Enron V: the home mortgage crisis. Part III.

Note: In our previous article, Part II, regarding the Community Reinvestment Act (CRA), we incorrectly attributed its year of enactment by Congress to 1976. It was 1977. Does not make any difference but you should know.

We referred to the times when it was necessary for Congress to step in and make sure that credit was available to everyone as “the lean years.” And banks realized that, in order to respond and provide those services required by the new law, they had to deal with a credit picture they were not fond of or familiar with, so it took a while for the new engine to get roaring both emotionally and technically. In reality, however, the banks benefited by the new rules. Indeed there was an unsatisfied demand for funds and, more importantly, people were deserving of an opportunity to get that demand satisfied. But something else was happening in the banking world at the same time: increase in technology.

Coincidental with the need to spread the services around, banks were being supplied with the growing availability of ATM machines and online connections that allowed them to do business everywhere anytime. And the large size requirements to implement the CRA compliance strategy meant larger banks as well and the ability to fund their deposit requirements from any source no matter where that source was located. Securitization of bank credit products started to become available as the banking world moved into the nineteen eighties.

Banks that could not afford to invest aggressively went by the wayside as merger mania took over. Big fish swallowed small fish. Do you remember the last time you saw a Bank of New England, Bank of Boston, Baybank or Shawmut Bank office sign? Do you even remember that such names existed? The match between borrowers and investors became looser. People went to their local bank for loans but the deposits that were needed to satisfy that thirst were not coming from their own communities and neighbors as it had happened in the past but coming from far away, first from other bank offices of the same institution and later from other sources of funds that included Wall Street and the international market.

I witnessed such a situation with the car loan business in the late nineteen eighties that went under the name of securitization. Car dealers all over the nation became associated with their banking institutions in large scale. Simply stated, you would go to the car dealer to buy a car on credit, the dealer would process the paperwork and their bank would supply the funds needed for the purchase, you signed the note, and out you went with your new jalopy. The bank, in turn, would accumulate enough of those notes and issued guaranteed securities backed up by those notes. Banks, corporations and individuals in the USA or even abroad would buy the securities and get repaid at a specified rate as the loans were paid down.

Bond rating agencies guaranteed the soundness of those securities that for all intent and purposes were like any other stock or bond public issues, including compliance with the rules of the Securities and Exchange Commission (SEC.) The negative side of those securities was that lack of performance by the car borrowers resulted in huge losses to the banks issuing those securitized instruments and, to our chagrin, I witnessed those losses in my own banking organization. And one of the reasons for the debacle was the availability of easy credit, I should call it irresponsible credit, on the part of lenders and borrowers alike. It is not easy to make loan payments on a new luxury car when your only source of income is an hourly rate from a fast food outlet or, when the car you bought is a lemon easy to abandon.

I am sure it is not difficult for you to visualize the similarities between lending and borrowing to securitize car loans and doing the same for a home mortgage. Unfortunately the basic difference is more dramatic. When one owns a car one may be able to borrow or rent one or use public transportation if one loses it. If the home is the loss, well, you are starting to get the picture. And the housing mess we are in now requires that we complete our mission in our next article: Part IV. See you then.

And this is my point of view today.

Note: At the close of this article, the FBI announced that it is starting an investigation of the players in the subprime mortgage crisis that is fueling the current Real Estate debacle.