News Column

Banks Again Deal in Toxic Assets

Oct. 10, 2012

Daniel Schnettler


Bonds based on high-risk mortgages fueled the financial crisis, but four years later, Wall Street financial institutions have learnt little from the collapse of Lehman Brothers, and are again dealing in toxic assets.

After the venerable investment bank Lehman Brothers collapsed on September 15, 2008, unleashing a financial tsunami around the world, technical terminology like mortgage-backed securities and sub-prime mortgages became household words.

Sub-prime mortgages - sold to home buyers without the creditworthiness to qualify for the best interest rates - were a euphemism for high-risk loans.

High-interest bonds based on those sub-prime mortgages became a lucrative assembly line: for lenders to bundle into mortgage-backed securities, for rating agencies to give cursory approval, and for banks and other institutional investors to boost immediate returns while ignoring the theoretical risks that only later became much too real.

Mortgage-backed securities came close to bringing down the entire financial system.

Four years later, banks are again dealing in sub-prime mortgages. Investors, including large funds, are playing the game.

"That's basically the only spots that you can make money right now," said Anthony Scaramucci, founder and managing partner of the hedge fund SkyBridge Capital, with an eye on the European debt crisis and on global economic uncertainty.

Sub-prime mortgages are cheap, he told financial news channel CNBC. And many people on Wall Street appear to agree with him.

Just how much of an appetite investors have for mortgage-backed securities was shown in mid-August by the sale of the New York Federal Reserve Bank's portfolio of loans. During the financial crisis, the regional branch of the US central bank took over large amounts of toxic assets from the world's largest insurance company, AIG, which was in effect nationalized in an emergency bailout.

When those assets were re-sold years later, a bidding frenzy by banks allowed the New York Fed to turn a $6.6-billion profit.

Since the crisis, many of these bonds have been derided as toxic assets, as default rates soared on single-family homes and flats nationwide. Such mortgage-backed securities, which were expected to produce steady profits for decades, stopped paying interest and became worth just pennies on the dollar as the principal evaporated.

When the US real estate bubble burst in 2007, weaker borrowers in particular - who took out sub-prime loans with minimal equity, often in hopes of refinancing when rates were lower and values were higher - were frequently the first to default.

A disastrous chain reaction was set in motion, leading to the collapse of Lehman Brothers and shaking financial institutions in Europe and around the world - everyone who had snapped up mortgage-backed securities without looking closer at the underlying fundamentals.

Many banks only made it through the crisis with state help, and taxpayers are still hoping to get their money back.

The toxic titles of old are again attractive to investors because the US real estate market is slowly recovering, at least in some states. More people are working and want to buy a home, which in turn is producing signs that the national residential real estate market is stabilizing.

The ABX Index, issued by US financial information service Markit, which since 2006 has tracked the prices of mortgage-backed securities, has risen significantly since May.

However, there remains a risk of setbacks, including over the European sovereign debt crisis. The economic recovery in the United States remains bumpy, too.

The U.S. mortgage market is far from solid: for an estimated 11 million U.S. households, mortgages remain "under water," where the principal owed to the lender is greater than the current value of the property.

In this environment, sub-prime mortgages remain a risky bet.

Source: Copyright 2012 dpa Deutsche Presse-Agentur GmbH

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