The International Writers Magazine: Sub-Prime Fairy Stories

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The Emperor's New CDOs • Dean Borok explains all you need to know about sub-prime lending Once there was a king who told his tailor, “Sew me the coolest suit in the world.” The tailor said, “Yes, Your Highness.” The king said, “You better, otherwise I will have my priests rip out your still beating heart and feed it to the piranha fish I keep in the royal aquarium.”

The tailor went home and racked his brains, trying to come up with something that hadn’t already been done.  In desperation, he called his son, who had an MBA from the Wharton School of Business.  His son suggested sewing a suit composed entirely of bank notes.  “Nah,” said the tailor, “that’s already been done by Jay-Z.”
“Well, then,” said the son, “How about a suit composed of collateralized debt obligations?”
“What are those?”
“CDOs are the hottest new structured finance instruments.  They’re taking the world by storm.  They are securities backed by the future proceeds of sub-prime mortgages issued to high-risk homebuyers.  Since these mortgages are bad credit risks, the interest rates are a lot higher.  It’s a real cash cow!”
“Thanks for the tip, son.  You saved my life.”
 
So the tailor sewed a suit composed of CDOs and presented it before the king.  “Looks cool!” exclaimed the king.  “In fact, I think I’ll put it on and take a little stroll down Wall Street.  Show the people on the street what real class looks like.”  So the king, attired in his new finery, marched in a procession through the financial district, accompanied by trumpets and heralds and bankers throwing rose petals at his feet.  All the financial analysts swooned.  “Omigod, the king looks fantastic!  Quick, call my tailor and tell him to whip me up one of those suits!”
 
The next day every banker on Wall Street was wearing a suit made of CDOs.  It was like a new financial era had dawned.  As it happened, though, a little girl walking with her mother asked, “Why are those men walking around dressed like that?”
“Why, those are the smartest men in the world,” said her mother.
“Then why are they walking around naked, dressed in worthless paper?” asked the little girl.
 
And all at once the bankers realized that the little girl was right.  They were walking around dressed in suits that were composed entirely of PURE SHIT!
 
A generation ago President Ronald Reagan reinvigorated a depressed and demoralized financial establishment by pronouncing his revolutionary axiom, “Greed is good.”  This dictum has been updated by George W. Bush, who has put into practice his own improved version, “Stupidity is Heavenly.”
 
What can the Republican administration and the Republican congress have been thinking when they enabled the banking community to put into place the mother of all ponzi schemes, otherwise known as sub-prime mortgages?
 
Broken down into bite-sized pieces that even I can understand, this is how the racket was set up: a mortgage broker unloads a house on somebody who can’t afford it for $250,000.  The first year the mortgage is set at a low rate, but thereafter it fluctuates according to much higher market rates.  This first year window of opportunity allows the mortgage holder to sell off the debt to a consolidator and cash out at the original $250,000, while the consolidator gets a deed worth upwards of $500,000, which is what the deal would be worth if the mortgage was carried out to term.  The consolidator then flips the mortgage again to an investment bank at a discount off the $500,000.  The investment bank bundles thousands of these mortgages together and issues securities backed up by the future income to be generated by all these mortgages.
 
All of these transactions take place in the window of opportunity period while the low teaser rate is in effect and the mortgagee is still able to make his payments.  After the initial low mortgage rate expires and the interest rate doubles, the homebuyer craps out and the ultimate holder of the worthless paper is left holding the bag.
 
Theoretically, the scam should have been short-circuited when the bond rating agencies like Standard & Poors and Moody’s reviewed the transactions for purposes of rating the bonds, but these agencies are funded by the investment banks, and they didn’t do their due diligence.  They passed the bonds with top ratings of AAA and AA.  Once these worthless securities went into the investment pipeline with AAA valuations assigned to them, they were snapped up by financial institutions around the world.  Most brokers are idiots who play video games and watch The Simpsons, and they enjoy having their thinking done for them.  Their job is to invest money, and a triple-A rating on a bond ensures that the placement passes muster with their manager, which is all they care about.
 
The ratings agencies subsequently admitted that they had based their valuations not on any kind of independent research, but on criteria supplied to them by the bond issuers themselves, and it’s irresistible to suspect collusion between the issuers and underwriters of these securities and the rating agencies.  They all would have a lot to gain, and the oversight system of checks and balances in the securities industry is flimsier than Paris Hilton’s nightie.  If a congressional committee were to shine a spotlight on this mess and force the managers who signed off on these fictional ratings to testify under oath, then the whole sordid truth would eventually emerge.
 
In China these guys would be shot for economic sabotage, the same as they shot the head of their Food and Drug Administration for taking bribes.  With the European and American central banks having been forced to spend close to five hundred billion dollars to maintain liquidity in the banking system to prevent a total collapse of the world economy, this scandal dwarfs Enron and World Com by a country mile.  The worst is yet to come in September and October, when trading starts up in earnest.  There is going to be some serious jail time handed down to these wiseguys when the whole thing gets adjudicated. 
 
The curse of Cassandra in ancient Greek mythology was that she could prophecy the future, but that nobody would listen to her.  I write for purposes of entertainment, and I sure don’t want to get caught up in a thing like that.  But it sure looks as though these collateralized debt obligations are just the latest in a long series of rackets devised by overreaching accountants to enrich themselves by playing fast and loose with the world financial system.  The obvious next question is: how many other worthless punchboard schemes are currently in circulation and, when we get through peeling away the onion layers of accounting shenanigans, what is at the core?
© Dean Borok August 20th
deanyorkave@yahoo.com>

Being French
Dean Borok - real power revealed
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