus the interest. Mortgage securitization process which got traction during 1990s and 2000s completely changes this mechanism. In this model banks started to use mortgages to create a new class of securities and started to sell them to investors in bond market. There are numerous reasons why the subprime market demonstrated the wildest growth of any mortgage market over the first decade of 21st century. On the supply side institutional and other investors were keen to buy the securities issued by mortgage pools, particularly because they faced shortages of other attractive investment opportunities. Individual mortgage brokers were eager to place new mortgages, partly because of the fees they made from creating mortgages and partly because the new technology made processing inexpensive. Original mortgage lenders received additional income by generating mortgage pools and selling them on to specialized trusts, which in turn issued securities against the mortgage pools. The mortgage pools’ originators could purchase default insurances on each of the pool securities. These insurances were cheap at first, meaning that the pools originators had even less incentive to monitor credit standards. These pool securities were called Collateralized Debt Obligations (CDO) and the default insurances on these CDOs were called Credit Default Swaps (CDSs). Investors in pool securities were happy with CDOs because they were starving for high-yielding assets that from their opinion were subject only to a low level of risk. SPECIAL AND STRUCTURED ENTITIES & SECURITIZATION Securitization is about turning revenue streams or “receivables” from time dependent assets into securities. Whether it is accounts receivables through ABSs (Asset Backed Securities) or mortgages through MBSs (Mortgage backed Securities) the basic notion does not change. Securitization needs a future payment stream (like mortgage payments or car loan payments) that has a securing collateral value. Investment banks realized that they required a host with account receivables much greater than corporation account receivables. First they used corporations account receivables and then mortgages on residential properties to create these securities and then they initiated the process of governments debt securitization. Sovereign Governments with their tax revenue streams and huge public collateral assets were the perfect source of Securitization. All they looked-for was sovereign Governments that needed money but was constrained from lending further. To initiate the securitization process they had to complete at least 2 steps: 1- They formed a Public Private Partnership (PPP) as the mechanism for involving the private business sector in public sector projects. 2- They form of a Special Purpose Entity (SPE) or a Special Purpose Vehicle (SPV) that would represent the private sector business sector interest. Investment banks liked “Special and Structured entities” like SPE, SPV since these entities could allow them to keep them off the balance sheet. By using the Special Purpose Entity (SPE), investment banks could receive contract for facilities such as hospitals, schools, and roads from government public sector departments. The private sector provider is paid an agreed monthly fee by the relevant public sector partner for a typical period of 25-30 years. This income allows the repayment of the senior debt. This is something comparable to a ‘reverse mortgage’. Like a reverse mortgage this contracts hide financing costs from the desperate borrower. The SPE- Private Finance Initiative preys on the unfortunate political entities in dire need for quiet and unpublicized solutions to their spending and their election promises. In other words, this was a great solution for those public sector departments you wanted to borrow money without being asked questions from people. Investment banks then started to use a type of Special Purpose Entity (SPE) called a Swap Agreement Securitization. Investment banks would take future tax streams and turned them into securitization products. The government got upfront cash immediately along with tax streams going to cover needed principle/interest payments. They would face balloon payments in the future. Banks would get the full value of the asset today which they can use as capital ratios along with ability to fractional lend out 10 times the value of the deposit streams. This permitted the International Banks to grow into quasi central banks with the capacity of creating money at any time a central bank is willing to expand their money supply. The financial mess we are witnessing in Greece is partly a by-product of Swap Agreement they signed with a well-known investment bank in USA. Greece government were engaged in two Swap Agreements: 1. They swapped debt issued by Greece in dollars and yen for euros using an historical exchange rate. 2. To repay the money Greece borrowed from Goldman, they entered in a swap contract tied to interest-rate swings. In 2001, Goldman Sachs formulated an arrangement to permit the Greek government to hide the degree of its rising debt from the public and the EU. Under that deal, Goldman gave new capital from super-wealthy investors into the Greece government and in exchange, Greek officials secretly agreed that the investors would get 20 years worth of the annual revenue generated by such public assets as Greeces airports. For its part, Goldman pocketed $300 million in fees paid by the countrys taxpayers. Goldman made the Greeces balance sheet look much better than it was, allowing Greek officials to keep spending. Eventually the repayment day arrived and Greeces huge debt exploded into a perfect storm, with its leaders disgraced and the country on the edge of the financial abyss. Greece is just another example of a poorly governed client that got taken apart by a financial giant. References Johnston, D.C., 2008, Attitude Adjustment. Columbia Journalism Review. New York, 47:41-45. Aguilar–Millan, S., J.E. Foltz, J. Jackson and A. Oberg. 2008, The Globalization of Crime. The Futurist, 42: 41-47. Calvano, L., 2008, Multi National Corporations and Local Communities: A Critical Analysis of Conflict. Journal of Business Ethics, 82:793-805. Cheng, P., C.J.M. Millar and C.J. Choi, 2006, Organizational change in stakeholder business systems: the role of institutions. Journal of Organizational Change Management. Bradford, 19:383. Fombrun, C. and C. Foss, 2004, Business Ethics: Corporate Responses to Scandal. Business Ethics. Corporate Reputation Review. London, 7:284-289. Marietta, M., 1996, The historical continuum of financial illusion. American Economist, 40:79-82.
Posted on: Fri, 12 Sep 2014 17:58:49 +0000
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