The other shoe

October 14th, 2010

The bailout of the US financial sector through the Troubled Assets Recovery Program (TARP) looks to have been fairly successful on its own terms – the banks have become profitable again and the final estimated loss to the government is relatively small. That doesn’t change the fact that the government took on huge risks for negative returns, without any reason to expect that the future behavior of the banks will change.

But all of that was based on assumptions of an orderly resolution of the mortgage crisis. Those assumptions now look very dubious, as the legal consequences of the practices of the financial sector during the bubble, ranging from sloppiness to outright fraud, manifest themselves.

First, foreclosure proceedings have ground to a halt as it has proved impossible to produce proper documentation. Even more striking is the latest scandal discovered by Felix Salmon (hat tip Brad DeLong).

It turns out that the Wall Street investment banks did perform due diligence on the mortgages they were being sold for repackaging into CDOs and other derivatives, and found that as many as half of those in typical samples were defective. Instead of killing the deal, they lowered the price they paid to the originating banks, and went ahead to sell the securities to investors, without telling them how bad the mortgages were.

Salmon gives chapter and verse on this and concludes “It’s going to be a very long time, I think, before the banking system is going to be free and clear of the nightmare it created during the boom.”

  1. SamB
    October 14th, 2010 at 12:46 | #1

    It is almost poetic … the company they outsourced due dilligence to was called … wait for it … “Clayton Holdings”!

    I guess they provide the due dulligence you have when you’re not having due dilligence!

  2. Andrew c
    October 14th, 2010 at 17:02 | #2

    The omplete lack of shame among the senior banking employees continues to gobsmack me.

  3. Alice
    October 14th, 2010 at 17:46 | #3

    @Andrew c
    Thats simply beacuse senior banking employees have been given so much global freedom – theirin the mistake. Banks are utilities in most cases.

  4. Alice
    October 14th, 2010 at 17:50 | #4

    sory – therein the mistake. Article in todays SMH about just this. The major banks have nowhere else to grow here yet they have shareholders breathing down their necks for growth – and govt guarantees – its logical they will sail into high risk ventures overseas that we in Australia may come to regret.
    I dont think the average saver in Australia (the source of their income) wants banks in high risk offshore expansions. Makes me nervous about banking my money with any of them. Ive just learned how a few have already been bailed out before the GFC (Wpac and Nationa).
    It gives me the creeps.

  5. James Haughton
    October 16th, 2010 at 17:53 | #5

    Two thousand six hundred years ago, Solon founded the Athenian democracy – in effect, western civilisation – by mass cancellation of debts on land, forbidding Athenians to be sold into slavery to redeem debts, freeing those already enslaved, and creating a democracy in which the poor had a vote, to ensure that the grotesque distortions of wealth and poverty to which Athens had sunk would never be repeated. He then left the country for ten years, in order to ensure that the citizenry didn’t keep making him dictator whenever something went wrong in the new order. The “shaking off of burdens”, or Seisachtheia, made Athens great. Why have we forgotten this founding myth and the lesson it teaches about the true role of landlords and debt?

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