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Hooray for the Market!

Subprime Lending and Shady Mortgages

by MATT VIDAL

Does anyone remember corporate ethics? This was the big economic issue after the collapse of Enron, WorldCom and other major companies at the beginning of the 21st century. Books were cooked, winks and nods acknowledged.

Enron and WorldCom used a range of fraudulent accounting practices: hiding debts, lying about profits, backdating contracts, understating costs, etc. Ultimately, both the energy and telecommunications sectors each saw one of their largest companies go bankrupt. The WorldCom bankruptcy was the biggest in US history.

We’ve gotten over that. The problem was one of corporate ethics, and it has been fixed some corporate governance legislation, criminal prosecution and moral outrage.

But the bad apples are back, this time in mortgage lending rather than accounting. Financial markets are currently reeling from a meltdown in the mortgage lending market, following shady financial dealings in the so-called subprime market, which serves borrowers with bad credit history.

The story in the mortgage lending sector is largely the same as in the earlier accounting scandals: shysters using opaque, complex financial instruments to conduct transactions, pump up markets, and manipulate hard working people.

The financial instruments in the subprime lending market are numerous and often esoteric. In the category of straight-up manipulation, we have questionable lending tactics that include offering home loans to borrowers who have no down payment, interest rates with low introductory levels that soon shoot to double digits, and prepayment penalties.

As recently reported by the New York Times, the country’s largest mortgage lender, Countrywide Financial, steered subprime borrowers into higher-cost loans — more profitable for Countrywide and more expensive than necessary for homebuyers — by using a computer system that excluded the cash reserves of borrowers.

At Countrywide and many of its competitors, mortgage lenders repackaged these shady loans and used them to back securities sold to investors. These mortgage-backed securities, which contributed to the housing market bubble, have come to wreak havoc in the credit markets. The crisis has intensified in recent weeks as major Wall Street hedge funds that had invested in mortgage-backed securities began to flop.

Questionable lending in the subprime market grew in a context of soaring real estate prices that gave a false sense of security to potential borrowers and homeowners. A steady stream of hot air fueled the housing markets, while seasoned investors happily bet away.

The warning signs were there — the explosion of dubious mortgages followed by increasing bankruptcies — and, indeed, a few hedge fund managers predicted the mortgage market meltdown and accordingly bet against subprime loans. Most investors, however, went along for the ride.

Countrywide was able to continue its subprime-driven strategy in large part because it was backed by banks and investors willing to give it a seemingly endless supply of money. After the contradictions of purely credit-driven growth came to a head, Countrywide’s share prices began to tumble and it had to secure over $11 billion in emergency loans.

What should be made of all this? For starters, consider the recent attempts to privatize social security. The current regime of goons in the White House tried to implement the long-standing conservative goal of taking the retirement security of the majority of the country’s workers and throwing it to the vicissitudes of the market.

The example of the mortgage market is instructive. It reminds of what capitalist markets consist: wild fluctuations, bubbles and drops, caused by extremely complex interdependencies in the political economy that are hard to understand, even for experts.

Schemers and cheaters trying to find opportunities to screw hard working people are an inevitable part of the system. But they distract attention from the economic system’s structural problems.

At an immediate level, the mortgage market crisis provides a reminder that turning social security over to the market is a bad idea.

At a deeper level, we can see that it’s not really the free market after all. Sure, people are exchanging things and the forces of supply and demand are felt.

But many of the forces behind these market fluctuations are institutional: Very complex financial instruments; winks and nods from regulators, analysts and auditors; and a whole range of economic transactions that are based on social conventions, unwritten rules, and long-term relations between key organizations and individuals.

More importantly, a key lesson here is not simply that "the market" is actually constituted at many levels by social institutions. Much of market behavior is driven more by the dynamics of capitalist organizations, rather than supply and demand creating efficient outcomes through price signals.

Why did major capitalist organizations such as Countrywide delve so aggressively into the subprime market? Quite simply, because the profit margins on subprime loans were higher than loans to prime investors. This is why we should expect schemers and cheaters, because at the end of the day, the name of the game is not efficiency-enhancing markets but profit-seeking organizations and individuals.

We are told, over and over, that it’s really all about the market, that this is the governing institution. But as left critics have been saying since Karl Marx, this line is simply part of the bourgeois ideology that works to mystify true workings of the economy.

The action is in organizations (and individuals) competing for profits. And whether these organizations seek their profits in the financial, manufacturing or service sector, they are the building blocks of an economic system that, in its regular workings, leaves not only scandal, but unemployment, underemployment, inequality and poverty in its wake.

MATT VIDAL is pursuing his doctorate at the University of Wisconsin in Madison. He can be reached at: mvidal@ssc.wisc.edu