Sub Prime Crisis Or Financial Engineering?

2008-09-07 Word Count: 734 Category: Investments

The current credit crisis, which many are suffering from to some extent or another is basically hinged upon two concepts most have never heard of and, if you have, possibly don't understand them fully or how they have been twisted and exploited to create the avalanche of problems in both the housing and banking industries. What many are calling the Credit Crisis or the Sub-Prime Contagion.

One might wonder, and correctly so, how the "Sub-Prime Crisis" has become such a big issue. Sub-Prime mortgages totaled $600 billion in 2006, accounting for about one-fifth of the U.S. home loan market. Large, but it is not statistically significant enough to ravage the entire banking industry, thus there must be another culprit. It is not Sub-Prime but Wall Street and its compatriots that have gotten us in this mess. One could call it the "Prime-Slime" crisis as every major and minor banking institution seems to be involved and / or affected by their own virus…a fraud of such gargantuan proportions we may never know its true size or extent but it is safe to say it makes Enron and World Com look like choir boys.

The only way a diseased patient is "healed" is to find the correct problem and then aggressively attack that cause point. The financial system seems endemic at this point, along with the housing system. Not to mention our government and its reactionary and ignorant meddling. It is all, of course, connected but we will only examine one piece of the equation in this article and that is the financial institutions and their continued role in financial disasters.

We could blame the price of oil, which many are doing, but I can tell you, being a student of that industry, that oil is the least of our problems. For the record, I am not an advocate of any oil company or industry. Oil is one of the cheapest commodities on the planet, relative to other commodities or services we consume all of which offer far less in value than power to our buildings, cars and civilization. This too is a subject so vast and entertaining it deserves its own space. In fact, a book as I believe the best thing that could happen to our country is $8/gallon gasoline.

Now that I have your attention, I want to point out that it is important to address the correct source of the "disease" before it can be corrected. And unless we do, it will continue unabated. All we have to do is look at history and the S&L and the Dot Com crises to see that nothing has changed except the size of the fraud and the players.

In fact, many are the same major players from Wall Street who helped create many of the problems of those crises reaped massive benefits from the Enron and World Com era, all based on a financial term known as Mark to Model, which I'll explain later so you can understand the true cause of the "disease" from which our economy is suffering. Unfortunately, the solutions to resolving the "disease" may not be very palatable.

One area is the lending process, which is called the sub prime crisis but which I have renamed the Prime-Slime crisis and the terms Mark to Market and Mark to Model - financial tools that were systemic in the Enron Era and the collective collapse of an entire industry: the Telecom Crisis and the Dot Com Bubble and are terms you should know.

Let's first examine the host of players and their roles: there is the Buyer of a home, the Developer or Builder of the home, the Bank or Mortgage company that loans the money, the group that acquires these loans, usually Freddie Mac and Fannie Mae (both public company's) and a host of others, and then there is Wall Street, the wizards of finance who acquire large amounts of portfolios of loans from Freddie and Fannie and the Rating Agencies appointed by the SEC to ensure that each company has a rating relative to its risk to repay its debt to protect investors by rating companies and their ability to repay their obligations. Then there are the Buyers that Wall Street convinces to buy these packaged loans who expect dividends, backed by these "highly secure assets".

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Gary Cardone earned his degree in Marketing and Economics from McNeese State University. He is a consultant for a number of private firms offering management tools, financing options and business development and is interested in helping people understand what is really happening.