A collection of junk is not a diverse portfolio

Washington Post:

It was Wall Street's version of an inside joke: Take a motley collection of largely unwanted assets, repackage them into a new set of bonds, and name it after the pristine white-sand beaches of an exclusive New Jersey town where Katharine Hepburn once summered.

No one is laughing now.

The Merrill Lynch bond deal known as Mantoloking has ended up with a different punch line: proof of the frenzied, foolhardy drive for upfront fees that helped bring down the world's financial markets and trigger the largest federal bailout in history.

Wall Street firms thought they had a surefire way to profit from the booming real estate market without much risk to their companies. They engaged in a kind of financial alchemy, creating a trillion-dollar chain of securities on the back of subprime mortgages and other loans, which were sold to investors in private offerings that no government regulator scrutinized.

With these deals, known as collateralized debt obligations, the world glimpsed the raw power of unchecked financial markets operating full-throttle to the point of self-destruction. The cascading losses on CDO bonds have undermined the solvency of several large banks and obliterated the trust that is the bedrock of all functioning markets. The debacle also has called into question the competence of Wall Street, the independence of bond-rating firms, the prudence of insurers and the foresight of regulators.

Deals like Mantoloking were "the height of lunacy," says Joshua Rosner, a bond market expert who issued multiple warnings about lax lending standards during the past seven years, earning him status as an early prophet of the credit crisis.

So many of these bonds have become untouchable that they stand in the way of restoring the flow of credit that the global financial system needs to operate and that the economy needs to climb out of recession. Experts say that firm prices must be established for the bonds -- no matter how low they may go -- so the system can clear itself of these toxic assets.

Not only did no government agency or official try to stop the bond deals as they were selling, but Washington cheered this new market because it expanded homeownership -- at least until defaults started piling up.

"Wall Street and Washington acted in concert to provide an artificial sense of a safety net," said Julian Mann, a Los Angeles-based investment portfolio manager for First Pacific Advisors who looked over many CDO offerings.

Like many others, Mann faults Washington for failing to rein in the subprime market, with its many no-documentation, teaser-rate loans that extended credit to those who couldn't afford it and invited fraud. He also blames Wall Street for relying on elaborate models that predicted that default rates would be low when common sense screamed otherwise.

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There is much more. In fact it was the Democrats who blocked attempts to rein in the bad mortgages that were poured into these new instruments. It was Democrats who created the environment where lenders were forced to make the bad loans that made up the portfolios of the CDOs. There insistence on making bad loans set off a cascading failure that is dragging economies down worldwide. They have created a crisis and they hope to use to impose the evils of liberalism on the US economy for years into the future. The people whose control freak lending policies caused the debacle will prescribe control freak measures that will stifle the securities market.

This is not to say that the Wall Street firms made no mistakes. They made huge mistakes, and they had no fundamental understanding of the underlying problems embedded in the new securities they were issuing to feed this mortgage debacle. They have also paid a very heavy price for that failure. Unfortunately, the Democrats have not only not paid a political price for their con job on the economy, the have been rewarded with election victories that will allow them to construct a cover up.