My two regular readers will note that this is a bit off-topic in that it discusses financial matters rather than energy matters; but it is related in a tangential manner. The energy industries require financing, whether the technology is solar, wind, wave, geothermal, solid waste conversion, natural gas, coal, nuclear, or whatever. If the credit markets are non-functional, then every such project is in jeopardy.
Years ago, a bank or other lending institution held the loans it made until maturity. The bank made money by a small upfront fee, and by the interest collected over the life of the loan. More recently, banks would sell the loan to obtain cash in hand in order to make more loans at a faster pace than simply waiting for the monthly payments with interest to come in.
The lenders made money by charging points and other fees on each transaction. The more loans that were made in a given month, the more money the bank made from those points and fees.
Where things began to unravel was derivatives. A mortgage loan, or more accurately, a package of mortgage loans, was sliced up into tranches, each paying a different interest rate, from high to low. Investors could then buy the tranche that suited their appetite for risk/return. The low-risk tranche may have paid as little as 5 percent on a loan that was made at 8 percent interest rate. The highest risk tranche may have paid 12 percent interest. But, if the property values declined, the highest risk tranche would be worthless, as it was the last in line to be paid if the properties were foreclosed. It did not require much of a decline in the real estate values for the highest risk tranches to be worth zero. And that is one of the primary causes of the present crisis.
One may have read about worthless securities, yet it is obvious that real estate prices did not decrease to zero. In many areas, real estate prices declined only 30 percent or so.
Former President Clinton was quoted recently as admitting he should have regulated the tranches and associated transactions more carefully during his 8 year presidency.
Until this problem is addressed, the financial markets will not regain stability, or investor confidence. Having a significant portion of a bank’s assets (or other institutions that purchase the mortgage-backed securities) with the potential to be worthless after a small decrease in real estate prices is a relatively new phenomenon and must be addressed. I try to follow this in my spare time, but have not read anything on the Obama administration's changes to this aspect of finance.
Roger E. Sowell, Esq. legal website is here.
aka energyguy on townhall.com
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