Designing financial instruments which destroy lives

Fact: Those with wealth seek to invest in varioùs assets which have the best return.

Sometimes financial instruments have been designed to fill the shortfall in asset availability.

Many of us have suffered after these machinations inevitably turn foul.

Many ideas central to financial mathematics began with betting … The scientists who cracked blackjack and roulette in the 1960s and ’70s eventually moved into finance, tired of the attention from casino security. To them, the divide was superficial. Like the modern teams tackling sports betting, they just saw another market, another set of inefficiencies, and another game to be beaten.

Adam Kucharski, May 2016,

It seems the gambling addiction practised in the world of finance has been given a divine status which allows detachment and impunity from being seen as it should be, a major harm to life itself.

Ann Pettifor describes the fallout from the 2007-9 financial crisis and mismanagement:

Among the safest assets are US government bonds (US ‘treasuries’) and British government bonds (‘gilts’). Unfortunately the slump of 2007–09 and its aftermath cut government tax revenues dramatically, as firms failed, individuals lost employment and wages fell in real terms. Instead of supporting the heavily indebted private sector by expanding public investment, increasing employment and supporting wages after the crisis, western governments responded to the slump by cutting spending further. This meant that governments stopped borrowing, and the issue of government bonds declined. At about the same time, central banks embarked on quantitative easing and, by purchasing government bonds and placing them on their balance sheets, helped create a shortage of such safe assets. As a consequence, the prices of all assets have risen, including government bonds, and the yields (the return an investor will realize on a bond) have fallen – in some cases to negative levels! Because of these low yields (returns) and this shortage of bonds, capitalists have to park their funds in other assets. The most attractive asset is property: valuable and scarce real estate in, for example, inner London, New York City or Hong Kong. The outcome of low yields on government bonds is the massive inflation of property prices – which in turn has led to a form of ‘social cleansing’ as prices rocket and ordinary Londoners, for example, can no longer afford to purchase property or pay high rents.

Charles R. Morris, in his book ‘The Two Trillion Dollar Meltdown’ takes us into 1994 and the dark world of Wall Street activities which:

took low quality mortgages and created the subprime market. These mortgages became structured Bonds called CMO’s (collateralized mortgage obligations). These bonds were then ‘tiered in horizontal slices, or tranches, and portfolio cash flows were preferentially directed to the top tranches. Since the top tranches had first claim on cash flows, they qualified for the highest investment-grade ratings. The bottom tranches absorbed all the initial defaults but paid high yields. The mix of very high-quality, high-rated instruments plus a smaller quantity of high-yield, high-risk paper matched up well with the preference of long-term investors. Wall Street inevitably pushed the tranching technology to an extreme, triggering a serious mortgage-market crash in 1994.

Efforts were made to redesign the mortgage market into Residential Mortgage Backed-securities (RMBS). These became the standard element in most big investor portfolios.

Next came the CMBS (commercial mortgage-backed securities)

pioneered by the federal agency charged with selling off multibillion of commercial mortgages acquired from failed S&Ls…..tailored to their underlying assets….don’t lend themselves to pooling. The solution was to involve the rating agencies in the construction of the pool. Banks would assemble a detailed profile for each property on a projected pool – it’s financials, management, tenant histoŕy, maintenance records and mortgage details. The rating agencies used proprietary models to estimate default risk and actively negotiated the pool structure – rejuggling properties to improve geographic diversity, or insisting on more buildings with long-term, blue-chip tenants. A typical CMBS had five or six tranches…….

This process enabled asset-backed securities (ABS) to “finance equipment, transportation fleets, or anything else investors could value”

In turn this led to commercial banks use of CBOs (collateralized bond obligations) and investment banks ‘experimented with CLOs (collateralized loan obligations) and the generic name for all types of securitized assets was CDOs (collateralized debt obligations).

“For banks, selling assets and liabilities off their balance sheets reduces strain on regulatory capital; for companies, it lowers apparent debt.”

Morris goes on to write most fascinatingly how each step of this process opened the floodgates which led to

The notional value of credit default swaps-that is, the size of portfolios covered by default agreements-grew from $1 trillion in 2001 to $45 trillion by mid-2007.

Lives destroyed:

What Is the Link Between Homeownership and the American Dream?

In many ways, the American Dream is a concept of optimism. It implies equal opportunity and that any individual can aspire to financial stability and even superior wealth—regardless of their background—through hard work, entrepreneurial ventures, or other means. A large component of financial stability and the American Dream is owning your own home. The Great Recession and the ensuing housing collapse in 2008 cast doubt on the so-called “American Dream.” The economic crisis precipitated by the 2020 lockdowns and job losses didn’t help.

The American Dream is now considered out of reach for many groups in American society. This article focuses on how 2008 started to dismantle it.

The pain goes on to the present day:

About borderslynn

Retired, living in the Scottish Borders after living most of my life in cities in England. I can now indulge my interest in all aspects of living close to nature in a wild landscape. I live on what was once the Iapetus Ocean which took millions of years to travel from the Southern Hemisphere to here in the Northern Hemisphere. That set me thinking and questioning and seeking answers. In 1998 I co-wrote Millennium Countdown (US)/ A Business Guide to the Year 2000 (UK) see
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