Thursday, November 13, 2008

Mortgage Backed Securities: A Serious Reaganomics Oversight?

The impact of unregulated Mortgage Backed Securities only reared its ugly head during the second half of 2007, turning the subprime mortgage crisis global. Human greed at it’s worst?

By: Ringo Bones

Well known for his staunchly laissez-faire economic policies, the former US president Ronald Reagan and his administration will forever be remembered for defending the underlying principles of American free enterprise. And also of promoting the Protestant Work Ethic as one of the leading principles that made the American economy what it was which made it outlast the former Soviet Union. But despite of the Reagan Administration’s sweeping economic reforms – affectionately nicknamed “Reaganomics” – that made the “Go-Go 80’s” possible. One of its serious oversights will forever mark the 1980’s as the “Decade of Greed”. Sadder still, the problem that drove our current global economy to the brink originated during this time period.

Back in 1977, Salomon Brothers and Bank of America jointly introduced the world’s first ever Mortgage Backed Securities or MBS. A college dropout initially hired to work in Salomon Brother’s mailroom, Lewis Ranieri, was assigned the task of selling these somewhat untested securities / bonds. Before the extensive Reagan Administration era lobbying in Capitol Hill made it available throughout America, Mortgage Backed Securities used to be legal in only 15 US states. Lewis Ranieri was then known to have a trader’s nerve and a salesman’s persuasiveness won lobbying battles in Washington that eventually removed legal and tax barriers against MBS. Ranieri then headed up a Salomon Brothers’ team that developed Collaterized Mortgage Obligations. Collaterized Mortgage Obligations are 2-year, 5-year, and 10-year Mortgage Backed Securities that are packaged to appeal to a variety of low, medium, and high-risk investors. Thus paving the way for the subprime mortgage crisis.

Though it is worth noting that the preexisting ideological climate of the Reagan Administration frequently confuses the Protestant Work Ethic with massive corporate earnings thus causing them to turn a blind eye when it comes to financial regulation. After all, it something earns money, then it must be good - right?

But everyone back then was too blind to see that Mortgage Backed Securities for all intents and purposes were high-risk bonds. As financial instruments, they are backed by more speculative or subprime mortgages, loans made out to high-risk borrowers. Which made them yield more interest than low-risk bonds. For 30 years or so, it was a veritable source of easy money until it triggered a subprime mortgage crisis that even hedge funds can’t even smooth out.

The incoming Obama Administration will now be facing a monumental task of solving a financial mess that can trace it’s roots back 30 or so years ago. It took 30 years of regulatory oversight to create our current financial crisis that is now sweeping across the entire world. Even the “greedy” people who caused this problem in the first place are no longer as rich as they used to be. And they used to claim that greed is good.

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