This post is a speech I gave at Kildare Communicators last week. It is the true tale of the growth of the American credit system which led to the subprime crisis in the US. Reading this may put Ireland's economic fall from grace into global context. Acknowledgement to the US today show.
My story begins with the global pool of money. But where does it end? Bear with me. This, a giant global pool of all the money in the world contains all the pension funds, insurance funds, private savings. When my story begins, 1998, the global pool sums 36 trillion Dollars. Thats a million euro on the day of Christ's birth, a million the next day for you and every day since- with a couple of trillion left.
That giant pool is watched over nervously by an army of investors whose job it is to make it grow, to keep it safe.
Between 1998 and 2000, two things happened. First around 1998 the global pool of money began to grow very suddenly. All sorts of unexpected countries like Abu Dhabi, Korea, China began to globalise their money. second, Alan Greenspan, the head of the US fed reserve made a speech announcing that US government bonds would stay at 1%- very low interest- for a very long time.
Suddenly, that army of investors began to have more money than they knew what to do with and needed more SAFE places to put that money.
So- Wall Street created a new financial product called a mortgage backed security. What's safer than houses?
At this point I want to introduce you to the three Mikes.
The first Mike, Mike Soden, works for Bear Stern. He is an investment banker.He looks after the global pool of money. He buys mortgage securities with other people's money and nets his clients a few modest % return. It's safe as houses.
Next meet Mike Garder, head of silverstone Mortgage bank Nevada. They sell loans to people like you and I. They borrow millions from bigger wall street banks to sell us mortgages to buy houses. Then they take back the mortgages ,gather them together in bundles of 2 to 300 and sell them back to wall street in mortgage backed securities.
Before long Mike in Wall Street owns little pieces of thousands of mortgages sold by Mike in Nevada.
By 2003 everybody who qualified for a home loan OR already had one was in the pool. BUT Wall Street couldnt get enough of these mortgage backed securities.
So month by month guidelines got looser until Mike in Nevada says they were literally pulling people in off the street and offering them home loans.
Lets look at he different loan types-
First you had a verifed income, verified asset loan- a VIVA. Then you had a Stated income Verified asset loan- a SIVA.
These are triple AAAs.
But soon you just needed an accountants letter to get yourself a No income verified asset loan. Finally they started giving out the loan you know you are going to default on- the NINA ! NO income NO asset home loan!
You see it was a new era- banks didnt hold the loan for 30 years anymore. They just bundled them up into triple AAA securities and sold them back to Wall
Now you would be right to ask- Where was the regulator? and yes there were ratings agencies. But they had no DATA for these new loan types. They relied on historical DATA about how safe home loans WERE. They gave virtually all these securities triple AAA ratings. They were rated as safe as government bonds.
Year by year if Mike Garder doesnt give a guy a loan , the next broker will. If Mike Soden doesnt buy the latest scurities the next banker will.
Year by year market forces took over. But how do you turn a NINA- a No income loan which is set to default from day one- into a security?
Because they are not all triple AAA. You have double B and triple B in there as well. How do they fly?
Meet the third Mike. Mike Francis. Mike Francis runs Dynamic Finance, Ohio.
He buys some triple AAAs from Mike Garder. He buys a LOT of double BBs and a LOT of triple BBBs.
He grades them, values them, sorts them. Then he shuffles them.
He splits them into bundles of 2to300 called tranches to create a new financial product, a new type of "security".
They are called collateralised debt obligations. CDOs. And Wall Street cant get enough of them.
Because by this stage the global pool of money had reached 70 trillion.
Some of these loans are ToXic Waste. But Mike Francis is an alchemist. He turns bad loans into good securities. Bad money into Good.
Mike Francis is an alchemist. But by the end of 2005 you could almost smell the sulphur.
Meanwhile Mike Soden in Wall Street watches his screen every day and all these securities and all these CDOs perform. Nobody misses a payment. Mike sends his investors a little dividend every month and everyones happy. These are Performing Loans.
But Mike now admits it was the triumph of Data over common sense.
Because by mid 2006 the average American home loan was over 4.5 times the average American annual salary. That ratio historically used to be 2.5. A leverage of 2.5 is the ratio you and I are safely able to pay back. Mike says what Wall Street didnt know was that the toxic loans hidden in the CDOs were propped up in the malls and on the high street by another loan product- the home equity credit line. People were taking out another loan to pay their mortgage. Now that didnt matter as long as house prices kept rising because we are all property speculators by this stage. You are going to sell the house next year anyway!
But by mid 2006 house prices reached a critical level and stopped rising. House sales faltered. The loans stopped moving.
Mike says he remembers the day it happened, just before Halloween 2006. Some of the numbers on his screen started to blip. Some repayments were missed.
Mike's boss said" would you look at that.... What are the fed offering on bonds today?"
Wall Street stopped buying CDOs and securities. Mike Francis in Ohio was stuck with a load of CDOs. He packed up his chemistry set and stopped buying loans from Mike Garder.
There followed a winter of discontent as the cycle of lend-speculate slowly ground to a halt.
Mike Garder in Nevada was stuck with a load of mortgages and soon keys started coming in the door. No one was buying homes even if you did repossess as home owners here and there began to default.
Around february 07 when the bank itself defaulted on a couple of big repayments to Citibank, Silverstone Bank Nevada declared itself bankrupt.
Staff were told and then people began to literally wheel photocopiers out the door.
Mike says his boss called it the valentines day massacre.
To everyone else it was the subprime crisis.
Mike Francis in Dynamic Finance, Ohio, who had split up and sold on shares in some 16 million home loans simply filled in all the paperwork, sent it to Wall Street and pulled the door closed behind him.
By mid 07 the language changed. They stopped referring to it as a subprime crisis. The problem became known as a CREDIT crisis.
This is because Mike and the rest of Wall Street had lost half the global pool of money.
They have been badly stung and their investors are mad as hell.
So now they want NO RISK. Suddenly government bonds at 1% look very attractive again. Suddenly no one wants to lend.
This is why Hungary, Turkey and lots of other places are paying 15% and Ireland's interest rate is rising rapidly also.
We are mixed right up in it because the trail of CDOs reaches all the way to OUR banks who borrowed and hedged and sold on securities, who used securities AS security on risky Dublin site sales. A trail that culminated in a late night phone call to the minister for Finance in September 08.
My three Mikes, NOT the three wise Mikes, are my seasonal tale of the decade.
To put this into perspective, this IS where we are. Its NOT the great depression. Wall Street says its more like back to the 70s.
We are stuck in neutral for a while. You can take Uriah Heep's view- he was Charles Dickens fictional stingy accountant- " Happiness is a surplus, misery is a deficit" OR you can hold onto my final word from the Dalai Lama
" This world is not perfect. But things like happiness and unhappiness are relative. Realizing this gives you hope. "