History Rhymes, The First Stanza

 Students of history know that it may not repeat per se but it very definitely rhymes. As Ecclesiastes said 2500 years ago, there is nothing new under the Sun. Let’s take a look back..

The Great Debt Crisis of 2007-09 was precipitated by a wanton disregard for credit risk, particularly in the real estate sector.  Trashy, subprime mortgages were packaged into tranched CMOs sporting ratings as high as AAA and sold to investors.  Mortgage and other loan originators were paid to lend as much money as possible, not to assess the borrowers risk.  They had every incentive to do so, since investment banks were hungry for fee-producing “product”.  Ditto for rating agencies, who charged mightily to provide algorithm-generated ratings, instead of doing solid credit analysis. Furthermore, an enormous side business in credit derivatives such as CDS and CDOs generated even more fees and profits.

The enabling mechanism was that those most responsible for the bubble - originators, mortgage and real estate brokers, loan packagers, investment banks, credit insurers and traders - did not keep any of the credit and market  risk themselves, since they were just fee-creator middlemen who passed the risk on to investors.  In other words, a kind of pyramid scheme.

When the pyramid collapsed, some where caught with too much “raw product” in their “warehouses” (eg Countrywide), others with too much “finished product” for sale on their “shelves” (eg Bear Sterns, Lehman, Merrill) and a few others had taken on too much insurance exposure (eg AIG).  They all failed, merged, or were bailed out using taxpayer money.

At the buyers’ end, banks, mutual/money market funds and pension funds were stuck with paper that was for all purposes worthless and they, too, mostly had to be bailed out by governments. Again, taxpayer money.

As always, there were those few “wise guys” who profited mightily from the bubble’s demise. I don’t need to tell you who they were, they even made movies about them. And, pointedly, they are still around and many are bigger than ever. 

The cost of the mess is still with us in the form of zero/negative interest rates, a very weak banking system  and a global economy beholden to cheap Asian imports purchased using vendor finance (eg Chinese and Japanese government bond purchases).

So much for the past then, or, in poetic terms, the first stanza. The rhyme will come in my next post, the second stanza...

Stay tuned.