If only someone had been listening….

“The frenzy continues and prices increase because nobody dares to get out, and people fool themselves into thinking they are rich from this paper trail — until it collapses, which is exactly what is about to happen in our boom and bust economy”  — July, 2007

It’s hard to believe I wrote this piece back in mid-2007 before the storm. I have adjusted it and brought it up to date. If only anyone was listening. Back then I had around 50 visitors per month.

Enron was just one of a long series of scams starting back in the 1960’s with changes in the acctounting rules that prompted Briloff to Write Unaccountable Accounting.

The essence of the scam is simple: put the risk on some unsuspecting schmuck and take all the money. It is the middlemen — the accounting firms, the law firms, the rating agencies, the investment bankers, and yes, the banks that clean up. They never take the loss.

It is the small investor and the fund manager desperate to show short-term performance that support the scam. There are several segments of the economy that are empty shells — business plans composed of smoke and mirrors.

Whether it is Boston Market which gave the money to the franchisors to pay for the franchise, or Enron which institutionalized off balance sheet transactions, or WorldCom who posted huge profits in tight margin industries, or the late spate of derivative securities many of which by their very name imply high sophistication to mask their low-down fraudulent nature.

Some Chinese workers get paid a total of ten bucks to make a stick of furniture. The Chinese company that employs them gets 50 bucks. The Chinese manufacturer, sells the furniture to a jobber for $75. The jobber sells the piece to an American Distributor for $100. The Distributor sells the piece to a retail furniture outlet for $150. The retail store sells the piece to a customer for $800 with no money down and no payments until 2012. The customer signs — and here is where the real fun begins — his signed document is sold by the retailer to some pool aggregator for more than 100 cents on the dollar. The pool aggregator sells the debt to an investment banking entity (SPV) for $1600 and the Special Purpose Vehicle sells it to investors for $2,000 .

The investment banker packages an income fund and sells it through retail brokerage to Joe Schmuck (investor) on the street, as a derivative security (collateralized debt obligation, which sounds very safe), with a return of 12%. The truth is no money exchanged hands until Joe Schmuck ponied up the $2000. Then it is sent down the line and everyone gets paid.

But the companies are allowed under current accounting rules to report the “sale”, the income from the sale and later the write-down when some of the paper goes bad — and they do this without the first dollar put up by either the consumer who “purchased” the furniture or the investor who will purchase the CDO security. And then these “middleware” companies report higher earnings and more people buy their securities and on it goes.

The frenzy continues and prices increase because nobody dares to get out, and people fool themselves into thinking they are rich from this paper trail — until it collapses, which is exactly what is about to happen in our boom and bust economy. Joe Schmuck is the one who actually bought the furniture and doesn’t even know it much less use it.

Nobody cares whether the customer who received the furniture ever pays because they are not at risk (Joe Schmuck has all the risk), and nobody cares if Joe Schmuck loses all his money a couple of years later when the pyramid collapses, because he bought pursuant to an incomprehensible prospectus that is mind-numbing even to experienced securities attorneys.

The disclosures are all in there, couched in language that probably nobody understands including the author who plagiarized it from another prospectus which itself was created from cutting and pasting the work of others who cared all about form and nothing about substance. Whether it is “mortgage-backed securities” or anything else if you create free money people are going to chase it and take it. Lots of people made a lot of money on this scheme and variations of it.

They are all based on hiding risk, and skirting the intent of disclosure requirements. They all produce ridiculous sums of revenue and income for middlemen in exchange for merely showing up. None of the middlemen provide value added. That is the weakness of our economy and the culture behind it is what is pulling down our quality of goods and services, our expectations and even our hopes and dreams.

The reason why costs have gone down and prices have gone up is not just that the companies we see and know are making more money, which they are, but because, we have institutionalized it into a feeding frenzy that invited more middlemen in to share in the bounty.

The more people in the chain, the more complex it appears and the thus the more legitimate it appears (or at least, there is considerable doubt arising from the confusing array of transactions, that anyone can prove that anyone did anything wrong).

The net result is that consumers and investors get screwed. Consumers are lured by “free stuff” (like houses) and investors are lured by too good to be true returns. Nobody else puts up any money. And if the Consumer actually pays part or all of the price of the furniture, then there is even more money to split up with transaction, handling and customers service fees attached. 

It all comes down to a simple code of marketing in the investment banking world. If you are selling, make it complicated — then you can call it whatever you want and price it anyway you sell it. If you are buying make it simple and pay only when you understand what you are paying for…

9 Responses

  1. Sacramento-area man called the housing crash

    http://www.sacbee.com/topstories/story/2159808.html

    He sold high and bought low

    Thanks,
    Dan Edstrom

  2. Neil,
    How the heck is Brad doing??
    Andrew

  3. Check out what Academia says is to blame:

    http://www.dsnews.com/articles/study-brokers-minority-borrowers-to-blame-for-most-mortgage-delinquencies-2009-09-02

    Study: Brokers, Minority Borrowers to Blame for Most Mortgage Delinquencies
    09/02/2009 By: Adam Weinstein

    Residential mortgages originated by brokers at the height of the housing boom, as well as loans given to minority borrowers, are to blame for the lion’s share of delinquencies in the current recession, according to a study released this week by researchers at the Columbia Business School.

    The findings were reported in a working paper titled “Liar’s Loan? Effects of Origination Channel and Information Falsification on Mortgage Delinquency”, assembled by a team of finance and economics experts at the school. In a study of all the 721,767 loans that an unnamed “major national mortgage bank” opened between 2004 and 2008, the researchers found that loans originated by brokers were 50 percent likelier to be in arrears than loans originated by the banks themselves.

    The study also found “significantly higher delinquency rates among Hispanic and black borrowers” than among whites. But researchers stopped short of saying discriminatory lending practices by brokers and banks were the cause, instead attributing the discrepancy to “information and experience disparities resulting from a lack of prior home buying experience or exposure to mainstream financial institutions.”

    “Our analysis highlights two major agency problems underlying the mortgage crisis,” the report said. Those issues were “an agency problem between the bank and mortgage brokers that results in lower quality broker-originated loans, and an agency problem between banks and borrowers that results in information falsification by borrowers of low-documentation loans-known in the industry as Alt-A or ‘liars’ loans’-especially when originated through a broker.”

    The report also compared differences between well-documented borrowers and those who didn’t need to verify their incomes and histories and loan documents. It found that the less-documented borrowers who reported high incomes were far likelier to default than those whose high incomes were verified – suggestion that loans were made on misleading information.

    “We provide evidence of borrower information falsification at both individual variable and aggregate levels,” the report said.

    An author of the report put it more bluntly.

    “Low-doc borrowers had slightly better credit scores, slightly better incomes-slightly better everything,” Wei Jiang, an associate professor at Columbia, told the Wall Street Journal. “But we estimate that low-doc applicants exaggerated their income by about 20 percent on average.”

    The unnamed bank itself did not escape scrutiny, however. The Columbia researchers also asked “why this major mortgage bank-as well as other market players-allowed such deterioration in borrower and loan quality to persist before tightening its lending standards.”

    The analysts concluded that the securitization of mortgages, and selling of them to investors, essentially left the bank free to originate loans without regard for any true standard of the borrowers’ creditworthiness.

    “The expansion of the secondary mortgage market and the ease of loan securitization weakened the bank’s incentive to screen borrowers by allowing the bank to offload risk,” the study said.

  4. neil …must you be so honest,and if so , who’s gonna believe you ?
    not enough lies to sell the story sir.
    as nauseating as it sounds i believe you& your soooooooooo right.
    i’m sorry that the only legitimate reply that makes sense to me is..
    fuck em! i think i’m gonna hurl!

  5. zurenarrh: Your statement: “when you’ve done the research and try to tell them how it works, no one believes you…and so the fraud continues”, is exactly true. I can’t believe so many think these loan mods are real. I am hearing of many attorneys who are duping the homeowners out of $2-3,000. to do loan mods, only to later tell the homeowner that the modification was denied and told to file bankruptcy.

    Bank of America claims to have modified 6% and Wells Fargo modified 4% of “eligible” loans. What is their definition of eligible? Perhaps 4% of the .001% of the loans they have cooking in their books? It is now common knowledge that Bank of America et al do not own the loans. is there any proof that any loans were modified. I would like to review ALL the paperwork involved in these so-called modifications.

    Thanks for writing the article.

  6. Neil,

    you sir are the shit!

  7. Is this a great country or what?

  8. The truth is, the more complex a transaction is the more likly that it’s a scam.

  9. Great post. I wish I had been listening back when you wrote it. It’s only in the last year or so that I really started to understand the inherent fraud that is our economy.

    You’re doing a great job, Neil–providing a valuable source of information.

    What’s screwed up about all of this is that so few people know that what Neil described above is how the economy actually works. And you kind of have to make it a research project if you want to find out anything about it, which is why most people don’t. Then when you’ve done the research and try to tell them how it works, no one believes you…and so the fraud continues.

    But I do think the tide is turning…VERY slowly, but turning nonetheless.

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