How a Bank turns your new loan into this years bonus
One of the more amazing features of American capitalism is the fact of bank failures in a system that makes making money as a bank so easy – it is perhaps the best proof that the best and the brightest are not running our financial institutions, just legacy folks with useful parents and mentors and good people skills to move in the social circles of the rich and corporate.
With the advent of the Federal Reserve System and the discount window, any bank has the ability to just get money from the Fed at a low interest rate and then loan it back to the government at a higher interest rate. It is hard to lose money in the round tripping of the governments money, but these “best and the brightest” find ways to mis-matched durations and cause losses. But this is a minor part of the game
The large current year bonus dollars are via the making of a mortgage loan. The current 30 year loan rate is about 4.0%. A bank tells an investor that they can sell them a pile of mortgages at that rate less a fee for the origination – usually amounting to around 0.25% if amortized over 30 years but worth about 3% of the loan face amount as an upfront payment.
The bank then tells you that it can’t go any lower that 5.5% because of your late telephone payment 5 years ago (yes, it as stupid as this) so now the bank has a stream of income not needed by the investor of the difference between 4% and 5.5%, or $1,500 per year, that it can sell, most likely in a package in a process called securitization (the pieces in this securitzation can be much more complicated but the thing in the end comes down to selling the excess payment in a securitization) which is worth in a 4% world about $25,000 of that $100,000.
So before the Bank has received the first payment from you on your new loan, it has made $28,000 ($25,000 plus $3,000) on your new $100,000 5.5% loan.
How in the world can the bank lose money? Well if you pay your CEO and friends $24,000 in bonuses, and some loans go bust triggering recoveries by the folks that bought the 30 year stream of $1500 and by the folks that that bought the mortgage itself but priced to yield 4%, that hit can be more than the $4,000 margin you left for yourself. But you need to be a greedy fool to get in this type of trouble (securitizations can be written so as to prevent any recovery problems for the bank but then they sell for less). The “best and the brightest”, once in trouble, are very good at keeping a straight face as they tell the government that they must pay that bonus to retain the “best and the brightest”.
Now the process can be bit more complicated with the pension fund investor giving its money to the bank for the eventual creation of a pool of mortgages that it will own (or it will only own tranches of those mortgages – parts of the repayment stream of money – if we have good bank salesmen), the bank puts the money in a wholesale-lender suspense account, then staff called mortgage originators bring in the loans. At this point the bank can take on more risk – it can buy a stripped bond at higher than 5.5% yield in the corporate market to repay the principal, and buy a tranch of just the interest payments on a poorer credit 8% loan that has a face amount of only $50,000, thereby covering the loan liability to the investor for interest – and with these two purchases, but now at more risk, it obtains more upfront cash for those bonuses.
And when our best and brightest get really stupid, they look for companies to buy that have poor business practice histories so that they can inherit their legal problems – say a Countrywide and Merrill Lynch going to BofA. BofA behavior before and after its Countrywide and Merrill Lynch purchase was greed as explained above, and not much else beyond fee gouging and over bonus’ing. But they now get a world where their own greedy behavior is added to the bad behavior of Countrywide and Merrill Lynch.
Heck of a situation for our best and brightest.
Now, is it time to talk about the behavior of Goldman and other investment banks and their fraud creation followed by their claiming to be simple investors who were hurt by the mortgage mess they started and promoted and lead?
Nah – Forget hedge fund/investment bank fraud and the greed and excessive risk taking for a bonus – lets go with the media and just call everything just some “poor business decisions” that mustn’t be reflected in lower pay for the “best and the brightest” lest they leave and take their “skills” elsewhere. /s