sub-prime mortgages

wrote

I honestly feel that even the upper ranks of lenders' staff are abysmally educated. Thus they got caught up in the housing bubble (you can't lose when houses only go up and by lots! [not]). Then they fooled themselves into trusting that high risk loans could be re-packaged into lower risk vehicles. I think when one is making money hand over fist, one gets blinded. (And but for the grace of god, there go I. I got a tad too caught up in banks' high dividends.)

I know many here consider this a sound theory. Just reiterating so maybe this will become a lesson to be recorded in the annals of history. Like the causes of the Great Depression.

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Because they could. The mortgage brokers got paid for making loans. As long as they met the standards to sell the loan, they didn't care. The buyers of the loans didn't care. They packaged them up, got some ratings agency to rate them "AAA" and sold the CDO's to investors, who believed the "AAA" ratings.

It all worked as long as housing prices kept going up. If the homeowner defaulted, the lender took the house and sold it for enough to be made whole.

-- Doug

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This is not a question about financial planning, but since the moderator approved it, I suppose it deserves an answer that also doesn't involve financial planning.

The subprime problem occurred because neither the mortgage brokers nor the bankers had any "skin" in the game. The brokers were lending money supplied by the bankers, securitized by investment bankers, and rated by securities rating companies. The brokers made money on every loan, but had no risk of loss if the loan failed. The bankers were selling the mortgages as soon as they were written to replenish their money supply. They were making money every loan they made, but were taking no risk, either. The investment bankers packaged the loans, obtained favorable ratings, and sold them to investors. They made money on every loan, but also had no risk of loss. The rating companies were paid by the investment bankers, who wanted high ratings to ease sales to investors, and satisfied their customers. They made money on every loan, but they also took no risk by overrating the packaged loans.

Loan qualification rules merely were impediments to the brokers, bankers, investment bankers, and rating companies making more money, so they found ways to relax the rules and finally to eliminate them completely.

Dave

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A Ponzi scheme?

Elizabeth Richardson

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Securitizing itself became part of the problem. In the 'old' days, even a 90% loan to value mortgage was something one could understand. If the house dropped 20%, the mortgage holder stood to lose 1/9 of their funds (plus costs, of course). Securitization brought in more liquidity, of course, but also created instruments that were incomprehensible, slicing and dicing pools of loans so some pieces had no underlying value from day one. Even in normal times, one can slice up the expected payment streams to create tranches which would be impacted by even a low default rate. This time, those tranches all bubbled up too soon and too many at once as rates rose. Joe

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Thank you, that is the clearest explanation of this mess I've heard yet. The greedheads keep pointing at each other so you can't figure out who to blame. Greed is good until you bring the whole house down on everybody.

I wonder if this is going to end like the Savings and Loan scandal of the Keating era (John McCain was one of his Five). Massive gov bail-outs for the greedheads and screw the middle guy.

That affects financial planning, brother!

Chip

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"Dave Dodson" wrote

Don't the many bank writedowns of recent months show that the banks gambled, took risks, and lost? Also, when a bank requires minimal-to-no downpayment on a home mortgage, and then the house price goes upside-down and many folks default, the risk is clear.

I agree there were underlings who made money on transaction costs of home sales, but this money was relatively meager. Also, these underlings do not control things like the integrity of re-packaged mortgages and how much downpayment is required.

Aside: I think this does go towards financial planning for ordinary folks. We are seeing history here, insofar as another bubble has burst. Noting what caused the bubble is important. Ordinary folks must never look at an investment such as a house, stock, or mutual fund as an ATM machine.

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Ordinary folks ought not to look at their house as an investment.

Elizabeth Richardson

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Agreed, but for some, the downsize after retirement can certainly help. No matter the economy, the person who sells their Boston or LA home and moves to a smaller home further away from a city is going to pocket some difference there. It would certainly be wise to underestimate that sum. Joe

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They must understand the difference between liquid and illiquid assets, and the typically higher transaction costs associated with the latter.

If that were true, then why would anyone buy a house?

From investopedia:

"Investment [definition]: An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth."

"Determining Assets [for net worth determination] -Liquid assets are simply those that can be turned into cash quickly. Bank accounts, certificates of deposit, stocks, bonds, mutual funds and similar investments fall into this category. Illiquid assets, such as your primary residence and other real estate holdings, also count, as do assets in your 401(k) plan and partnerships in businesses. All of these items should be included in your calculations."

-Mark Bole

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How about as insurance? We have ~$250,000 in equity, according to a re-finance 6 months ago. We are both retired and love the house. But when either of us goes to the great pie in the sky, the other plans to sell the house and get out of Dodge. Surely the quarter $Mil is worth considering in a financial plan.

Chip

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Because I prefer not to sleep on a park bench. I own a house, but do not consider it an investment, as I've said many times here. I own it free and clear of any mortgage. If I had either a mortgage or had to pay rent, I would have had to squirrel enough money away to generate additional income to pay for my shelter. So in my accumulation years, I prepaid my retirement shelter.

Elizabeth Richardson

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And the problem continues to escalate today because a large percentage of the *homeowners* today have no "'skin' in the game", so they're simply walking away. Long after the banks have tightened up on their lending practices, it's still sliding downhill as homowners who have nothing to lose simply walk.

They're all complicit - including the homeowner.

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look at a home as an "investment" because it gets people out of a spending mind-set into a savings mind-set. Although it can be classed as shelter you must have and use every day, the house nevertheless increases in value over the years and provides a slow build-up of equity and inflation-protection that renters do not have. Putting money into a mortgage payment every month is a lot better than wastefully spending it. A few folks might have the discipline to put the difference between rent and a mortgage payment into a mutual fund every month, but I would guess there are not very many. Anyway, investment in mutual funds probably carries somewhat more risk than does counting on the equity in your house to increase.

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For the same reason that you buy a car, to use it as you see fit. In more numerical terms, there are times when owning becomes more economical that renting. That's when I bought a house.

So the house you live in fails this definition, at least the second sentence, since you live in it today.

-Will

william dot trice at ngc dot com

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I don't think that a house provides inflation protection since they generally rise in value with inflation. From an economic standpoint, it may actually be better to spend the mortgage money on consumption. But having said that, I agree with you that a house may provide a useful psychological crutch to get folks to accumulate wealth when they might not otherwise do so.

-Will

william dot trice at ngc dot com

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Indeed. We're seeing a persistent problem in our homeowners' association where folks would rather walk away from their homes than pay homeowners' dues. A few years ago, the association would slap a lien on a delinquent property and that quickly got the homeowner's attention because they had equity to protect. Now they walk over stupidly small sums because they have no or negative equity. The HOA actually owned one home briefly last year, not a business they want to be in.

-Will

william dot trice at ngc dot com

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It is some protection, because rent increases over the years, while mortgage payments do not. And monthy payments for rent never end, while mortgage payments do!

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I included those in my greedheads term. It's the middle guy with responsible financial dealings that is going to get screwed again.

Chip

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