The news that real estate broker Ed Ahmad had plead ?guilty? to ? bank and wire fraud that included conspiracy? to defraud various lending institutions by doing false appraisals of the values of properties, created quite a stir in his native Guyana and in the large expatriate community centred in Richmond Hill, Queens, New York. But behind the sad denouement in this Horatio Alger Guyanese-American success story, lies a larger tale of a dysfunctional financial system that facilitated the fall, but one which the authorities refuse to fix.
Ed Ahmad?s rise and fall is a product of the U.S. subprime crisis that was created way back in the 1980s. The ?securitization? of mortgages by private institutions turned the staid mortgage business into a go-go casino. The traditional mortgage model involved a bank originating a loan to the borrower/homeowner and retaining the credit (default) risk. Securitization is a process whereby loans or other income generating assets are bundled to create bonds which can be sold to investors.
Started by some U.S. government mortgage institutions, it also became a process through which the biggest private financial institutions realised they could spin straw into gold. Unlike the government, they pooled non-conforming mortgages and generally did not guarantee the bonds against default of the underlying mortgages. That is, they had no responsibility since they transferred both interest rate risk and default risk to the purchaser with their mortgage-backed securities and collateralized debt obligations (CDO). ?Through a formula there was theoretically always a fraction that would ?perform? ? and these could now be sold as AAA.
Not surprisingly, the practice encouraged what is understatedly called ?moral hazard? since the processing of mortgage transactions was incentivized but ensuring their credit quality was not. High-risk mortgages were now demanded. In other words, brokers like Ed Ahmad were encouraged ? even pressured ? to push through mortgages without credit checks. The government itself did its part by pushing the notion that home ownership by the poorest Americans ought to be facilitated.
?Subprime mortgages?, made out to borrowers with lower credit ratings skyrocketed. As a result of the borrower?s lowered credit rating, lending institutions charge higher interest than in conventional mortgages in order to compensate themselves for carrying more risk. One typical variety, sold by people like Ahmad, was the 2/28 Adjustable Rate Mortgage (ARM) loan, known as a ?hybrid? mortgage. The ?2? stands for the first two years of the mortgage loan, which have a fixed rate. The ?28? represents the next 28 years of the loan which have an adjustable rate and are subject to interest rate adjustments approximately every six months.
Most often, people obtaining a 2/28 loan consider it a temporary situation and intend to refinance within those first two years because of the potential of high interest adjustments making their payments skyrocket. 2/28 ARMs have a ceiling rate like any adjustable rate mortgage, but this rate can be upwards of 13 per cent. Clients take the risk, because in a booming real estate market they can always refinance with second mortgages. Ahmad?s clients claim that they were not aware of the implications, but in the real estate market it was always ?caveat emptor?.
By March 2007, with the value of American subprime mortgages estimated at US$1.3 trillion, the United States housing bubble burst and the demands of the NINJA home mortgages (no income, no jobs or assets) came home to roost. Millions of borrowers who had boasted about their ?assets? locked up in their homes could not make their payments. For them the foreclosures that threw them into the streets was a tragedy.
But for the banks and other financial institutions that sold billions of dollars of securities backed by the mortgages it was just a blip in their spinning of gold from straw. They were ?too big to fail?, received bailouts from the government, and are now busy throwing people into the streets. They were not jailed.
Source: http://www.guyanatimesgy.com/?p=2614
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