All the Devils Are Here [158]
The poor level of disclosure in CDO prospectuses, Ranieri says, “makes the risk levels neither readily apparent nor easily quantifiable.” You can hear the anger in his voice. “This. Is. A. Private. Securities. Market,” he says evenly. “It gets sold to the public. It gets sold to foreign investors who, I will tell you, don’t have a clue. It is supposed to be equal information that is available to all.”
When Ranieri finishes, an audience member asks a simple question: “What do you see as the less than rosy scenario when the mortgage market goes into the toilet?”
“I don’t understand what the ripple effects would be,” he replies. “All sorts of people are holding risks that would be hard to track down. And in some cases they wouldn’t even know they are holding the risk.”
Scene 4: Same place, same morning. “Finally,” Josh Rosner thinks to himself as he listens to Ranieri. “Someone is calling it as it is.”
Rosner is the skeptical analyst who back in 2001 wrote the prescient paper “A Home without Equity Is Just a Rental with Debt.” In mid-2005, his sources at the Fed start telling him that rates are going to rise significantly, in no small part to “cure” the excess speculation in housing. He is soon warning clients that the housing market has peaked.
In recent years, Rosner has continued to dig into the numbers underlying the housing boom. It is apparent, he says, that “we’ve bumped up against the law of large numbers in homeownership.” At the end of 2000, the official homeownership figure stood at 67.4 percent. Four years later, with the subprime bubble well under way, the homeownership rate hits 69 percent. That is as high as it will ever go. All of that craziness—not just the bad loans themselves, but the devastated neighborhoods, the people thrown out of their homes, the huge buildup of debt on both Main Street and Wall Street—for a gain of 1.6 percent? Is it really worth it?
To Rosner, the answer is clear: no. His data shows that most of the frenzy hasn’t even been about purchasing a place to live. Rosner’s eureka moment comes when he sees data showing that about 35 percent of the mortgages used to purchase homes in 2004 and 2005 are not for primary residences, but for second homes and investment properties. And as he has been saying for years, the number of people borrowing to buy an actual home is dwarfed by the number of people borrowing to refinance. The refis, in turn, are made possible by rising home values—which may not even be real, given all the inflated appraisals. (In fact, Alan Greenspan himself noted in a study he co-authored in 2007 that about four-fifths of the rise in mortgage debt from 1990 to 2006 was due to the “discretionary extraction of home equity.”)
Like Ranieri, Rosner has become worried about the CDO market. Around the same time as Ranieri’s speech, Rosner approaches a finance professor at Drexel University, Joseph Mason, to co-author a paper with him. They deliver it in February 2007 at the Hudson Institute. The title is a mouthful: “How Resilient Are Mortgage Backed Securities to Collateralized Debt Obligation Market Disruptions?” Their conclusions, however, are straightforward. The issuance of CDOs, which have mushroomed to more than $500 billion in 2006, is propping up the housing market by buying almost all of the riskier tranches of mortgage-backed securities. Investors—real investors, who are not part of the daisy chain—no longer want them. Even investment-grade CDOs will lose money if home prices