Mortgage crisis starts with CDOs - Ahwatukee Foothills News: Commentary

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Mortgage crisis starts with CDOs

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Posted: Tuesday, December 15, 2009 12:00 am

A recent report on home-price declines is an excellent basis for assessing our persistent economic catastrophe. A recorded 30 percent ($6-trillion-plus) drop since the 2006 peak has plunged home prices back to 1990s’ levels. Continuing, unabated foreclosures could readily drop prices even further.

Among the financial meltdown’s devastating consequences, the most obvious is the tremendous loss in Americans’ net worth. From a total of $61 trillion in 2007, net worth fell by an incredible 18 percent in 2008 to $50 trillion ($110,000 median American’s reduced net worth). Lower middle-class households lost the most, as the illusory wealth signaled by the housing bubble encouraged unprecedented levels of consumer debt, exerting a tremendous drag on the economy.

The housing bubble could never have occurred without mortgage-backed, collectivized debt obligations (CDOs). This practice of bundling mortgages into large debt packages and selling them to pension funds and other investors promoted reckless gambling in a formerly safe, sound market. Before CDOs, mortgages were held by lenders, who remained on the hook for losses. That was the basis for rigorous credit checks and down-payments, typically 20 percent. These practices assured sufficient collateral for loans. They accordingly minimized foreclosures and stabilized the housing market, which exhibited a slow steady price rise in the previous half century.

The advent of CDOs gave mortgage bankers a disastrous means of shifting risk to others. In the free-lunch Bush economy, mortgage lenders became obsessed with fast bucks from initial fees. Insulated from risk, they abandoned all pretense at sane credit criteria. Warm bodies qualified borrowers for fraudulently crafted mortgages designed to lure naive victims into hopeless contracts far beyond their means. Forfeitures inevitably multiplied, house prices started collapsing, and the financial house of cards collapsed. Overwhelmed by credit default swaps and other toxic derivatives, the economy fell into its first depression in 70 years, weighed down by hundreds of billions in socialistic bailouts for the people who created the havoc.

Suppose we had never had CDOs? Home ownership would be at least at today’s level. We would have avoided overcapacity and waste in home construction. We could have devoted those energies and financing to more productive economic pursuits – infrastructure repair, green energy development, improved education, more efficient health care. And we would have escaped the gloomy, panic-prone economic psychology that always hampers economic activity in scary times.

It could all have been avoided if we had learned anything from the Reagan era’s disastrous de-regulation. It gave us the savings-and-loan bailout, which cost taxpayers some $450 billion in inflation-corrected dollars. If the bankers get their way, Congress will ignore the regulatory lessons of the much larger current fiasco. And the banker plutocrats will move on to their next self-aggrandizing, socialistic enterprises.

 

C.W. Griffin has lived in Ahwatukee Foothills since 1988. He is a retired consulting engineer and a published author.

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