Saturday, October 9, 2010

Karl Denninger Asks and Answers the Most Important Question: "Why?"

Karl has a new post up this afternoon with some observations about foreclosuregate.  While his claim that nobody but he has been asking the "why" question is incorrect (Yves Smith has been asking the same question for at least a week), I think he is the first one to provide a comprehensive answer.  You can find the post here

While it is well worth it to read the whole thing, here is the punchline:

So what we have here are two answers to "Why?"
  1. The deals were un-economic unless someone cheated.  That is, there's only so much risk-adjusted "spread" in a particular lending transaction.  The common law of business balance says that nobody ever works for free, and as a consequence the more hands that touch a deal the more that profit is dissipated among those hands.  In a competitive market where multiple entities compete for business this means that the true yield available to at least some of the investors would always have to understate the risk of default, and therefore someone was always going to get screwed.  On balance there's nothing unlawful about that, so long as you properly and fairly disclose everything about the deal - there's nothing that stops you from buying a thing that is disadvantageous to you.  We take this risk every day when we, for example, buy a pack of cigarettes.  The "pleasure" (such as it were) from smoking may come with a horrific cost (lung cancer); it was only when the Tobacco Companies tried to conceal this risk that they were held responsible.
  2. As the pyramid grew higher, the number of good borrowers was exhausted.  To keep the charade going it was necessary to fund loans to "patsies" - the infamous "fog-a-mirror" lending.  That would have been ok too, except that the lenders actively concealed the fact that the loans they were stuffing into the securities did not meet the standards under which they sold those resulting MBS to investors
So between #1 and #2, we have two things that would not be illegal if they were properly and fully disclosed, but if they were fairly and fully disclosed there would have been no money in securitizing these loans, as nobody would have bought them.
To sell them, they had to cheat.  And when the "caught" part of the cheating became apparent as housing prices started to collapse, they attempted to cheat again to cover up the earlier cheating, which is what you're seeing now.
The next question is why cheat?  As I said in a previous post, public companies like the TBTF banks all must show perpetual growth or see their share price plummet.  There are only so many ways to keep the illusion of perpetual growth alive, and the last resort is always cheating, which can be as trivial as timing sales and as brazenly criminal and systemic as the predatory lending, the fraudulent conveyance of mortgage-backed securities that were not, in fact, backed by mortgages, and the subsequent foreclosure fraud to cover up their prior misdeeds.