A Mortgage in Stockton Flaps Its Wings and Global Finance Collapses

This credit crisis didn’t just “go global.” It’s been global.

Let our journalists help you make sense of the noise: Subscribe to the Mother Jones Daily newsletter and get a recap of news that matters.


In chaos theory, the “butterfly effect” is the idea that a tiny flap of wings in one country will contribute to a reaction in another that can wildly alter the weather of, possibly, both.

The current global credit typhoon has its own butterflies. Among them: a modest 2002 home purchase in, say, Stockton, California—financed with a nonprime, or otherwise faulty, mortgage loan.

By the time that home in Stockton was supporting two or three ill-advised loans in 2005, those loans had disappeared into packages called asset-backed securities (ABS), then were to global banks, insurance companies, and pension funds—particularly in Europe. Like their US counterparts, the European financiers bought boatloads with borrowed money. Then they, too, shoved them off books into Structured Investment Vehicles that required no capital charge and little reporting.

With US investment banks making huge profits from packaging churning loans, volume in mortgage securities exploded. US investment banks then added another link to the chain, repackaging ABS securities into CDOs, or collateralized debt obligations. In that way, the Belgian-Dutch bank Fortis (and others) came to own a piece of Stockton. If one Stockton home defaults, the global effect is miniscule. But if lots of home loans go under, the damage reverberates globally—just as it is now.

The current global fallout might have been manageable, if banks hadn’t entered a massively interconnected circle of $55 trillion worth of privately negotiated credit default swaps.

But that wasn’t the case.

While European institutions are getting hit mostly by exposure to toxic US assets, mortgage markets in the UK and Spain also are coming under increasing pressure. The bigger problem is the global borrowing still going on. With an average leverage of 10 times, we could be looking at an eventual $14 trillion systemwide loss. That’s a dark scenario, which is why it’s imperative that the US government help homeowners in Stockton keep their homes by backing renegotiated lower mortgages with lenders.

John McCain explicitly mentioned this in the last presidential debate. Barack Obama noted that Treasury Secretary Hank Paulson’s $700 billion purchase plan, vague as it was, contained the ability to do this.

Meanwhile, as the leaders of central banks throughout the world realize they are all in this together, they will be forced to keep injecting capital into the banking system. And, hopefully, to do some thinking.

Three weeks ago, the Federal Reserve decided that saving Merrill Lynch could be accomplished by giving it to Bank of America. Since everyone calling the shots in Washington has been spectacularly ineffective in preventing the downward spiral of the financial system so far, one wonders why other bank mergers are now going through without examination. Moreover, why are European banks heading in the same direction? Merging murky books with deteriorating ones is not a recipe for strength and stability.

In the absence of a controllable framework, central banks around the world are paying for the excess of an unregulated financial system. What we need is a Glass-Steagall Act for our times. Can we regulate the $55 trillion credit derivatives industry unleashed by the US Commodity Futures Modernization Act of 2000? Can we have higher global capital requirements going forward, or put a structure in place that will both contain the current fallout and avoid future credit typhoons? It’s time to find out.

IT'S NOT THAT WE'RE SCREWED WITHOUT TRUMP:

"It's that we're screwed with or without him if we can't show the public that what we do matters for the long term," writes Mother Jones CEO Monika Bauerlein as she kicks off our drive to raise $350,000 in donations from readers by July 17.

This is a big one for us. It's our first time asking for an outpouring of support since screams of FAKE NEWS and so much of what Trump stood for made everything we do so visceral. Like most newsrooms, we face incredibly hard budget realities, and it's unnerving needing to raise big money when traffic is down.

So, as we ask you to consider supporting our team's journalism, we thought we'd slow down and check in about where Mother Jones is and where we're going after the chaotic last several years. This comparatively slow moment is also an urgent one for Mother Jones: You can read more in "Slow News Is Good News," and if you're able to, please support our team's hard-hitting journalism and help us reach our big $350,000 goal with a donation today.

payment methods

IT'S NOT THAT WE'RE SCREWED WITHOUT TRUMP:

"It's that we're screwed with or without him if we can't show the public that what we do matters for the long term," writes Mother Jones CEO Monika Bauerlein as she kicks off our drive to raise $350,000 in donations from readers by July 17.

This is a big one for us. So, as we ask you to consider supporting our team's journalism, we thought we'd slow down and check in about where Mother Jones is and where we're going after the chaotic last several years. This comparatively slow moment is also an urgent one for Mother Jones: You can read more in "Slow News Is Good News," and if you're able to, please support our team's hard-hitting journalism and help us reach our big $350,000 goal with a donation today.

payment methods

We Recommend

Latest

Sign up for our free newsletter

Subscribe to the Mother Jones Daily to have our top stories delivered directly to your inbox.

Get our award-winning magazine

Save big on a full year of investigations, ideas, and insights.

Subscribe

Support our journalism

Help Mother Jones' reporters dig deep with a tax-deductible donation.

Donate