Did They Follow Their Own Advice?

This article was posted by Ben F Kushner on: 19 09 08 - 09:21

Stockbrokers and financial advisors worth their salt preach balance and diversity. Buy the best of breed in each sector. Make sure your investment capital is spread equally among the best stocks in technology, staples, financials, energy, retail, international, large cap and small cap etc.

But unfortunately for the nation and the world, the large Wall Street houses did not follow their own advice. During the 90’s and early 21st century, they shifted a disproportionate amount of their assets into securitized real estate loans.

Mortgage purchases were great for about 16 years but the bubble got bigger and bigger until the beginning of 2008. But that boom that went off in Times Square at midnight 1 January 2008 was not the sound of popping Champaign bottles but the securitized mortgage bubble exploding leaving Bear Sterns, Merrell Lynch and Lehman remnants zooming across the globe.

Many if not most of the loans that were bought and sold were solid. Hundreds of billions of dollars were invested in credit backed shopping centers, office buildings, hotels and solid residential investments. These loans continue to be well performing for their note holders.

But as the supply of good properties dwindled, the thirst was unquenched for profit from the sale of these loans. They then moved into what became known as the sub prime market. Sub prime is a synonym for “uncollectible”. Loans made to borrowers who have no business buying a house they cannot afford and lenders making loans that all underwriting criteria point to a default.

So why would they make them? Simple. They could sell them for a profit. All these loans, the good, the bad, and the ugly were placed in bundles called traunches to be sold at auction to the financial outfits from around the globe including Wall Street firms and  banks. If the loans were made at an interest rate of 6%, they would be sold to the highest bidder willing to accept the lowest return on what they bought. If a huge volume of loans were made on a 6% rate and sold at 5.5%, the resulting 50 basis point profit can equal a multi-million dollar profit at a single auction.

The buyers of these ultimately non-performing assets were money market funds or banks that were paying their depositors sub 2% interest on their liquid deposits while investing them at the risk of the financial institution in the 5.5% sub primes. Great profit if it works. It did not. But your local bank along with the Merrells, the Lehman’s et al had to pony up the money when their depositors came calling for their money out of their checking and savings accounts.

When the land boom in Atlanta in the early 1970’s was causing raw land with little short term potential to double and triple in sales in a matter of a few months, an older fellow told this story: a guy bought a can sardines for one dollar; he sold the same can for $2 who then sold it for $4. Ultimately the same can of sardines was sold to a buyer for $10. This buyer wanted to eat the sardines. He opened the tin only to find worms and rotten sardines. When he complained to the guy from whom he bought the can, his seller commented, “These sardines aren’t for eating, they are for selling!”

Sub primes were not for collecting, they were for selling.

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