It seems that there are now several dozen readers of my blog who both read and corroborate the information I have shared. As a result, they are asking increasingly sophisticated questions. The latest question is the question of why Lehman Brothers went bankrupt. Since they were selling certificates, not buying them, and they were not holding any receivable due from homeowners, how did they lose any money?
You are forgetting a major feature of the scheme. LB made no loans. It made payments as an intermediary pass-through funding source. The Source was an off-shore lender —- usually Credit Suisse, Deutsch or UBS. If they had just left it at that, they would have experienced no loss or liability.
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But they didn’t leave it at that, and neither did Bear Stearns, Merrill Lynch et al. Those were all second-tier players who could be and would be thrown under the bus when the scheme blew up.
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After securing the line of credit for offshore funding, LB would draw down what they needed to send money to the closing table with homeowners. Contemporaneously with that “closing” the LB would sell (1) certificates that were falsely labeled as Mortgage Backed Securities, (2) derivatives whose value was based on the certificates, and (3) minibonds (mostly in the Asian markets) consisting of hedge bets (Credit default swaps etc) deriving their value from the derivatives.
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LB was the issuer of these securities that were exempted from securities regulation by Congress and the President in 1998. As the issuer, it received the proceeds of the sale of these securities. That is where they made their profit (not from interest on “loans). The securities were issued under various names all 100% controlled by LB. Some of the names used were simply fictitious names that falsely represented the existence of a trust. Later, some of the trust names were registered — without any assets, beneficiaries, or powers vested in the name of the trustee.
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There was a theoretical 30-day gap between the loan from offshore sources and the closing of a sale of certificates to investors. LB and the other second-tier players leveraged that gap by borrowing more money than the one deal in anticipation of new deals. If the new deals happened, they then had the money to pay back the off-shore sources (from a fund sourced from the sales of certificates).
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LB began borrowing money and funding homeowner transactions well before the sale of the certificates, derivatives, and minibonds. In some cases, it operated in reverse, wherein LB sold the securities before borrowing any money and before funding any money at any “closing table” with the homeowners.
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As long as the homeowner signed the “loan” papers, there was no loan needed. But if the deals stopped like in 2008, then the investors had purchased certificates under false pretense — or at least under a scenario wherein there was a failure of condition subsequent. So the liability for the incomplete transaction switched from a liability to a lender to a liability to investors.
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But if there was an interruption of sales of certificates (like the 2008 crash), then the new deals were not happening, and LB was stuck having borrowed funds to advance to closing tables with homeowners without having any way to pay it back. As usual, having found a pot of gold, the “geniuses” on Wall Street concentrated on selling rather than risk analysis. It was too late when they finally discovered that they had stepped over the line.
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Our love affair with money gave rise to the presumption that if someone throws money around, the person must be rich and a brilliant businessman. As stated in Fiddler on the Roof, “because when you’re rich they think you really know.” As a result, we usually default to a position wherein we assume that the “geniuses” and titans” of Wall Street know what they are doing. They usually do not. All they know is that they want to sell another deal.
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Until lawmakers and law enforcement accept that basic truth about human nature and human knowledge, we will be stuck with an unending series of predatory schemes that undermine the general welfare of our country. There is no free market, and there is no capitalism unless the government acts as a referee to make sure there is an even playing field, which means that the participants in the marketplace are required to disclose information that would be material to the counterparty if they knew.
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But none of that is going to happen as long as legislators, law enforcement, and government agencies remain ignorant about the details of what is happening within their jurisdiction. That can only come from education. And education is apparently last on the list of priorities. Mandatory education of public officials is not even on the radar, even though we require it from all other professionals.
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Neil F Garfield, MBA, JD, 75, is a Florida licensed trial and appellate attorney since 1977. He has received multiple academic and achievement awards in business, accounting and law. He is a former investment banker, securities broker, securities analyst, and financial analyst.
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