9   The Economic Topography is Changing Beneath Us


The economic topography is shifting around us. The old clichés about licking inflation and all will be well are still heard from time to time, but nobody seems to take them seriously any more. For something deeply baffling is taking over and shifting from industry to industry, over oceans and across continents.

It began with subprime debt and the realization that risk management upon which the world was being restructured was clearly not working because it had undermined our subprime mortgages. In these collateral debt had in fact replaced clear obligations to deliver legal tender when due. And now it was hopping across continents and oceans. The collateral debt obligations backing the debt was no longer in legal tender, currency of the land, but instead in an artificial array of bits and parts of collateralized debt And the obligations can change. After a year or two and when that takes place in a world where for decades now the mortgagors on the hook for keeping in good standing all the bits and pieces of the mortgages which might be diced and attached to other mortgages backed by different securities of different degree of risk and allotted to yet other creditors.

Enter Subprime Credit Card Debt

And games with derivatives and other fancy toys are no longer confined to mortgages; they are turning up with all sorts of debt. Thus The Wall Street Journal (1/14, "High-End Cards Fall from Grace" by Robin Sidel and David Enrich) informs us that these new structured collateral debt obligations have taken over the upper reaches of the credit card business. Calling it "collateralized debt obligations" is an evasion, just as calling syphilis "structured collateralized sex" would be. There is a misleading sense of fake security about both. But let us hear what the WSJ has to say on the subject: "The luster on all those silver, gold and platinum credit cards is getting tarnished. For the past few years banks that issue credit cards have aggressively wooed affluent customers with lavish perks and fat credit lines. Now, that high-end strategy is coming back to bite the banks. There are growing signs that some of these consumers are having a hard time paying their bills.

"It is the latest in a series of woes for US financial institutions, struggling to contain a growing variety of credit-related problems after years of strong profits. Banks have lost billions of dollars from soured home loans and mortgage-related investments. And defaults in commercial and industrial loans could rise later this year if the economy weakens further.

"Investors and analysts will get an in-depth look at the credit-card problem this week when Citigroup Inc. and J.P. Morgan Chase & Co. – two of the biggest issuers of plastic – report fourth quarter results. Both are expected to set aside hundreds of millions of dollars to cover consumer loans.

Cleveland Subprime Mortgage Capital of the Land

The Globe and Mail (1/19, "2 million foreclosures $100 billion in losses" by Paul Waldie) reports: "When Sam Robertson took out a second mortgage on his home in suburban Cleveland three years ago, he couldn’t believe how easy it was. The interest rate seemed low, the approval process quick, and soon he had a $61,000 (US) loan backed by a house worth $100,000. Then Mr. Robertson, 55, lost his job with a plastic-bag company. He found temporary work, but he got behind on payments just as the interest rate on his mortgage reset at a higher level. The house his family had lived in for 27 years is in foreclosure.

"Versions of Mr. Robertson’s story are being played out across Cleveland. which has become the epicentre of the housing problems plaguing the US and across our border. The foreclosures in Cleveland have soared from less than 300 in 2003 to 7,583 in 2007, one of the highest rates in the US.

"The defaults have depressed property values, cut local tax revenue and left many streets lined with vacant buildings. Most have been stripped of windows, doors, siding and even copper wiring and pipes.

"Over the next two years, 1.8 million subprime mortgages, these aimed at riskier borrowers, are expected to reset at higher interest rates. It is expected that 1.2 million of the loans will go on to foreclosure. Those that don’t default will barely get by after making their payments.

"Mortgage woes and falling house prices have prompted consumers to cut their spending to a five-year low. Banks and other institutions that pumped out more than $2.5 trillion of subprime loans between 2000 and 2007 have taken massive losses. This week two of the biggest, Merrill Lynch and Citigroup reported a combined loss of $20 billion for the fourth quarter In total, banks in Canada have piled up more than $100 billion in housing market losses. Throw in higher energy costs, weak unemployment and lower stock prices, and it’s no wonder that many economists predict that the US could fall into recession this year. And that means a slowdown for Canada as well.

"Subprime loans don’t exist in Canada, but they have been around in the US for decades. They were initially intended to help wealthy people buy second properties, but as the housing market soared, they morphed into a vehicle for riskier borrowers to obtain a mortgage. Many subprime loans in Cleveland started at 8% and increased to 11%. Borrowers were often told not to worry because they could always refinance later, because their house would be worth more by then.

"To fund borrowers, mortgage companies sold their subprimes to big banks. The banks then packaged them up as securities and sold them on the stock market around the world. Investors snapped them up, convinced that the securities were backed by the booming US hosing market. From 2000 to 2006, the number of subprime loans increased from 911,360 to 3.2 million, according to a study by the Center for Responsible Lending."

US Mortgage Subprimes on a World Tour

"To feed bank demand mortgage companies offered higher commissions to brokers who steered clients into subprime loans, which prompted some to loans with few if any background checks. Some loans required borrowers to show little more than pride of ownership.

"Mortgage brokers and lenders became little more than aggressive salesmen, even going door to door in some neighborhoods. In some neighborhoods in Cleveland brokers would show up with lists of purported building code violations and coax owners into taking out loans to fix the problems. One woman in a poor Cleveland neighborhood ended up with a $70,000 loan convinced that her garage needed repairs. Some brokers worked with corrupt building inspectors. Later if such financing were arranged to do the prescribed repairs, the mortgage broker would split the fee."

Much of the paper-work was "outsourced." It was enough to have a mortgage risk appraiser insure the soundness of the loan. In the old days such insurance was rarely if ever called upon to cover a claim. But that was in a world of rising property values, and in which some serious concern and responsibility were sere shown by the insurer. There is no room for that in the current frantic universe of spliced and diced and prepackaged risks. In this world, a new ethic has taken over – the originators of the mortgage consider their work done and their commission earned up front, and it is enough for them to have provided an insurer of recognized trustworthiness to vouch for the soundness of the mortgage and the mortgagor.

In the light of that an item in The New York Times (19/01, "Two Bond Insurers End the Week Severely Weakened" by Vikas Bajaj) had the resonance of a knell in its implications for the subprime debt crisis: "It was a terrible week for Wall Street, and a devastating one for companies that promise to protect investors against bond losses. Already under siege for having branched into risky mortgage-related debt from far safer municipal bonds, two bond guarantors – who have insured hundreds of billions of dollars of debt – ended the week in severely weakened conditions."

Insurance in Need of Insurers

"One insurer, Ambac Assurance, which dropped nearly three-fourths of its stock market value in the first four days of the week, lost its most coveted asset on Friday – the AAA credit rating that has allowed its guarantee to vouch for lower-rated bonds. The company has guaranteed $556.9 billions in bonds, and about $66.9 billion of the amount is issued by collateralized debt obligations that have under scrutiny in recent months. Altogether, bond guarantors have written nearly $3.3 trillion in insurance."

Thus one thing leads to another in this strange world of collateralized debt, but these are no daisy chains. They drag you mercilessly to the world where everything is supposed to be determined by consumer supply and demand, and no serious double entry accountancy is allowed to interfere with the power privileges of those in charge of the system.


– from Economic Reform, February 2008