Once Upon A Time On Skid Row

- A Play in Four Acts by BrotherGee

CAST OF CHARACTERS

"The Loan" = Sub-Prime Mortgages
"The Homeless Person" = Sub-Prime Mortgage Borrowers
"You" = Sub-Prime Mortgage Lenders
"Shylock Jones" = Fannie Mae and Freddie Mac
"Shifty the Banker" = AIG, Lehman Brothers, et al
"Investors" = Banks and Corporations All Over The World

ACT I - THE PREDATORY LENDER

You lend a Homeless Person (HP) $900. You tell him that he can pay you back $5 a month for five years, the first two years at no interest. In the third year, the interest on the loan will rise to 10%. The homeless guy says sure. Three years is such a long way down the road. Surely, he'll have a job by then. The total amount of the loan at maturity will be $978.The homeless guy has no cash, no assets, nothing. But you lend him $900. He signs a contract agreeing to your terms. Deal done. The homeless guy heads straight to the liqour store.

You then take this note, this "promise-to-pay" and sell it to someone else. We'll call him "Shylock Jones". Shylock agrees to give you $900 plus plus a "sweetener" of, say, $40. You pocket $940 and hand Shylock the loan contract. You have washed your hands of the matter. You have made $40 and can go on to make another $900 loan. The Homeless Person now owes Shylock Jones the $978.

Now, Shylock does not want to be bothered with collecting from the homeless guy. After all, they smell bad, carry disease, etc. So he asks YOU to continue collecting the payments. For this, he will allow you to take a small percentage of the monthly payment as your "fee", let's say 75 cents. You say, "sure thing!". The Homeless Person continues to make his monthly payments to you. As far as he is concerned, he owes this money to YOU. He has no idea who the heck Shylock Jones is.

ACT II - THE COLLATERALIZED DEBT OBLIGATION (CDO) a.k.a "HOMELESS-BACKED SECURITIES"

Shylock Jones is a clever man. He buys loans like these all the time. He knows darn well that these Homeless People's loans are very risky investments. He is too smart to hold onto them. So he bundles them together in "pools" or "baskets". Let's say, ten risky loans to a "pool", each loan just like the one given to the Homeless Person: $900 plus interest.

He divides the loan pools thusly:

Group A: three most risky loans - $2700 + $234 interest
Group B: three medium-risk loans - $2700 + $234 interest
Group C: four lowest-risk loans - $2700 + $234 interest

He has now "securitized" the loans. He has turned "debt obligations" into "investment-grade securities". The pool of loans (known as a "collateralized debt obligation" or CDO) is designed to pay a steady stream of monthly payments to whomever owns the CDO. Not only that, Shylock can "slice up" this security and sell "pieces" of it to different Investors. He can sell the Group "A" basket to Investor X, the Group "B" basket to Investor Y, etc. This results in mo' money for Shylock Jones in fees and commissions! He gets back $8,800-plus and makes additional money in fees by forwarding the monthly payments to the Investors. Now you AND Shylock Jones are both collecting commissions from the loan without owning the loan. Ain't High Finance grand?

So, class...here's is Pop Quiz #1. Who now owns the loan?

That's right! Investors "X", "Y", etc. are now "owners" of the loan. But not ALL of the loan, only a PORTION of the loan. The "risk" has been spread among many investors.

ACT III - THE CREDIT DEFAULT SWAP (CDS)

The Investors are not stupid either. They know how risky these "Homeless-Backed Securities" (HBS) are. So they go off to the side and buy themselves a little "insurance". They sign contracts with a guy named "Shifty the Banker". Shifty offers to insure these Investors from anything bad that happens to their HBS. They agree to pay Shifty $15 every three months in return for his promise to make good whenever any of their HBS go into default. Even better, he also promises to pay if certain events take place. Like if the homeless person ends up in the hospital, or drug rehab, or moves to a new neighborhood. These things are called "credit events". They act as "triggers". If any one of these events occur to an insured Investor, Shifty has to pay off IMMEDIATELY. IMMEDIATELY!!!

The contract just described is what is known as a "Credit Default Swap". It shifts the risk of holding those Homeless-Backed Securities from the Investors to "Shifty the Banker". Without this insurance, no right-minded Investor would buy these crappy securities.

"Shifty the Banker" has negotiated hundreds of these contracts. He collects his premiums and does really well. After all, what are the odds that the Homeless Persons involved in this scheme will all default at once? Shifty feels so confident that sometimes he even TRADES these contracts to OTHER people, who then take over the collection of premiums from the Investors.

ACT IV - THE COLLAPSE OF THE PYRAMID SCHEME SCENE

At the beginning of the third year, the interest rate on the loan rises from zero to 10%, as agreed. Now, the Homeless Person has to fork over $7.16 a month instead of $5. The HP balks. Heck, he was barely making the $5 payments! He simply can't do the extra two dollars. He's STILL HOMELESS, still has a negative net worth. So, he eventually stops making payments altogether. He realizes that being broke was easier!

Now, let's say that all the Homeless People who took out loans with you decide to walk away from THEIR payments as well.

Pop Quiz #2: What happens when a significant number of debtors default at once?

That's right! The "credit events" in the CDS contracts are triggered. "Shifty the Banker" is now obligated to make IMMEDIATE PAYMENT to all of the Investors who have credit insurance with him. The problem? Ol' Shifty, just like all bankers, is highly "leveraged". That means he doesn't have thousands and thousands of dollars of cash on hand. He's spent his premiums on luxuries, vacations, mistresses, etc. He now owes out thousands of dollars that he cannot immediately pay! "Shifty the Banker" is now in need of...

...a "Bailout". He goes to the rest of The Neighborhood, a neighborhood that he's never done anything for but to suck blood out of them, and ORDERS them to loan him thousands and thousands of dollars. He even threatens them with financial ruin if they don't give him what he's demanding.

Talk about chutzpah.

EPILOGUE

It is difficult to tell how much money Shifty will need because it is nearly impossible to determine the value of these "Homeless-Backed Securities". Remember when they were split up into "Groups"? What if Group "A" has all defaulted but Groups "B" and "C" are all paying as agreed? Does that make the whole security "bad"? Do you just count Group "A" in the bailout? Multiply the above scenario by the hundreds of thousands, perhaps millions(?) and you will have an idea of how this Global Crisis REALLY happened.

Final Pop Quiz #3: Who bears the MOST responsibility for this crisis?

Hmmm, you've got multiple choice there. I'll tell you who bears the least responsibility- THE NEIGHBORHOOD and THE HOMELESS PERSON. The Homeless Person knew he was destitute. Someone throws money at him, what's he supposed to do? Turn it down? The Neigborhood was minding their own business. Now, some bloodsucker is banging on their doors determined to turn their pockets inside-out???

There's plenty of blame to go around, plenty. But the "money men" are the ones who are deeply responsible for crafting this scheme KNOWING FULL WELL THAT IT WOULD EVENTUALLY END IN COLLAPSE!!

THIS WAS THE INTENT OF THE SCHEME ALL ALONG.

I hope this has been enlightening, and if not, then I hope it has at least been entertaining!

Finis

~~ G

Addendum: My math is way off and I apologize. The monthly payments should be $15. The loan at maturity should be $954, and the payments beginning in the third year should be $16.50. What's important is that there was a point to be made, and I hope that I have succeeded in making that point. I promise accuracy in the future.

Luv to all...