Originally published at www.thedollarlama.com
The New York Times reported on Saturday that Bear Stearns is acting to bail out one of its investment funds (Bear Stearns High-Grade Structured Credit Fund) as it experiences investment losses related to the subprime loan market. Here we see two opposite ends of the financial spectrum, acting together in their own shadows.
Follow me for a moment: Subprime borrowers are those with poor credit, who cannot qualify for traditional mortgages. In the aftermath of September 11th, 2001, interest rates plummeted and borrowers who could not otherwise have afforded to buy homes flocked to home ownership through subprime loans. This drove home values up, allowing more established borrowers to take out home equity loans or lines of credit and spend, spend spend in our economy. We showed those terrorists -- our economy leaped to life, our real estate surged in value and people who had never owned their own homes owned real estate.
A quiet look at how these loans are structured shows that they're not intended to be in place for very long -- after a couple of years (presumably during which time the borrowers have managed their money better than before and improved their credit scores, qualifying them to refinance into traditional mortgages) interest rates adjust, and the borrowers still in subprime loans face steeply higher payments.
Subprime loans are designed for responsible borrowers who know how to manage their money well and stay on top of their obligations -- and who have had a life experience (such as divorce, job loss or a health issue) which has negatively impacted their credit score.
Subprime loans are often taken out by people who are not honest with themselves about their spending habits -- people who spend more than they earn, who buy that which they cannot afford, trying to find happiness in the material culture of more, more more to which they are constantly exposed, through television, magazines and movies.
As it has happened, dramatic percentages of the subprime borrowers from the last few years have faced these interest rate (and payment) increases and walked away from their homes, defaulting on their loans. Banks have foreclosed on record numbers of homes, dumping them on the real estate market and depressing home values by ballooning inventories of homes for sale. Borrowers have lost their homes, any equity they've had and their credit reports have been trashed.
Which brings us back to the Bear Stearns High-Grade Structured Credit Fund, which invested in pools of these subprime loans and had earned investors annual returns of 12% to 18% for almost four years. As subprime loans defaulted, the Bear Stearns fund began to lose money (down 10% for the year 2007 by April) and the fund's investors began to demand their money back. The New York Times reported that Bear Stearns put up $1.5 billion of its own money, backed by $500 million from a group of investors including Citibank and Barclays.
They're covering the losses so that the fund's investors won't lose any money.
When 12% to 18% annual returns just aren't enough, Wall Street reaches into its pockets to make sure its largest investors don't lose money.
And it's all about more, more, more: More house than I can really afford; higher returns in our institutional investment portfolio. Both sides of the spectrum, dancing together from within their own shadows.