A year ago we were all trying to figure out why Wall Street investors were pulling their investments out of stocks and sinking them into oil futures when these same investors knew very well that they were damaging the economy by driving up fuel prices. Yet that didn't stop them from doing it. That whole thing turned into a little circus ring with investors seeing oil futures going up and finding the temptation too great to pass up. The more investors dumped stocks and went for the oil futures, the more money there was in that market chasing after a fixed commodity, so the prices rose making the investment in oil futures even more tempting for other investors. Money seems to have a bubble mentality.
I never did figure out if the oil futures market wound up ahead on that game or lost their shirts when oil futures toppled.
But it's the mortgage securities market that really baffles me. We all know that investors lost their shirts on that one. I was thinking about that today and it occurred to me that it isn't really the bankers themselves that lost at that game. I mean, banks did lose but not as much as investors lost. It was a good game for banks. They made the loans, then packaged them and got their money back by selling those mortgages to investors. But really, what did investors see in low-interest mortgages? Why were they so hot to buy that crap when stocks were still on the rise? What made this market in low-return mortgages look more appealing to investors than actual productive stocks?
Clearly it wasn't the return on investment represented by mortgage interest. There had to be something besides interest that made these securities seem so appealing. But what?
The only thing I can think of is that the value of the property secured by these mortgages had some sort of appeal. Back in '03, '04, and to some extent '05 there was an attitude that real estate was a secure investment. But the security of real estate seemed to be rising. Property values were on the rise and seemed to be rising at a stronger rate every year. Mortgage investment strategy, the packaging of mortgages for sale to Wall Street investors and the seemingly endless supply of easy money for real estate purchases, was throwing ever more money at a limited commodity, housing. This extra money was driving up the prices of real estate. These rising prices seemed to offer security to investors so even more money came flooding in from Wall Street. That whole thing turned into a little circus ring with investors seeing real estate futures going up and finding the temptation too great to pass up.
There's only one hitch here...
There were only two ways for Wall Street to see any sort of "good" return on their investments in low-interest mortgages.
One was if the mortgages were short-term and the interest rates would be higher when the mortgages were renegotiated. Did Wall Street stand to gain this way? Was that part of the scheme? Somehow I doubt it. I doubt that the investors expected the homeowners to give them higher interest rates rather than refinancing the mortgages and leaving the investors with near-zero return.
The other way seems much more likely to me. The other way I'm referring to is that Wall Street could see gains if the mortgage became a foreclosure and the investor wound up holding a property whose value had inflated well above the value of the mortgage. With property prices rising like a space shot to the moon, that option must have had a very strong appeal to investors who knew the loans were being given to many people who simply did not have the ability to pay them off. Foreclosures were a sure thing.
So what was it that finally tipped over this apple cart?
It was Katrina when gasoline prices finally rose above $3.00 a gallon. Do we remember that? We were paying $3.10, $3.20, even $3.50 or more a gallon for a little while back then. The price soon came back down, but the scare altered the landscape of our economy. The scare scarred us.
For one thing it allowed the advocates of "peak oil" to convince us that there was a tipping point in the supply/demand scale for oil and that this tipping point was getting close. Talk of $5.00 and $10.00 gasoline didn't seem so far-fetched anymore. Gasoline had gone from $1.50 a gallon to $3.50 in just the first five years of the Bush Administration and the sky was the limit. We were actively alienating our suppliers around the world as well as our competitors and the future looked bleak.
So all of a sudden American home buyers began finding themselves a little short of money as they commuted in their new SUVs from their new far-suburban homes to work. Already the Federal Reserve Bank had decided there was a risk of commodity inflation so interest rates were on the way up. Low-interest credit was getting harder to find. But consumers were finding they had less money left each month to make house payments. They were paying too much of their income for heat and gasoline.
At first it must have looked like a wet dream come true for Wall Street. People would soon be foreclosing on property that was worth much more than what they paid for it.
Wet dreams rarely end well.
The only way most people would foreclose is if they had no way to sell their property and pay off the mortgage. The only way that would happen was if the value of the home was falling and had fallen below the current value of the mortgage.
Somehow Wall Street hadn't taken this into account -that is to say if my option two above was true, if Wall Street anticipated foreclosures as a part of the investment returns strategy. Wall Street anticipated foreclosures in an inflating property market. Instead, they got foreclosures in a deflating market. They got foreclosures in the only way that foreclosure made sense.
Maybe now with less money to throw around, we can find some stability for awhile. Maybe we can figure out a way to stop investors from building these ridiculous pyramid schemes that just wind up being clown and elephant filled circuses?
And why are there elephants in the circus and not donkeys?
Maybe this is like a high stakes poker game where there winds up being far more money on the table than entered the room in the players' pockets.