25-Dec-2007 Melbourne – By Les Lothringer
The accusation of endemic, pervasive corruption that foreign critics of China, particularly Americans, level at it is now rendered passe, unfashionable in light of the systemic, widespread and criminal fraud that defines the American financial system and its manipulations of securitized mortgage debt. Bonused senior banking executives, commissioned valuation officers and just about everybody in-between, including the rating agencies, have operated and co-operated to manipulate the mortgages system for their own financial gains. And the evidence is in the documentation trails in every part of the American banking system.
The properties that ultimately back the value of those mortgage financial instruments are declining in value. Goldman Sachs recently forecast a 40% decline in Californian house prices! China and other Asian sovereign and bank investors have been very large buyers of these securitized debt instruments. Yet they remain noticeably quiet about the extent of their doubtless considerable holdings, publicly that is. It is probable that their investments have become, or will become, a fraction of the worth that they were rated at and so paid for. What might they do about that?
The fundamental problem in the American mortgage market is not that mortgage rates will reset and so force even more defaults and distressed property sales – problems nonetheless and profit opportunities for finance market traders who saw the recent decline [AKA working both sides of the street]. The problem is something else and one well understood by finance industry insiders, as they scramble to extricate themselves from the real possibility of criminal charges and jail.
That problem is origination fraud and thus where fraudulent misrepresentation formed a part of securitized debt sales, mortgage debt investors could well force these banks to take back their bonds. Naturally those banks do not want to do that. Nor quite possibly the sovereign fund bond holders either. These bonds may be now worth or will become a fraction of their “value” and as there is so much of this toxic debt, a mark to market valuation would render those banks insolvent with some bank executives looking at “Enron” like prosecutions. Sarbanes-Oxley proved useless, but that should have been obvious to anyone who read it.
Obvious too is that integrity is no longer a part of a finance industry executive’s job specification and even the big external auditing firms have worked within their usual low standard of not being paid to detect material fraud, no matter how large or obvious. Ditto the executive recruiters who are likewise pretty well useless at assessing integrity and honesty in job candidates and both these professional groups fail to approximate to the slightest degree their relentless self promotions of professional excellence. This makes them natural partners to a delinquent American finance system.
Interest rate reductions by the US Federal Reserve can not fix this. Interest rates will be heading up because the increase in the money supply is causing inflation. The argument now is not about a US recession but whether it is to be a soft one or a hard one. I would not be banking on a soft one. This boom will come to an end soon enough now.
Does China now hold an even stronger hand of cards? – a positive trade deficit and a trillion plus US dollars which it is keen to convert to US equity investments – and now a holder of fraudulently promoted and priced mortgage bond investments. Just how do they deal with a US Treasury Secretary who was heading up a bank that was also involved in mortgage debt origination? Or the major New York banks that are also being relied upon to solve the sub-prime problem, being the ones who both created it and profited immensely from it? It is not all that difficult to work out.
Of course the banks that sold these faulty instruments should take them back and revalue them. Bank bankruptcies and jail for their executives should result, so they will not do that. Might Chinese bond holders litigate? The possibility of successful legal action and staggeringly large liabilities, the drawn out and very public displays of how financial markets have corruptly operated and the debilitating impact on the banks is enough to make them very negotiable.
At the most basic level and with their usual regard for self-preservation, Main street bankers have started selling equity to foreign sovereign funds. It cannot possibly stop here for the write-downs will continue through 2008. Their stellar twenty year plus off-balance sheet manipulations have reached their zenith and, right now, banks just no longer trust each other to lend. They ought to know.
Interesting times indeed.