Leveraging, Derivitives, Swaps, Mortgage Backed Securities == FRAUD!

Hugh Sunday explains the predators’ techniques in A short rough primer on leveraging and derivatives: “Leveraging means something like this. You sell $10 million in stock. You use this money as the basis to take out a loan so you can buy $100 million in mortgages. Now say you issue mortgage-backed securities based on these and sell them. Now you have a $100 million in cash so you go out and buy more mortgages only this time you use your $100 million to buy a billion dollars of them. You have just leveraged your initial $10 million 100 times.”

Can anyone do this? No. “This works if you, your banks, and the buyers of your paper are all sufficiently greedy. Why would banks loan you $100 million on $10 million collateral? The short answer is they wouldn’t for you or me, but they would and did to financial companies because of the fees and interest they made off of such transactions and because they ‘knew’ those companies were good for it. . . .”

Here is another scam vehicle known as ‘swaps.’ “This was a kind of insurance policy in the event that some mortgages declined in value. This derivative basically said if you pay me a certain fixed amount, say every 6 months, I will make good on any difference between what you initially paid for your mortgage-backed security and what it is worth when you come see me. When the housing market was going up, this amounted to essentially free money for the issuers of this kind of derivative. They could sell it as extra insurance to conservative institutions secure in the knowledge that the housing market would rise forever.

“Except of course it didn’t. The original idea was that if a package of mortgages or tranch lost value because of a high rate of defaults, the swaps or insurance buyer could demand a settlement from the swaps issuer to make up for the loss of revenue. Now on the upside of the bubble, default rates were low. Homes that went into default could be resold at even higher prices so there was no downside. However, when the bubble burst, default rates went up and issuers of these derivatives didn’t face payouts on one or two of them but on a huge number of them.”

But these devices could not occur without a kind of dangerous “we’re all connected” web. It is made up of the banks, investment houses, mortgage companies, brokers, hedge funds, insurance companies, international money launderers, Buffets, Greenbergs, Soroses all around the world, now connected by greed and computer terminals, and able to leverage or debit billions on paper or swaps in a nanosecond.

Among other favorite ploys, “are mortgage-backed securities. They are not the mortgages themselves but a financial instrument (or to use the technical term, “thingy”) based upon or derived from them. (Buyers of these are not interested in the underlying asset but in the cash flow from it, i.e., the mortgage payments.) These can themselves be further sliced and diced into further generations of derivatives . . . one that is based on 50% of this derivative plus 30% of that one and a final 20% of a third. And so on and so on. All this was to dilute and spread risk or moral hazard, but it also had the effect of putting vast distance between the mortgage title and the holders of the derivatives based on that mortgage.”

The derivatives crept like succubae into the incubus of America’s body politic and financial system. Obviously, many financial types could not “just say no” to them? In fact, in order to get their $700 billion bailout, they could manipulate the market for hundreds (even thousands if necessary) of losses in Dow points — trillions in assets wiped out, pensions, credit, bank accounts, trusts, even freezing assets of universities and colleges beyond the ability of the average Joe Sixpack to fight back, other than to vote for a demented Sarah Barracuda and Citizen McCain.