Investment Banks Feeling The Pinch

Yesterday a co-worker told me about the problem Bear Sterns was facing, requiring a request for funds from the US government to prevent the investment bank from failing. My co-worker's comment: “I thought you said that banks weren't the ones suffering the fallout from the sub-prime and ARM loans! But here's a big one on the verge of bankruptcy!”

But I stand by my statement to my co-worker. You'll find that commercial and 'regular' banks, such as mutuals and so on, aren't suffering much from the effects of foreclosures on homes with sub-prime mortgages or adjustable rate mortgages (or ARMs). Most learned their lessons back in the late 1980's/early 1990's when the housing market collapsed and banks were left with billions in underperforming or non-performing home loans. In New Hampshire alone over $1.3 billion of real estate went into foreclosure and five major banks failed. That happened because the banks gave mortgages to borrowers who weren't qualified for the amounts the banks lent and when the recession hit they could no longer make the payments.

This time around the traditional banks stayed out of the mess. But the investment banks, which are really investment firms or brokers and not what one would normally think of as banks, took the gamble and lost. They saw no problem with taking the risk, seeing the potential for huge profits. But I have to wonder if these firms let visions of huge profits blind them to the downside of the loans and signs of encroaching weakness in the housing market. Those with sub-prime mortgages and ARMs also gambled (though some receiving these mortgages were misled by the mortgage brokers writing the loans), figuring if they got behind they could sell their homes and get out from under the loans. But the housing market cooled off, homes were no longer selling quickly and prices fell. Some mortgagees, even if they were able to sell, found their homes sold for less than what they owed. Even after the sale they still owed the mortgage holder thousands, if not tens of thousands of dollars.

Why would anyone in their right mind lend to someone with little or no downpayment and with a poor or non-existent credit history? It was a gamble, no different from laying down a bet in a casino in Las Vegas. They lost and now they want the taxpayers to cover their losses. Frankly, I don't think we should because we'll be setting a bad precedent, sending a signal to financial institutions that they can expect a bailout if they make poor choices and squander the investors' money on questionable loans or enterprises.

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