The 'Neutron' Loans Fiasco

Article excerpt

PARIS

Several "once in 100,000 years" events "cost billions and point to flaws in the design of quantitative trading strategies." That's how one learned analysis explained the subprime mortgage fiasco this summer.

This was highbrow talk for lowbrow greed that piled one sleight- of-hand scam upon another in an international Ponzi scheme that began unraveling in June.

Prominent international bankers, speaking not for attribution here, said prestigious credit-rating companies kept kicking the can down the road that said "subprime mortgage meltdown." They arbitrarily decreed that borrowers who take out a second loan for the down payment on the first weren't more of a risk than a standard mortgage.

This defied common sense but still triggered a boom in subprime mortgages.

These universally trusted outfits eventually revised their opinions. But by then there was a $1.1 trillion subprime mortgage market. West Europeans owned 57 percent of subprime loans. Throughout 2006, those who knew and were in a position to blow an authoritative whistle didn't. Ignored were precursory warnings about subprime delinquencies, homes repossessed or refinanced to avoid foreclosures.

A symbiotic relationship between banks and mortgage companies erected beautiful monetary sand castles on the world's financial beaches, just out of range of high tide. They hadn't reckoned on a subprime mortgage rip tide that flattened them. Investment banks and bond rating agencies failed at the same time.

Banks sold leaky mortgage vessels to hedge funds hungry for high- interest payments. Securities markets and their high-rollers took over from bank managers. Those who took on risk on the verge of default always expected to find someone willing to take on a bigger risk ad infinitum. Risks were even carved up, sliced and diced, repackaged as CDOs -- collateralized debt obligations -- and passed on as good as bonds to make them look less risky. CDOs insured $3.3 trillion worth of paper in 2006.

All this was gerrymandered on millions of individual borrowers who were led to believe the value of their homes would keep appreciating and therefore they could afford to go into deeper debt. Thus millions took mortgages to buy homes beyond their means.

Now millions stand to lose the homes they could not afford. Irresponsible, reckless driving has played into the hands of those who advocate more regulation in underregulated financial markets, along with a new right to sue everyone -- from brokers who sold the repackaged loans to banks that originated them, to investors who picked them in secondary markets.

Those gulled by the American dream of a modest dwelling can no longer get a mortgage because of earlier default. For many, it's back to trailer parks.

The insiders called these subprime mortgages "neutron (bomb) loans" after the Cold War weapon of mass destruction that killed people but left buildings intact. Get-rich-quick schemes spawned the unacceptable face of democratic capitalism. From 350 billionaires at the turn of the 21st century seven years ago, the club has just gone over 1,000 members, many of them in tax-free shelters with exotic names of countries the size of a dot on a map of the world that seldom make the news.

Even Bill Gates was upstaged last month by Mexico's Carlos Slim Helu (of Lebanese descent), the world's richest man at $59 billion. (Mr. Gates gave over $30 billion to his foundation that is focused on the world's most critical health problems. …