By: Dr. Mike Campbell
As a child, I played football with a friend who always blamed others for his goalkeeping failures. Now the US Federal Housing Finance Agency (FHSA) is attempting to do much the same thing over the subprime crisis which was the trigger event for the global financial crisis. The Agency is planning to bring lawsuits against 17 national and international financial institutions for loses incurred on mortgage-backed securities which cost the US tax payers tens of billions of Dollars.
Debt is a commodity that can be bought and sold and forms part of many portfolios, but exposure to individual loans could be risky, so a number of loans are bundled together, “securitized”, to create a financial vehicle with lower risk – the number of good loans outstrips the small number of bad debts, spreading risk and (almost) guaranteeing returns. So goes the theory. In good economic times, very few individuals or businesses will default on their loans, so the investment is pretty much “as safe as houses”.
The sub-prime market involved lending money to borrowers deemed to be poor risks. Invariably, such borrowers had to pay higher premiums to get the loans and these debts were also securitized, but the obvious elephant in the room was that piling together lots of questionable loans did not produce a lower risk product. When confidence and the economic climate turned against subprime, the individual loans making up the package were highly likely to fail and financial institutions acted to try to minimise their losses, as the value of these assets plummeted..
HFSA is claiming that the financial institutes misrepresented the quality (risk) of the securitised mortgages that they were selling; a claim they hotly dispute.
The move has sent bank shares in the affected institutions sharply lower and is likely to jeopardise voluntary compensation moves that were being discussed between the banks and all of the US States Attorney Generals. The timing of the move is also highly insensitive in view of the fragility of global markets.