Depends on the loan. A “non-recourse” loan is totally secured on the property, so if the house isn’t worth enough to cover the loan, it’s the lender’s problem - they can take your house but that’s it.
With a “recourse” loan, the lender can come after the borrower for more money.
I don’t have a mortgage so I don’t know too much about this, but as I understand it, most UK mortgages are the former type. I don’t know about the US but I suspect it varies.
Sad to say, but the credit crunch came when too many people began living on credit cards. I have been in line behind people who had many credit cards and scanned through them to find one that wasn’t maxed out. Too many people bought houses they couldn’t afford. Then charged the furnishings as well. They took vacations they couldn’t afford,bought expensive gifts for their children all on credit. What isn’t fully paid for isn’t yours. We have had a false ecomomy since credit card companies gave cards to college kids who didn’t even have a job.
My husband and I went without until we could afford to buy something. We did most of any work we needed done our selves. We bought second hand things until we could afford new. My husband used pieces of lumber that was being thrown out and used it to remodel our family room. it is very nice. He saved windows that we had from another house and used them for our barn.
We are not rich but we paid cash for our cars. We lived under our income. Even a millionaire will go in debt if he earns a million but spends a million and $10.00 a year.
One can only live on borrowing from Peter to pay Paul for so long a time then it catches up with you.
Now there are more people borrowing than can find lenders and Peter wants his money now.
Monavis
I’m lacking in finance lingo here, but…
Isn’t it true that mortgages are rated according to risk by strict rules? You qualify based on debts you already have, your income and other assets, age, etc., and then they accept or decline at a given interest rate and other terms? Then a “grade” is applied based on how strong the case is that you can/will repay it?
Lenders et al are in a fiduciary position and if I understand correctly, the rules were relaxed to allow lending to less desirable candidates, okay, fine…but if they’re reselling grade C shit, mislabeling it as AAA chocolate, then they lied, period. It’s a little difficult to believe that those buying the packages of loans didn’t know there was a lot of predatory lending going on, caveat emptor and all that…or is it more still complicated than I imagine?
People with money to invest choose the instrument that best suits them. Maybe you’ve got 10K of mad money and you put it in a risky venture because you know if it pays off, it pays off big and you’ll laugh all the way to the bank. But if that 10K is your life savings, you put it in something VERY secure and accept the lower payoff.
I think most of these posts have the basics down. It makes sense to me. Sub-prime lenders packaged up bad debt and sold it to people who didn’t look closely at what they were buying. People who couldn’t afford the loans defaulted in record numbers. What I want to know is who allowed it to continue? I’ve seen information from numerous sources and the finger is being pointed at everyone.
I don’t think so. There are rules for banks as to how they can price assets on their balance sheets, and there are rules about which types of bonds/instruments e.g. pension funds can invest in (e.g. AA- or better), but a lot of these ‘reconfigured’ chocolate bars were so complicated that no-one (not even the banks that held them) knew how they should be valued on the balance sheet, and if you could palm them off to some chump as a high-rated bond rather than keeping them on the balance sheet, no-one cared what they were actually worth. The companies who rated bonds etc. for quality got paid by the people selling the bonds, and got a bit distracted by the need to keep their customers happy at just the time they needed to pay attention to getting the ratings accurate.
So low-risk investors turn out to have bought rubbish when they thought they were getting AAA senior-rated low-risk debt, the people who sold it to them are now bust or in bad trouble, the ‘recipe’ for the product they have bought is a 47-page formula attached to a phone-books worth of ‘best-effort’, ‘assumption’ and ‘based on information provided’ disclaimers, and the money they paid has evaporated.
What exactly do you disagree with? Is it not reasonable to say that the advent of all these risky loans wouldn’t have been there had there not been two huge market distorting GSEs buying these risky securities (often times from each other) or guaranteeing these subprime loans? If the GSEs weren’t directly competing in the market, if they did not provide the impetus to push more types of the loans on to the market, would it be as bad as it is today? There is no one real good reason, but as all complex things, a multi-host of factors played a role. The fact is any derivative-based security (i.e. a loan in good repayment, sliced and diced and repackaged as a security) always risks default, because by and large these are based off no-recourse loans. Why did the subprime and Alt A loans break down? Because people stopped paying them. Why did people stop paying them? Because the housing market tanked. Why did the market tank? Because it was a bubble brought upon by easy credit. Why was there easy credit? See, this can go and on and on.
As more of these loans defaulted, the loans and credit based on those derived assets dried up, and is now causing the retraction we’re seeing today. Any more fine detail is highly debatable.
As I said above, the loans were graded according to their risk. They were repackaged labeled for how much risk was involved and the interest was set accordingly. Insurance could be applied to reduce the total risk. As long as housing prices went up, this generated what has been called a “wall of money,” even a “tsunami” of money. Even defaults weren’t considered to be a problem. Those were normal and had historic rates.
Two factors changed everything. One was that the ratings agencies had nothing historic to base the risk of these brand-new types of packages against. They looked at the way the deals were structured (way too complicated for me to explain - it’s in Morris’s book) and accepted the top-level deals as AAA-rated, guaranteed not to fail. But that same structure also meant that a domino effect was set up. When the lowest-rated deals failed, they toppled upward and took the supposedly risk free deals with them. That was last year’s set of huge failures.
Then the housing bubble burst and the failure rate went to numbers not seen since the Depression. That wasn’t in anybody’s models.
Who’s the blame for all this? Everybody. The only truly criminal activity came from the very bottom, where certain lenders got uninformed families to take deals they didn’t understand, based on huge future, but hidden, interest rate increases. Those lenders got extra money for making the deals so they had incentive to cheat their way to success. Some of the paper they generated that way was totally worthless, but it’s still a small part of the total meltdown. Everybody else just took advantage of greed and their own sense of being able to beat the system.
I may be missing some technicalities, and it may be that blame can be better fixed in the future. But one of the points of Morris’s book is that these meltdowns actually take place every few years as people think they figure out new ways of beating the system. Then the good times come back and everybody forgets about the last time this happened.
The only real question now is whether things *can *be changed to prevent this, and if so, if they *will *be changed. I wouldn’t put money on it, pun intended.
This New York Times article from 1999 (Fannie Mae Eases Credit To Aid Mortgage Lending) is the earliest connection I’ve come across between Fannie Mae and subprime lending. A couple of highlights:
*"Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates – anywhere from three to four percentage points higher than conventional loans."*
And later in the same article:
“In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.”
This obviously doesn’t tell the whole story, but it’s a major milestone along the way. As Rysto so colorfully explains, the repackaging of loans of varying security into bundles so large as to make their contents almost incomprehensible magnified the impact of this problem immensely.
This Time article (“Let Risk-Taking Financial Institutions Fail”), argues that the bailout’s focus should be on the underlying mortgages, not the institutions that engaged in repackaging these mortgages into dubious commodities.
The problem was that the risk of offering subprime mortgages was hidden from investors by the creation of the derivatives with deceptive ratings. At least part of the blame lies on the failure to regulate the derivative market.
First off, thanks for everyone’s answers. I had my own GQ thread on this, but I don’t think I understood anything well enough to start with to know what questions to ask.
So, to see if I understand this correctly… basically, the people who created the first iteration of bundles lied to the rating agencies to get good ratings on bundles that were mostly iffy? So they got highly-rated, and sold at an over-valued price, and resold and so on and so forth… Because while I understand that while a rating agency can’t take a bundle of (say) 1000 loans and scrutinize every single one, oughtn’t they to scrutinize at least a few? I mean, how can anyone believe that giving a half-mil mortgage to a family of five making $40K a year is a good idea? The lenders wouldn’t care, since they were trying to sell them off to get their money anyway, so how did the rating agencies miss it?
And if there’s lying involved, is there anyone being prosecuted for fraud, here?
And then… this is hitting the stock market because these bundles were repackaged and sold as something similar to a bundle of stocks that were stuck into people’s mutual funds and 401(k)s, yes? So when it was discovered that these bundles had no real value, it’s like holding stock in a company that suddenly goes bust… the stock had high value yesterday, and zero value today, so you’ve lost every cent you had invested there?
And my last question – there’s so much running about and screaming hysterically over this. How long could this last? It seems the general consensus is that stuff like this “always” recovers eventually, but when is eventually? A year, five, thirty? Is it possible for the markets to be so damaged they never fully recover at all? If I start now pumping money into an IRA, say, or buy a condo thinking prices can’t get much lower and can only rise from here, am I being smart or stupid?
Thanks for posting. I listened to the whole podcast…it boggles the mind.
I really think some heads should roll. When they can loan $500K + to a guy with no income/no assets for a mortgage, laws had to be broken. It’s greed, pure and simple, the defeat of common sense by faulty inferences of data.
A guy I work with said his father used to be a broker. The father said that if the government hadn’t weighed in with the intention of stepping in to fix this on the day they did, there could have been a run on the banks that same day. :eek: He proceeded to explain why; I proceeded not to understand.
The lying came farther down the chain. The lenders understood that the mortgages were risky and represented them that way. They may not have understood all the deceptive practices being used and they certainly overestimated the brightness of the future, but they didn’t lie to the rating agencies. That the ratings agencies didn’t understand exactly what these new instruments were seems to be also true.
Doesn’t seem to be happening. All those people are long since out of business, they have defenses buried in the fine print that nobody read, and fraud cases are
hard to prove and eat up huge amounts of prosecutorial time and money. Nobody is going to be doing this again for a long while so there’s no deterrent effect to compensate.
No. Business lives on credit. If you can’t get a loan, every for everyday transactions, nothing else happens. The stock market is responding to the cessation of credit availability.
This is the crux of the problem. Nobody knows. I could blather on about buying low and saving money is always better than not and so forth, but nobody knows. I can’t imagine things getting better in a year - there still are plenty of mortgages out there that haven’t even hit the point of having higher interest rates kick in. I also can’t imagine what anything at all will happen in 30 years.
The question is, what is the alternative? What else do you do with your money? (Hey, look, the commodities markets have also just tanked.) You need to do something other than stick it in your mattress. What that is will become clearer with time and money will start migrating there. But I won’t pretend I have a clue about that future.
At the end of the podcast, the question was, “Will this be like the 1930s or the 1970s?” and the answer seems to be the latter. High interest rates, little expansion of the economy, tight job market, and so on.