Saturday, October 27, 2007
Investigating The Sub-Prime Mortgage Crisis
Sub-Prime Mortgage Crisis - Step By Step
There is still a huge issue that needs investigation by the financial reporters in New York and London, and that is who knew what about the Sub-Prime Mortgage fiasco while it was unfolding in the financial markets. What is clearly reported by the investigators so far is that Sub-Prime Loans from many mortgage companies in the U.S. were incorrectly credit rated and sold as higher credit loans to other financial institutions in the U.S. and other parts of the world. It has been reported as an example that two hedge funds run by Bear Stearns invested in these mortgages, but what is not so clearly reported is where the equity went after that. Hedge funds probably want to make a profit so they would probably re-package the debt and sell the mortgages to other financial institutions through some form of swap.
As the story continues, the question becomes: how many financial institutions did these deals with the sub-prime mortgage companies and where were the Risk Management Analysts, Associates and Vice-Presidents of the Investment Banks when all these deals were happening? Is it true that someone could buy a 100 million dollar loan portfolio without verifying the credit integrity at the source? Or if people knew the loans were incorrectly risk rated, why did they not say anything? Could that many people be so ignorant or was it part of a larger game? Which hedge funds or private equity companies took highly leveraged positions in significant companies using loans originated from these swapped mortgages?
The reason why the answer to these questions is important and needs to be resolved, is that if we allow the integrity of financial institutions to move from absolute truth to something else, then the whole foundation will be questionable. We are in more danger by covering this up than by dissecting what went wrong, and who the key players were that caused the mess in the first place. The other question is whether this process is still ongoing and what further mess we are creating by not getting to the bottom of it.
If some of the private equity houses are out in the markets at this very moment buying solid asset companies (with real cash on the books) using borrowed capital that has no real asset backing and sourced from the original sub-prime mortgages, then to allow this process to continue will enlarge the crisis further. The SEC (Securities and Exchange Commission) and the European Financial Regulators need to investigate all Investment Banks as to what their real exposure is to curtail any further nonsense.
One has to praise Merrill Lynch's Chief Executive Stanley O'Neal for disclosing on Wednesday the full 7.9 billion USD Q3 hit his bank would take for the writedown against bad CDO's, Sub-Prime Mortgages, and complex debt instruments. It also shows he is a true leader of his company and can come before the analysts and expose the full extent of his bank's errors and then outline the forward strategy that Merrill will take. Some analysts were negative about this, but for a general investor, Merrill Lynch looks like an honest bank to deal with from these actions, and builds a sense of confidence for the future.
Some other investment bank analysts have criticized Merrill Lynch for their performance today, but the question investors will want to know is who has hung most of their dirty laundry and is now ready to buy new clothes.