Banking: This Disaster Was Guaranteed; costing some banks billions

[EV_Ares]

Money-back assurances on subprime-linked securities are costing some leading banks billions
by David Henry

Although refund policies have long been standard practice for retailers, they've rarely been given for financial investments--and for good reason.

A closer look at the mortgage meltdown reveals Citigroup (C) and other big banks offered a type of money-back guarantee to buyers of nearly $100 billion of subprime mortgage-linked securities, according to a BusinessWeek analysis. Incredibly risky in retrospect, the refund policies were critical in the banks' push to keep a steady stream of money coming in during the peak years of the housing market from 2004 to 2006. But the myopic decision has been a central cause of the billions in losses that some banks are now reporting. Citi, which declined to comment, announced on Nov. 5 that it was on the hook for $25 billion worth of such deals.

The refunds are emblematic of the "What, me worry?" attitude that permeated the housing market. Everyone involved, from banks to borrowers to investors, convinced themselves they were taking little, if any, risk.

For the investors, at least, it was free money. In an effort to attract money-market funds--a new group of buyers for subprime-related securities--banks started putting guarantees on some products a few years ago. The deal appealed to the target audience, a conservative group seeking higher yields at low risk. After all, it was a no-lose situation. The funds didn't have to worry if the underlying mortgages started to look shaky since the banks agreed to pay back the investment plus interest, with few exceptions.

At the same time, the banks convinced themselves that it was a low-risk proposition. They figured the securities would at least maintain their value. And even if the investments did stumble modestly, the losses would be minimal and affect only the lowest tier of investments. So the banks never figured they'd have to make good on the refunds. "It sounds like there was so much hubris that they thought something bad couldn't happen," says Jack T. Ciesielski, publisher of The Analysts' Accounting Observer.

The refund policies came at a pivotal juncture in the housing market--the point at which the boom turned into a bubble. They allowed the banks to tap into a new pool of money, which in turn attracted more money from players already in the game, such as hedge funds.

article continues @ link: http://www.businessweek.com/magazine/content/07_50/b4062026774092.htm?chan=top+news_top+news+index_businessweek+exclusives

[aquart]

1. What kind of bonuses did the bankers give themselves for this?

[Warpy]

2. They all clamored for deregulation

and got just what they screamed for. That allowed the thieves in and now they're screaming that they got taken.

Well DUH, boys.