Treasury Proposes Mortgage Securities Pricing Scam that Appears Facially to Resemble Price Fixing

October 15, 2007

The International Herald Tribune reported yesterday that the largest US banks including Citigroup, Bank of America, JPMorgan and others are in talks to engage in a fraud to avoid the market pricing of mortgage backed securities.  See article at http://www.iht.com/articles/2007/10/14/business/banks.php

The action is described in the article as an effort to create a "fund" of about $75 billion to buy up "structured investment vehicles" or "SIVs" that represent a part of the commercial paper market.  These are tradable short term loans backed by the collateral of other loans -- specifically mortgage backed bonds, and other types of debt bonds on things like credit card balances.  The "institutions" holding some of these instruments are "affiliates" of banks which allows them, in a somewhat Enron-esque way, to hold these liabilities off of the banks' financial statements.

But banks have been buying up these instruments from their affiliates to varying degrees to keep the prices from dropping too far.  The goal is to avoid the markets setting a real price for mortgage backed securities.  And there is significant worry that investors in these products will soon start trying to sell them creating a real market price for these securities.  The US Treasury, the Federal Reserve and America's largest banks are trying desperately to fix prices on mortgage backed securities to avoid this day of reckoning.

This is where the veil is being lifted on the true nature of what has become of American capitalism.  Mortgage backed securities have a market.  The market for years priced them too high because of what can arguably be described as fraudulent AAA ratings by the largest US credit rating services.  Those services rate trillions of dollars in bonds that are bought by investors all over the world and they were taking billion dollar payments from the same banks whose mortgage backed securities they were rating creating a mammoth conflict of interest.  These agencies described these mortgage backed securities as diamonds and now the curtain has been lifted revealing a glass beads.  This effort of the US Treasury Department and America's largest banks to meet in secret about the terms of how they will set up a fund to buy these securities in the hopes of artificially increasing prices over what the market will naturally pay is nothing more than fraudulent accounting.  These banks have 1,000 pounds of glass beads that are valued right now on their balance sheets as diamonds.  The goal of this wild exercise is to set up a fund to pay diamond prices for glass beads only on the margin because the small number of transactions that close define the market price of the huge iceberg of securities that are not for sale, but merely sit on balance sheets.

I suppose that when the US Treasury Department has finished helping these banks to fix prices at the margin, that the Federal Reserve will ultimately inflate away these bad debts because when a coffee costs $20 at the local cafe, you can expect that these securities will no longer be underwater.  But you should fully expect the CPI to only show 2% inflation -- perhaps the "substitution" aspect of CPI's new methodology can be used to remove everything from the basket except rice and digital cameras.