Survival__ Structuring Prosperity for Yourself and the Nation - Charles George Smith [110]
Again the most desirable client is one who has the worst financial habits, not the one with the best. There is a reason that someone who carries a balance gets a higher credit score than someone who pays off the balance. All is swell at least until that underwater client defaults with thousand of others. Not even the industry written bankruptcy "reform" will hold the tide as that happens in increasing numbers.
Banks
Banks, in this "new era," expanded their traditional lending operations into broader "financial services." There was more money to be made and more market share to grab by creating a whole new host of products built around "servicing" loans (rather than just collecting them), providing financial advice, and establishing credit lines. Especially as money becomes cheaper and cheaper (i.e. the Federal Reserve sets effective bank lending rates near zero), the effective marginal profit from straight lending dwindles. Banks cannot pay anything lower than a quarter percent to savers, and competition forces the lending percentages down. Since traditional reserves are based on capital from savings (considered a liability), the pressure mounts to find a way to "capitalize" through debt.
So banks "branched out" in tune with "successful" lobbying and deregulation. This created both conflicts of interests and dangerous precedents, effectively merging banking with insurance and investment brokering. Maintaining capital reserves became a quaint notion because money lying around was so "unproductive." A myth arose that money would always be there and interest always low. This myth has proven, of course, false. Even with low interest, there is now a liquidity crisis, because real wealth was siphoned off by unproductive and no-value-added services, either stored as private wealth in opaque Swiss bank accounts, invested in worthless crap (like credit default swaps), or dumped into plunging markets (like housing).
Credit default swaps (CDS’s)
I’ve already written many essays on this subject, so I will only summarize the transparent fraud perpetrated under these "vehicles." CDS’s are unregulated insurance against defaults on loans. Though the mechanisms have not been officially investigated and audited, it does not take a genius to conclude that AIG and others could "guarantee" loans and receives premiums for nothing, that is, without actually possessing any reserve capital or exchange service at all. Using their once respected reputation as collateral, and dubious investments conveniently and generously assigned value by their own accountants, these institutions could create cash flow without providing anything in return except assurances. No wonder these vehicles were so attractive.
This would be like you or me receiving nice batches of money from our neighbors to insure against their houses being destroyed by fire, using our own house as collateral, with all of us living in the middle of a tinder-dry pine forest. The fire simply is going happen sooner rather than later with these conditions (akin to the poor fundamentals in the economy), and you and I won’t have anything left with which to pay others. However, we will have a huge private stash created by the fees and premiums we have charged and the bonuses we’ve given ourselves. This, at least, could help us rebuild our own mansions.
Housing
According to any kind of fundamental analysis, the transparent irrationality of house prices could not have been clearer. Real incomes have been flat or declining over the last decade, even though productivity rose substantially. Purchased houses in overheated markets required monthly payments three times what is would cost to rent the same house. Some people were paying as much as 10, even 20, times their salaries to buy a house. (I remember a newspaper report of a 750,000-dollar house bought on a 40,000-dollar/year salary.)