: what was the subprime mortgage crisis ?


: what was the subprime mortgage crisis ?

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In an effort to encourage more people to buy homes, politicians passed feel good legislation that loosened lending requirements. This allowed people who previously couldn’t qualify for a home loan to be able to get a mortgage and buy a home. The loans were considered sub prime because they were given to people with less than prime credit scores and income. When the economy had a down turn many of those sub prime lenders were no longer keep up with their payments.

Of course politicians always blame others for their mistakes so they started blaming the mortgage companies (banks) The problem with their complaints is that the same politicians decoupled the mortgage process from the mortgage companies. So you had. And still have mortgage brokers creating the loans. Then many mortgages are bundled and sold to a lender like a big bank.

So suddenly when the economy went sour these banks, especially smaller banks were saddled with unrecoverable debt and many started to go bankrupt. When a FDIC insured bank goes bankrupt, the federal government is required to step in and repay the customers. As you can guess, it would be very expensive for the tax payer if a bunch of banks went bankrupt. So one solution, rather than spend huge sums of money on failing banks, some big banks large sums of money to buy the toxic mortgages from the smaller banks. By allowing smaller banks to off-load their bad loans, it kept them from going bankrupt and saved the federal government lots of money. The big banks, because they have more assets were able to administer the mortgages without going bankrupt.

Of course the same politicians who reduced lending requirements, decoupled mortgage brokers from the actual lenders and blamed then blamed the problem on mortgage companies and lenders then attacked the solution as a bail out for big banks.

Banks started lending money to home buyers who could not afford it.

And they did it because housing prices kept rising.

You would go to the bank and get a mortgage then fix or just sit on the house for a year or 2 then sell it for big profit…

Banks even had negative interest loans. With these you owed more money every month than you paid in.

The crisis was when suddenly houses stopped going up in price and actually dropped.

Suddenly people who couldn’t afford the mortgage now owed more money than the house was worth.

Now banks had to foreclose and repossess and sell the house. But the house is worth less than they lent out.

Since this kept happening housing prices dropped more because suddenly hundreds /thousands of houses were on the market after foreclosure.

Because the housing market kept dropping even more people who took out loans owed more on the loan than the actual value of the house.

* Home loans (mortgages) represent a steady stream of income for the debt holder.
* Banks can sell mortgages – they get their big chunk of cash back now to use again, and the buyer gets a steady income stream over a couple of decades.
* Buying a single mortgage is a little risky, as any given homeowner has a risk of defaulting on the loan
* Buying a single mortgage is also more than people might want to spend all at once.
* However, if instead of buying one whole mortgage, the bank splits a thousand mortgages into a thousand strands, this fixes those two problems – the risk of any default is greatly diluted, and you can buy any thickness bundle of strands you want.
* Hooray! Everyone is happy!
* This gives the banks a *huge* incentive to give out mortgages to absolutely anyone. They sell the risk to other people, and they can make a nice little return on their loan – and they can keep doing it over and over.
* This incentive means banks bend, break and just flat-out ignore all the rules about responsible lending, and give home loans to people who are never going to be able to pay them back.
* *Millions* of them.
* Now those bundles have a *large* percentage of dead strands, of loans that are never getting repaid. Those bundles are worthless, they’re dead assets, they’re worthless as collateral.
* So the banks conveniently don’t mention that.
* The banks also cook up a whole new product – they split up the bad bundles and remix them back together into new bundles, and now it’s a fresh *new* product and the risk is defined as being diversified, so it’s considered premium quality again.
* Now millions of investors across the country have sunk all their money into worthless investments, and *used those investments as collateral on loans*.
* Eventually, the loans come due, and enough people default on their loans… and everything turns to shit.
* All the investors now have nothing.
* All the loans the investors took out using the bundles as collateral… are now unsecured
* Banks *cannot* have unsecured loans. They’re absolutely not allowed to – it constitutes fraud to loan out their customers’ money without a guaranteed way of getting it back.
* Oh fuck.
* Now everyone wants their money out of the damn banks before they go under – and this drags them under.
* fuck fuck fuck fuck fuck

You should watch *The Big Short*, if it’s still on Netflix.

It goes into the whole thing in a lot of detail.

Mortgages all come with a risk the borrower won’t pay. Someone with a low-paying, insecure job and a history of missing payments on loans will probably have a low credit score, meaning they’re more likely not to pay. Subprime mortgages are mortgages given to people with lower credit scores.

If I lend you money to buy a house, it’s possible for me to sell that mortgage on to someone else. Let’s call them ABC Finance. I get money now, and ABC Finance gets your repayments. In the US, a high proportion of mortgages were sold like this.

What this means is that ABC Finance now takes the risk on your mortgage. If you don’t pay, they lose out.

If the mortgage is a “prime” mortgage, they also have a nice, low-risk asset and they can borrow more money against that asset (which they might use to finance more mortgages!).

But what if it’s subprime? Well they *might* still want it, but it’s higher risk, so not as good an asset, and they won’t pay me as much for it.

Here’s where a smart/terrible idea comes in. What if I sell big bundles of mortgages selected in a way that makes the overall risk is low? So, for example, people in New York might miss their mortgage payments if there’s a downturn in the financial industry, and people in Kentucky if there’s a bad harvest. But what are the chances of both those things happening at once? A load of mortgages from New York or a load of mortgages from Kentucky are a bad risk, but bundle them together and the risk is a lot lower!

Now I can sell these high risk mortgages as low-risk bundles. In fact, I can get rating agencies to officially say they’re really low risk. ABC Finance gets a nice low-risk asset and I get more money for it. In fact, it turns out I can make more money selling subprime mortgages than prime mortgages.

So here a problem comes in: there’s an incentive for me to sell more and more subprime mortgages. Standards slip. I stop doing even basic checks on the people I lend to. And nobody really looks into these big bundles of mortgages, including the rating agencies who are supposed to be checking them. Everyone’s buying them, everyone is making plenty of money, everyone trusts them, so why go into the detail?

The really fundamental problem is that there are some things that can hit bank workers in NYC and farmers in Kentucky at once. Things like an economic downturn in the US, or like big problems in the financial sector. If something like that happens, these bundles of mortgages will crash in value. And that causes more problems because lots of lending is based on them being low-risk assets. So it can cause mortgage lending to slow and the financial system to start to seize up, which just makes things even worse and the mortgages worth even less.

And that is exactly what happened, kicking off a financial crisis that spread beyond the mortgage sector and beyond the United States.

The short version is that banks thought they had figured out this *one weird trick* to spread out risk so much that it wouldn’t matter ever again. Instead, what they had done was create a system where *everyone* was exposed to the risk but had no way of knowing how much.