NEW YORK
Rich and poor have tended to part company over the past decade as the buoyant tide of globalization raised more yachts than boats. So here is a touching tale of how the struggling and affluent are linked, all the way across the Atlantic.Christine Leroy, teacher, divorced mother of two, was offered a mortgage she could not believe for a cute bungalow in Sacramento, California. The deal from EHB (Ever Hopeful Bank) came with no verification of income or assets; a piggyback second loan to cover the down payment; and interest only at a teaser rate for the first two years.
"But what do I do when the rate bumps up in a couple of years?" she asked.
"Ha!" beamed Errol Sunny, the ever-smiling EHB broker specializing in 2-28 loans (2 years of bliss, 28 of purgatory). "You'll refinance. And by then you'll have a ton of home equity the way prices are skyrocketing."
Well, Leroy figured, if she ever had a problem making a payment she could always max out a credit card or get a new card from that MEC (Mind-bogglingly Easy Credit) outfit that kept pestering her with mailings.
As for Sunny, what did he care? He knew EHB could offload this sub-prime loan to some Wall Street outfit, probably BFM (Bamboozling Financial Mechanics), that would package it with some slightly less toxic loans and maybe a few good ones into an attractive mortgage security.
Sunny remembered vividly his first lesson from Dick Sharp, the veteran EHB chairman. "What do you do with plutonium?" Sharp had asked. "Dilute it a little!" The same principle applied to toxic loans: diversified, they lost some toxicity.
That is what BFM specialized in: diversification of risk, whatever risk actually meant. Risk had been re-priced on the basis that it did not exist.
Sunny, who sometimes caught himself saying "sub-crime" when he meant "sub-prime," knew an underwriter at BFM, Nick Cocktale, who specialized in assembling mortgage bonds.
Cocktale would take thousands of loans and divide them into high-, medium- and low-risk tranches. The blend was so nice, nobody ever thought about the likes of Leroy. "It's like making a good Daiquiri," Cocktale explained. "Has to be smooth."
The funny thing was Cocktale sometimes worked with the very people from ratings firms who would end up giving triple "A" grades to the securitized sub-prime loans once they had been suitably camouflaged in the mortgage bond. These firms naturally collected billions of dollars for their labors.
But what did the hedge funds or mutual funds care if the ratings on these high-yielding securities seemed a little generous? Hell, if the securities has been given a "B" rating, which is what Pakistan gets, or even a "C" like Ecuador, they might have been barred from buying the stuff and other outfits would have cashed in.
That is not the American way!
As it was, hedge funds could use high leverage - borrowing cheap to aggregate the spread between the low cost of short-term money and the high return on the mortgage securities. When a bond's return is higher than the cost of your borrowing, you're in a nice business - until, of course, things unravel.
As it would happen, one bank that ended up acquiring a mortgage bond whose collateral - yes, they called it collateral! - included Leroy's Sacramento loan was French. The bank, BPI (Banque de Promesses Infinies, or Bank of Infinite Promises), had a niche fund that favored these securities.
Its manager, Jean-Pierre Leroy (Sorbonne and Wharton), was shocked to discover in recent days that he could not put a fair value on his fund because he could not sell bonds backed by U.S. mortgages. "We 'ave to freeze the fund," he muttered before departing for a long lunch.
On his return, going through the paperwork, he was amazed by the sloppy credit standards on loans like one to a certain Leroy in California. "Maybe a long-lost relative," he mused, already thinking about the Chateau Latour he had set aside for dinner.
Christine Leroy, meanwhile, was hard pressed to afford a meal. Her equity stood at zero as house prices plunged. When she suggested refinancing, brokers laughed. Sunny was not returning her calls.
At their last meeting, Sunny, now unsmiling, had said: "In future, Christine, you must remember the distinction between liquidity and credit availability. You confused your liquid assets with the extent of your access to liabilities."
He added that after foreclosure and repossession, EHB might be prepared to rent her the bungalow on generous terms.
Email: rocohen@iht.com
1 comment:
the fact is, easy credit no longer exists, so things like taking out a mortgage can sometimes make you end up with negative equity. Its a good job there are Mortgage Bond to help out.
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