Karl Denninger on Foreclosure-Gate: The Question Nobody Is Asking

10-10-2010 • Market-ticker.denninger.org/

So what we have here are two answers to "Why?" The deals were un-economic unless someone cheated. That is, there's only so much risk-adjusted "spread" in a particular lending transaction. The common law of business balance says that nobody ever works for free, and as a consequence the more hands that touch a deal the more that profit is dissipated among those hands. In a competitive market where multiple entities compete for business this means that the true yield available to at least some of the investors would always have to understate the risk of default, and therefore someone was always going to get screwed. On balance there's nothing unlawful about that, so long as you properly and fairly disclose everything about the deal - there's nothing that stops you from buying a thing that is disadvantageous to you. We take this risk every day when we, for example, buy a pack of cigarettes. The "pleasure" (such as it were) from smoking may come with a horrific cost (lung cancer); it was only when the Tobacco Companies tried to conceal this risk that they were held responsible. As the pyramid grew higher, the number of good borrowers was exhausted. To keep the charade going it was necessary to fund loans to "patsies" - the infamous "fog-a-mirror" lending. That would have been ok too, except that the lenders actively concealed the fact that the loans they were stuffing into the securities did not meet the standards under which they sold those resulting MBS to investors. So between #1 and #2, we have two things that would not be illegal if they were properly and fully disclosed, but if they were fairly and fully disclosed there would have been no money in securitizing these loans, as nobody would have bought them. To sell them, they had to cheat. And when the "caught" part of the cheating became apparent as housing prices started to collapse, they attempted to cheat again to cover up the earlier cheating, which is what you're seeing now. I wish I could tell you there's a simple way out of this. There isn't. Someone is going to get hosed; the question is "who"?