The Disease That Was Subprime Lending

Those who think that the subprime mess was an unfortunate accident that could not be anticipated by management should read a BusinessWeek story called Sex, Lies, and Subprime Mortgages. Fraud and trading of sexual favors for mortagages that could be bundled into hot securities were supposedly common, and whistle blowers were shut down by managers who didn't want the good times to end. What went on was literally criminal, and I suspect that the major Wall Street institutions simply turned blind eyes to everything in their quest of deals that could yield profits and a quick exit before the players got caught. Unfortunately, the collective moral depravity set off a chain reaction that we will be facing for years. It does make me wonder what similar may have gone on in credit default swaps, credit card-based CDOs, and other such debacles.

Credit Swaps are Old Friend

Virtually everyone going on in the media about the credit crisis keeps talking about the subprime mortgages, but there's little talk about the credit swaps which were the real force in knocking everything over. At his blog, billionaire investor Mark Cuban pointed out that the crash of 1987 also was triggered by schemes to insure leveraged investments. In each case, the sudden requirement to pay up as things went south was why companies had to "dump everything AND sell stock index futures to raise cash, which in turn lead to a crisis of confidence and deleveraging." And he makes an additional interesting point:

Which is the genesis of our problem in the US. Its not wrong to run with bull markets and leverage to the hilt. That can be a very good thing. But we have to make the upside based on investments, rather than financial engineering. Which is exactly why we have to change our tax code. We want to encourage investment, not financial engineering.

He suggests having zero capital gains tax on selling stocks and bonds bought during an IPO and held for five or more years, and if sold early it would become taxes as regular income. Cuban also would not allow stock to be borrowed against, requiring a sale instead. I understand the impulse, but it's my understanding that there are already types of financial deals that effectively transfer ownership of stock for periods of time. Although I see the impulse, I suspect this would be as easily walked around as other blockades that regulators and legislators have tried to erect. How can you keep legislators from loosening things up over time because they get entirely too much money from the financial services industries?