By Amir Said
Exploitation. Say it together now, ex-ploi-ta-tion. That's the key word for today. Coming into last weekend, Lehman Brothers and Merrill Lynch, two of Wall Street's most honored behemoths, faced extinction. By Monday morning, (this oh so surreal morning), only one of them would survive. Good bye Lehman Brothers. You drank the sub-prime Kool-Aid and now you're dead. Hello Bank of America stepchild, Merrill Lynch. You, too drank the sub-prime Kool-Aid; only you were smart enough to put yourself at the mercy of another company, rather than take your shaky chances with the U.S. government.
Back to the word of the day, EXPLOITATION. If you're a little confused about all of this "sub-prime" talk that you've been hearing throughout the past 12-18 months, let me try to break it down for you. First, like with many great American financial tragedies, the issue revolves around credit, more specifically, the access to credit. Though there are about 4 or 5 credit "levels", (usually associated with a score somewhere between 500 and 850), borrowers (credit seekers) are really split into two classes: prime and sub-prime. Prime refers to the best possible interest rate that any borrower can expect to receive, based on their credit history. Typically, a credit score around 700 sends borrowers to the prime window. Anything around 630 or lower, borrowers have to go stand on the sub-prime line; mind you, this is the line with the highest interest rates.
Enter the Housing Boom
About 5 to 7 years ago, the housing market was booming pretty much everywhere in America. As housing prices went up, so did the number of sub-prime mortgage applications. Only instead of most of these applications being denied (as they should have been), a great deal of the sub-prime loans were actually approved. What's worse are the "instruments" used to actually get these sub-prime mortgage loans approved. The most striking of which was the infamous "no income verification" loan. Yep, that's right. As recently as 24 months ago, virtually anyone could walk into a mortgage broker's office and apply for a mortgage, without having to verify their income... But I digress...
Now the idea behind the sub-prime boom was essentially this: since the housing market is rising at a clip of about 10 to 20% a year, if the borrower develops any problems repaying the loan, nothing to worry about because the home itself is the collateral. Borrower can't pay, no problem, they just refinance and tap the equity, right? But what happens if the housing bubble bursts, you ask? Hold on, I'll get to that....
Sub-Prime Packages
Mortgage brokers and other groups, who at the time specialized in sub-prime mortgages, packaged these sub-prime loans and sold them to the big ballers all Wall Street, who are always looking for a can't-miss fire sale. Here, it's important to point out that these sub-prime mortgages featured incredibly high interest rates, and most cases, crazy adjustable rates. And heere, it's also important to note that NONE of the Wall Street big ballers screened the sub-prime applicants. So they had no real idea of whether or not the loans could actually be paid back! But as soon as one of the big ballers began drinking the sub-prime Kool-Aid, here came the other ones, all just as thirsty as the next. And I mean these guys are gulping this stuff down, cup by cup...no, barrel by barrel is more like it. Some of the greedier big ballers, like Citigroup and HSBC, go back even for more. And some, like Bank of America and JP Morgan, get their fill rather quickly, only taking a few cups of the stuff. And still some, like Goldman Sachs, stay away from the suicide party altogether, never really drinking the sub-prime Kool-Aid at all.
The Housing Burst
Ever wonder why the mortgage brokers packaged those sub-prime loans and sold them to the big ballers on Wall Street? I'll tell you, they knew a bubble was coming. They knew a BIG bubble was coming. And they saw their opportunity to flip the situation to their benefit. (Here's where you realize how thin the line is between a seedy used car salesman and a seedy mortgage broker). So the housing bubble bursts, and prices start plummeting at the very same time that many home owners are falling into foreclosure. Ruh Roh! The Wall Street big ballers are in trouble. They have a massive stock of the worst kind of bad debt: unsellable homes in a declining housing market. Yikes! Did some one say, liquidity problem?
O.K., o.k, back to "exploitation," the word of the day. Having followed the breakdown I just presented, it's very clear that sub-prime borrowers were exploited. Then thereafter, the Wall Street big ballers were exploited. And today, on the heels of the Lehman Brothers bankruptcy filing, Merrill Lynch was further exploited. Bank of America swooped in and bought them at a true fire-sale price. But you have to wonder, is Merrill Lynch really being exploited by Bank of America, or are they the ones actually doing the exploiting? Note to Bank of America: check Merrill's books twice...then check 'em again.
Oh, there's one more group that has been exploited: former Lehman Brothers employees. Unfortunately, most of them had their pension valued in Lehman Brothers stock, which means that their pensions have effectively been wiped out...
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