Subprime Mortgage Debacle Will Hurt All of Us

You may not be directly affected by the subprime mortgage scandals, but one way or another, you probably will be. If you’re not familiar with finance, here’s what happened: low interest rates sparked a lot of home buying causing the prices of houses to go up; the increased home values allowed homeowners to sell their homes for a profit and afford to put a sizable chunk down on a new house. The decrease in home sales would have been bad enough for the economy, but the financial world created mortgage-backed securities, sort of like a stock or bond based on home mortgages.

Paul Krugman explains it this way:

Today, when a bank makes a home loan, it doesn’t hold on to it. Instead, it quickly sells the mortgage off to financial engineers, who chop up, repackage and resell home loans pretty much the way supermarkets chop up, repackage and resell meat.

It’s a business model that depends on trust. You don’t know anything about the cows that contributed body parts to your package of ground beef, so you have to trust the supermarket when it assures you that the beef is U.S.D.A. prime. You don’t know anything about the subprime mortgage loans that were sliced, diced and pureed to produce that mortgage-backed security, so you have to trust the seller — and the rating agency — when they assure you that it’s a AAA investment.

But in the case of housing-related investments, investors’ trust was betrayed.

As long as housing values were rising, everything seemed to be working out all right. But unscrupulous mortgage companies started making money by giving loans at unrealistically low interest rates to people who generally didn’t know any better. These people have begun defaulting on their mortgages, which means they aren’t paying their mortgages, which means the people who bought these loans as an investment aren’t getting their money, which means they can’t pay their bills, which tends to have a negative effect on the economy.

As Krugman writes, “the bursting of the housing bubble means that someone, somewhere, has to accept several trillion dollars in losses. A significant part of these losses will fall on mortgage-backed securities.” The rest will fall on our backs in shades of the savings & loan scandals of 1980's.

And TWPE’s way of dealing with the crisis? Denial. According to Krugman, a “new plan would create a “super-fund,” the Master Liquidity Enhancement Conduit, which would seek to restore confidence by, um, borrowing from the public and investing the proceeds in mortgage-backed securities.

You need to read the whole article to understand what Krugman (and Alan Greenspan) are saying, but it sounds like TWPE wants to take our tax dollars and put them in worthless investments.

-Mb