# What Was the Cause of the Mortgage Meltdown? **URL:** \ **Category:** Great Debates\ **Created:** [September 3, 2010, 9:28pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544 "2010-09-03T21:28:12Z")\ **Posts on this page:** 20\ **Page:** 4
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [September 6, 2010, 1:23pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/61 "2010-09-06T13:23:21Z")
> [@PBear42](#): > > You’re making sense, but I think you’re mistaken. 🙂 Using your numbers,they weren’t buying $100,000 houses for $120,000; they were buying $120,000 houses for $120,000 And to get each loan, the houses had to appraise for that value based on comparable sales. There was a period where banks were issuing loans up to 125% of the value. I personally don’t understand how people side stepped the appraisal process, but I think part of the problem was that house prices in an area were skyrocketing so there were comparables to base the price off of. Essentially, someone was willing to buy the house across the street for $20k more than it was worth (because they thought it would go up $40k). And as far as I understand, that means now your house can appraise for $20k more. > [@PBear42](#): > > But all of this assumed a certain credit market, which vanished almost overnight when lenders got antsy (the real lenders, the ones buying the securities). My recollection is that it was the subprime defaults which caused that, but I’m open to having my ignorance fought. After all, I’m just going by recollectoin. Part of my current interest in this topic is that I previously had similar recollections. I latched on to the term “sub-prime lending” and was happy to go with it. But that term doesn’t mean what we think it does. A sub-prime loan isn’t even that risky, it’s just slightly more risky than a prime, which is more risky than a super-prime. Now, there is no question that combining sub-prime with no-money-down is a recipe for disaster. But it is my contention that is was the latter not the former that played the biggest roll, and my reasoning is that prior to this whole mess sub-prime mortgages were fine. There was a base level of foreclosures (probably mostly from sub-prime), it wasn’t until the addition of no-equity-mortgages did shit start going south. And as has been shown, prime mortgages made up 51% of foreclosures. (I need to try and find a stat from the 80s or 90s to compare). > [@Voyager](#): > > People were overpaying for houses in retrospect. For at least five years, in California at least, the overpriced houses one year seemed like bargains the next. With the small increase in wages during the Bush years, people who waited to save 20% kept on getting further and further behind. This is very true, and I had forgotten about that problem. It was like a gold rush and people were desperate to get in. But like every gold rush previous, the last people to show up got let with the shovels and an empty mine. > [@Voyager](#): > > Lack of increase per se doesn’t hurt anything, assuming normal mortgages. After all, house prices have risen only nominally for most of the past half century. A couple of things were different this time. > > First, low introductory rates. Many of these mortgages were written to be difficult to get out of. Even before the total collapse, there was concern about how many of these were flipping to higher payments. I don’t see how having equity makes an unaffordable mortgage affordable. That’s true, but again the stats show the balloon mortgages weren’t a significant factor. Further to that, people were sold on these mortgages based on the notion that their house were appreciate x% over the 4 year teaser period. Keep in mind, that house prices actually went up over 100%. People were told that they could get the mortgage at 100% now, because when the value goes up they can renegotiate using the increased equity. This worked for a lot of people, and made a lot of investors extremely rich. > [@Voyager](#): > > Second was home equity loans written on the supposed equity increase. The ads for these made them sound like free money. I suspect most people don’t really understand cash flow. But these got written for positive equity, and just made the system more volatile when the crash did come. Exactly. And that second loan creates more negative equity. That second loan is also not included in the article’s research. But I remember those ads, and a lot of people fell for it. > [@Voyager](#): > > You haven’t yet given a clear process of how the crash started. A combination of balloon mortgages blowing up, subprimes which couldn’t ever be afforded, home equity cash flow problems which couldn’t be postponed by getting another loan off more equity when the market slowed all pushed it over the edge. That caused true negative equity, which is where we are now. Okay, here is as clear a process as I can provide: 1. Here’s a [graph](http://mysite.verizon.net/vzeqrguz/housingbubble/) of house prices since 1970, showing how slow and steady prices were. Housing was a nice safe investment. You paid into your mortgage and gained equity. And over 20 years you’d make a small profit. But notice that it was a very small profit. It wasn’t until about 10 years ago that house prices started going up fast enough for people to “flip.” ie for people to buy and sell in a short period of time for profit. 1. Traditionally, a mortgage was based on the assumption the house value wouldn’t go up very much, and might even go down a bit. 2. As people started buying in 2001 the assumption was that the trend would continue. The belief was firmly implanted that the $25,000 increase over the previous 4 years would continue for the next 4, and the next four after that. In a little less than 10 years we had a nearly 100% increase in house prices. Looking back, you’d be crazy not to take advantage of that. Like you said, if you were saving for your down payment, you were losing every year. It actually made more sense (looking back) to take the teaser mortgage, put 5% down now, pay the PMI. In 4 years your house value would go up another $25k and you could refinance and get rid of the PMI. (I was actually told this by a broker in 2009 as well). This is what I see the root of the problem. It is true that sub-prime mortgages are more likely to fail, and traditionally account for about 3 times as many foreclosures compared to prime. But it was the assumption that prices would continue to go up that caused all the future problems. 4. Like any commodity, house prices HAD to eventually reach a ceiling, even if it hadn’t crashed prices had to peak and fall a bit, it’s just natural. Their price rose so much faster than inflation and raises that eventually people wouldn’t be able to afford them. Oddly enough, it seems people look back and feel this was a “credit tightening.” To that I say bullshit. Credit didn’t tighten, it had been loosened as far as it could possibly go. That was the end of how “loose” it could get. Down payments went to 0%, credit ratings when below 600. Income was projected 4 years in the future. Loans were issued at 125% of the house value. You can’t get looser! 1. So now, anyone buying after about 2004 was dependent on the graph continuing up (and I’m sure more than a few people thought it would accelerate). This, above all else, was the actual mistake. It’s the same mistake every single new investor makes, throughout history. The last guy is always left holding the potato. All it took at this point was for house prices to slow. The first guy that was expecting 20% increase only got 18%. The next guy only got 16%, then someone only got 14%. Suddenly, all those speculations\* failed to pay off. As a result, the investors\* started dumping property in order to secure their 10% and walk away. This is what happens at the top of every stock move. As those investors start dumping their properties, values eventually stop going up, and being to fall. 1. Remember that house prices historically would rise and fall small amounts. It’s okay, it’s natural. But up until this point no one\* had really counted on it. After 2000 it seems EVERYONE was counting on it. The mortgage structure was set up to require the house to appraise by double digits. When that stopped, the mortgages had to fail (prime or otherwise). 2. Now you can add in the sub-prime issue. More sub-prime loans were made than probably should have. And they were made with the belief that the property value would go up. So perhaps we can call this the accelerant. The fire started burning when people started counting on their house to appreciate more than 20%. It picked up speed as the values stopped increasing. Then all this caught up with the sub-prime and boom. Afterwords, all we remember is that gunpowder blew up the barn. It’s true there shouldn’t have been that much gunpowder, and he should have been labeled properly. But there was a fire that lit the powder keg, and all we’ve all forgotten that in place of “sub-prime mortgage crisis.” Which you have to admit sounds waaaay better than the “negative equity mortgage crises.” 1. So it’s at this point that I believe it was a bank in France that realized those shitty mortgages had been securitized and bundled. This called into question all of the mortgage backed securities, as well as all of the investors holding those security. It was actually THIS action that destroyed the banks/lender/investors. Must like the tech bubble, eventually someone realized there was nothing to invest in, and that the house prices were entirely artificial. 1. Now we have a REAL credit crunch because investors were counting on that profit, and LENDING on that perceived profit. Individuals and business thought their balance sheet had gone up 100% since 1998, borrowed on it, and invested on it. Without that, no one had money to lend. BUT all the mortgages from 4-5 years previous were dependent on refinancing. All the {wink winks} at the banks four years ago assumed it would be as easy to refinance in 2009 as it was in 2004. And it was REALLY easy to refinance in 2004. All that was gone. No one could refinance, the party was over. Conclusion: Sub-prime mortgages couldn’t possibly account for enough of this. They had always been risky, and they were still risky. The _new_ problem was that it was the prime mortgages that actually became risky. Until this point foreclosure rates has always been below 1%, and prime foreclosures had accounted for less than 1/4 of that. 5 years later prime foreclosures now exceed 50% of foreclosures. And prime mortgages didn’t get risky until people built in the assumption that their equity would go up for them. - Part of the price increase was purely speculation. Because house prices were going up so fast people turned it into an investment. Buying then selling. They had even less of a stake in the house. If the profit wasn’t there they’d dump it. And it’s the dumping that causes prices to really fall. ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [September 6, 2010, 7:44pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/62 "2010-09-06T19:44:19Z")
First, I definitely agree that tight credit was not the cause of the problem - it was a result of the problem. Second, do you have a cite for banks offering 125% loans? I know people who fell into the equity trap, in an up market, and were never able to get anything like that. I don’t recall ever reading about this type of loan. No money down (or side loans to disguise the fact that there was no money down) yes. You are saying that there weren’t enough people running into cash flow problems to trigger the crash, but also say that a relatively small number of investors did. That might be true in some markets, like Florida, but it wasn’t true here. Your description is of a slowing in the increase, not an equity crash, and that I accept. But here is another way the slowing caused the crash. The risk models of all the banks were based in a steady increase in housing prices - they admit they never took a drop into account. When this started not happening, their portfolios started looking a lot worse. If they then stopped refinancing those with balloons, they got left holding the bag, started, to miss payments, and the instability of the prices caused the crash. Lots of people with these low mortgages couldn’t afford a normal one - though some could, and got sold bad ones anyway. ---
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [September 6, 2010, 8:50pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/63 "2010-09-06T20:50:50Z")
> [@Voyager](#): > > Second, do you have a cite for banks offering 125% loans? I know people who fell into the equity trap, in an up market, and were never able to get anything like that. I don’t recall ever reading about this type of loan. No money down (or side loans to disguise the fact that there was no money down) yes. Here you go: [Credit unions: Where the credit flowed too freely](http://www.startribune.com/business/51633817.html?page=2&c=y) "By 2002, a credit union founded to promote thrift was allowing customers to borrow 125 percent of the value of their homes. When housing prices fell, “a lot of those people simply didn’t pay,” said George Savanick, 71, a retired physicist and former volunteer member of Fort Snelling’s three-person supervisory committee, which analyzed a small sample of the credit union’s loans each month. “And we were too small to absorb the losses.” " And as far as I can tell, banks are STILL offering 125% loans. Essentially, they allow a 95% mortgage, and then a 30% unsecured loan on top of it. But if you look at that earlier chart showing house prices, it was GREAT idea back in 2000. People were bidding so fast on houses you needed to be able to compete. I’ll address the rest of your points a bit later. ---
**Author:** ![RickJay](https://avatars.discourse-cdn.com/v4/letter/r/bb73d2/32.png) [@RickJay](https://boards.straightdope.com/u/RickJay)\ **Post date:** [September 7, 2010, 12:53am UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/64 "2010-09-07T00:53:01Z")
> [@randy054](#): > > So let me see if I got this right? No, you don’t. ---
**Author:** ![Airman\_Doors\_USAF](https://avatars.discourse-cdn.com/v4/letter/a/e36b37/32.png) [@Airman\_Doors\_USAF](https://boards.straightdope.com/u/Airman_Doors_USAF)\ **Post date:** [September 7, 2010, 1:07am UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/65 "2010-09-07T01:07:29Z")
> [@Duckster](#): > > Greed. > > Greed on the part of lenders who lent money to those who did not pass the smell test. > > Greed on the part of buyers who smelled too much and were lent money by lenders with stuffed up noses. The banks arguably had little choice in who they loaned money to. Remember the [Community Reinvestment Act](http://en.wikipedia.org/wiki/Community_Reinvestment_Act)? Now, arguably, this did not cause the subprime crisis. It did, however, set the stage for people who could not pass the “smell test”, as you put it. The banks have their own culpability as well in the way they established monetary instruments using these somewhat risky loans. And, of course, people ignored the reality of any sort of economic “bubble”: what goes up must come down, and when it does people get hurt. It was [tulipmania](http://en.wikipedia.org/wiki/Tulip_mania) all over again. There’s lots of blame to go around, and nobody gets a pass on it. Everybody had some level of culpability, from the people who tried to profit on real estate investment to the banks that made bad loans all the way to the regulatory agencies that hoped that such a state of affairs would continue in perpetuity. ---
**Author:** ![Saint\_Cad](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/saint_cad/32/18907_2.png) [@Saint\_Cad](https://boards.straightdope.com/u/Saint_Cad)\ **Post date:** [September 7, 2010, 5:20pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/66 "2010-09-07T17:20:29Z")
First of all, the lowering of the down payment requirement. I’d like to believe that the banks realized that there were many potential home buyers like me who have good paying, stable jobs that could never get 20% of the purchase price while we were busy paying rent. On many homes in my area, the mortgage is lower than my rent. Second of all, the two people I know that lost their homes to foreclosure kept refinancing to pull money out for trips, cars, etc. and over time their payments crept up to where they could barely afford them and as soon as a financial setback came up they had no equity and couldn’t pay on the note. ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [September 7, 2010, 7:40pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/67 "2010-09-07T19:40:49Z")
> [@Airman\_Doors\_USAF](#): > > The banks arguably had little choice in who they loaned money to. Remember the [Community Reinvestment Act](http://en.wikipedia.org/wiki/Community_Reinvestment_Act)? Countrywide and the other non-bank lenders, who did a lot of the subprime damage, were not covered by CRA. I also invite you to show me a specific line in the CRA requiring banks to lend to people without income verification. In fact, the Times printed a study showing that when you matched areas of New York with the same income levels, minority areas had a much higher rate of subprime mortgages. Now, if the banks were forced to do bad loans because of CRA, you’d expect mechanisms to reduce the number to the bare minimum. In fact, the mortgage writers were incentivized to write as many subprimes as possible, since they got higher interest rates and thus produced more profit. There was a great demand for these loans, because they had higher returns and the slicing and dicing, and their AAA ratings, made it seem as if the higher returns were not accompanied by higher risk. ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [September 7, 2010, 7:51pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/68 "2010-09-07T19:51:54Z")
> [@emacknight](#): > > > [@Voyager](#): > > > > Second, do you have a cite for banks offering 125% loans? I know people who fell into the equity trap, in an up market, and were never able to get anything like that. I don’t recall ever reading about this type of loan. No money down (or side loans to disguise the fact that there was no money down) yes. > > Here you go: [Credit unions: Where the credit flowed too freely](http://www.startribune.com/business/51633817.html?page=2&c=y) > > "By 2002, a credit union founded to promote thrift was allowing customers to borrow 125 percent of the value of their homes. When housing prices fell, “a lot of those people simply didn’t pay,” said George Savanick, 71, a retired physicist and former volunteer member of Fort Snelling’s three-person supervisory committee, which analyzed a small sample of the credit union’s loans each month. “And we were too small to absorb the losses.” " > > And as far as I can tell, banks are STILL offering 125% loans. Essentially, they allow a 95% mortgage, and then a 30% unsecured loan on top of it. > > But if you look at that earlier chart showing house prices, it was GREAT idea back in 2000. People were bidding so fast on houses you needed to be able to compete. > > I’ll address the rest of your points a bit later. Thanks for the link. It appears to be just that one, though they gave an example of another credit union doing 100% loans, which is bad enough. They also said that low initial interest loans and interest-only loans were common, which I definitely accept. But as far as I can tell the 125% people were outliers. Some people are morons - that is why there are regulations, to protect us from such. ---
**Author:** ![elucidator](https://avatars.discourse-cdn.com/v4/letter/e/8edcca/32.png) [@elucidator](https://boards.straightdope.com/u/elucidator)\ **Post date:** [September 7, 2010, 9:05pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/69 "2010-09-07T21:05:05Z")
Stiil an understandable error, since bankers and financial insititutions have so few friends in the hallls of power, and groan under the iron grip of the poor, and minorities. ---
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [September 7, 2010, 9:26pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/70 "2010-09-07T21:26:51Z")
> [@elucidator](#): > > Stiil an understandable error, since bankers and financial insititutions have so few friends in the hallls of power, and groan under the iron grip of the poor, and minorities. It’s bad enough the meek shall inherit the Earth, but do they have to fuck with the banking system too? ---
**Author:** ![rivulus](https://avatars.discourse-cdn.com/v4/letter/r/839c29/32.png) [@rivulus](https://boards.straightdope.com/u/rivulus)\ **Post date:** [September 8, 2010, 6:15pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/71 "2010-09-08T18:15:26Z")
**Damuri Ajashi** , thanks for the explanation. It seems to follow what I’ve heard on NPR and other similar sources. Except… I got lost with this sentence: > [@Damuri\_Ajashi](#): > > Then people started adding credit enhancement to their securitizations and all of a sudden these securitizations were producing tripleAAA rated securities and the market exploded. Can you explain “credit enhancement” in more detail? Thanks. I’m just curious to understand this better. Incidentally (and here I am agreeing that CRA is not such a key cause of the crash), whatever effect the CRA may intend, banks have creative ways of dancing around it. For example, suppose a neighborhood is designated as a CRA zone (based on the median price, I believe). The bank must meet certain lending thresholds in the area. Sometimes it does this by loosening underwriting standards just to get the numbers. But a loan does _not_ have to be a subprime loan to count. Prime borrowers count too. And banks can flag (and even target) these borrowers for special treatment in order to get their business and, therefore, offset the risk. ---
**Author:** ![pinkyvee](https://avatars.discourse-cdn.com/v4/letter/p/6de8d8/32.png) [@pinkyvee](https://boards.straightdope.com/u/pinkyvee)\ **Post date:** [September 8, 2010, 6:25pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/72 "2010-09-08T18:25:52Z")
> [@yorick73](#): > > The federal government pressured banks to lend to “underserved populations” who traditionally have poorer credit and are unable to produce a 20% down payment. The Bush administration considered down payments to be a hassle that got in the way of home ownership. FHA loans only require 3.5% down, even today, and are backed by the full faith and credit of our government. > > Lending institutions were more than happy to provide no doc and no down payment loans that they would just sell to Fannie and Freddie. Profits were privatized while losses were socialized. If the lender were on the hook for bad loans they would require larger down payments and very good credit. > > The bad guys in all of this are the politicians who, I believe, had the best of intentions. Everyone on Capitol Hill was pushing home ownership as part of the American dream. Unfortunately, politicians very often don’t think of the consequences of their well intentioned policies. Correct ! Lowering the bar … right here. [http://www.youtube.com/watch?v=kNqQx7sjoS8](http://www.youtube.com/watch?v=kNqQx7sjoS8) Unintended consequences of “good intentions”. ---
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [September 8, 2010, 6:44pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/73 "2010-09-08T18:44:02Z")
Something I personally don’t understand is the role that PMI (private mortgage insurance) plays in all this. A 3.5% FHA requires a PMI. So shouldn’t that have kicked in when people defaulted? ---
**Author:** ![crazyjoe](https://avatars.discourse-cdn.com/v4/letter/c/f14d63/32.png) [@crazyjoe](https://boards.straightdope.com/u/crazyjoe)\ **Post date:** [September 8, 2010, 7:04pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/74 "2010-09-08T19:04:53Z")
> [@emacknight](#): > > Something I personally don’t understand is the role that PMI (private mortgage insurance) plays in all this. A 3.5% FHA requires a PMI. So shouldn’t that have kicked in when people defaulted? It did, and a lot of PMI companies went bankrupt trying to pay out on all the policies. AIG needed a massive influx of cash to pay out on a lot of those policies. Also, a lot of lenders did the old 80/20 trick to allow people to avoid PMI payments. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [September 8, 2010, 7:19pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/75 "2010-09-08T19:19:18Z")
> [@rivulus](#): > > **Damuri Ajashi** , thanks for the explanation. It seems to follow what I’ve heard on NPR and other similar sources. Except… I got lost with this sentence: > > > [@Damuri\_Ajashi](#): > > > > Then people started adding credit enhancement to their securitizations and all of a sudden these securitizations were producing tripleAAA rated securities and the market exploded. > > Can you explain “credit enhancement” in more detail? Thanks. I’m just curious to understand this better. > > Incidentally (and here I am agreeing that CRA is not such a key cause of the crash), whatever effect the CRA may intend, banks have creative ways of dancing around it. For example, suppose a neighborhood is designated as a CRA zone (based on the median price, I believe). The bank must meet certain lending thresholds in the area. Sometimes it does this by loosening underwriting standards just to get the numbers. But a loan does _not_ have to be a subprime loan to count. Prime borrowers count too. And banks can flag (and even target) these borrowers for special treatment in order to get their business and, therefore, offset the risk. Credit enhancements were frequently third party guarantees on some part of the principal or interest. A common form of credit enhancement was a guarantee to cover up to a certain number of interest payments if the proceeds from the underlying mortgages were insufficient. The credit providers hedged their risks but ultimately all the risk had to end up somewhere and as it turned out the lack of regulation placed too much of the risk in key hub financial institutions. To be fair, there was never any set of regulations at any time that would have prevented the meltdown but there were certainly bureaucrats that warned of the risks but were ignored because the trend of the regulatory environment had been going in the other direction for a very long time and everyone was happy with it until things blew up. Noone WANTED this too happen but the free market fanatics placed the risk of this happening at near zero. We now recognize that the chances of this sort of thing happening is just a matter of time without sufficient regulation. The general puiblic has a much better (although still very simplistic) understanding of the mortgage derivative industry. What I’d like to emphasize is that prior to the last decade of so, most mortgage derivative work was very vanilla, cookie cutter work for Freddie Mac and Fannie Mae (and to a much lesser extent Ginnie Mae). This industry was populated by bright industriouos but somewhat conservative professionals who did their job in providing liquidity to the mortgage market. I’ll never forget what my friends at Lehman used to tell me:“the greatest risk in mortgage securitizations are prepayment risk” Thats right!!! They thought the greatest risk was that the homeowner would pay off their mortgage sooner than anticipated!!! It sounds crazy right? Well, not if you’re an investment bank and you are slicing and dicing these mortgages into teeny tiny pieces with REMICs and CDOs. Many REMICS sliced the mortgage pools vertically and just created seniority so that Tranche A got paid it scheduled payments before Tranche B, which got paid before Tranche C, all the way down to the toxic waste and uneconomic interest. This is the more common formulation and we can see how extremely high defaults coupled with a tight credit market and falling home prices might make a formerly TripleAAA rated tranche C suddenly seem quite risky. Well they ALSO sliced these mortgage pools horizontally as well. For example I would sell you the first 2 years worth of interest payment, I would sell someone else the next two years and so on anhd I might sell the principalpaymensts to someone else. Well, if you were the guy that owned the interest payments from eyar ten, you had no idea how much you were going to get, if interest rates dropped sufficiently, you might get very very little as everyone refinanced. If you owned the principal, you would end up getting repaid much much sooner than you expected and your yield would be higher. Of course mortgage originators sliced these tranches up for horizontally and vertically. Then they would take the slices they couldn’t sell for whatever reason and put them in ANOTHER securitization vehicle and slice it up again to create marketable slices. The demand was very high because the fed was essentially pursuing a low interest rate policy with no real good reason for doing so (my conspiracy theory is that some people wanted to “prove supply side economics right” and did what they could to produce results with what supply siders expected with supply side economics). ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [September 8, 2010, 7:23pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/76 "2010-09-08T19:23:33Z")
> [@pinkyvee](#): > > > [@yorick73](#): > > > > The federal government pressured banks to lend to “underserved populations” who traditionally have poorer credit and are unable to produce a 20% down payment. The Bush administration considered down payments to be a hassle that got in the way of home ownership. FHA loans only require 3.5% down, even today, and are backed by the full faith and credit of our government. > > > > Lending institutions were more than happy to provide no doc and no down payment loans that they would just sell to Fannie and Freddie. Profits were privatized while losses were socialized. If the lender were on the hook for bad loans they would require larger down payments and very good credit. > > > > The bad guys in all of this are the politicians who, I believe, had the best of intentions. Everyone on Capitol Hill was pushing home ownership as part of the American dream. Unfortunately, politicians very often don’t think of the consequences of their well intentioned policies. > > Correct ! > > Lowering the bar … right here. > > [http://www.youtube.com/watch?v=kNqQx7sjoS8](http://www.youtube.com/watch?v=kNqQx7sjoS8) > > Unintended consequences of “good intentions”. Youdo realize that fannie and Freddie do not have a single NO DOC loan on its books right? I am not sure but I don’t think they have no down payment loans on its books either. What the securitization market did was provide a secondary market for mortgages OTHER than Fannie and Freddie. So adhering to “conforming standards” stopped being as important to mortgage originators as they once were. ---
**Author:** ![Damuri\_Ajashi](https://avatars.discourse-cdn.com/v4/letter/d/898d66/32.png) [@Damuri\_Ajashi](https://boards.straightdope.com/u/Damuri_Ajashi)\ **Post date:** [September 8, 2010, 7:43pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/77 "2010-09-08T19:43:19Z")
> [@emacknight](#): > > Something I personally don’t understand is the role that PMI (private mortgage insurance) plays in all this. A 3.5% FHA requires a PMI. So shouldn’t that have kicked in when people defaulted? FHA PMI is not PMI. It is not “priivate” mortgage insurance, FHA PMI is provided by the FHA, its provided by the government, and it is not cheap, they want almost all the money at closing and you don’t get off the hook if you default. The PMI you saw prior to the crash was mostly “private” mortgage insurance, frequently provided by folks who had only ever insured munucipal bonds. Then when their credit rating fell, so did the credit rating of municipal bonds. You saw failed auctions and all sorts of fallout from the collapse of the mortgage market. The housing market had been the sole engine of growth for the country for years and most of the growth was based on financial alchemy combined with an acommodating federal reserve and Republican ideology. ---
**Author:** ![elfkin477](https://avatars.discourse-cdn.com/v4/letter/e/a9a28c/32.png) [@elfkin477](https://boards.straightdope.com/u/elfkin477)\ **Post date:** [September 9, 2010, 3:38am UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/78 "2010-09-09T03:38:54Z")
> [@elucidator](#): > > Alas, the poor bankers! Friendless, bereft. You would think that at least in a Republican administration the could find a sympathetic ear, but no, no, the corridors of power are closed to those who only have huge piles of money to recommend them. Don’t worry, they’ll be okay. Fannie Mae is starting a new program to sell as-is forclosed houses to people who may need someone else to pay their downpayment. Some highlights of the new [Homepath program](http://www.fanniemae.com/homepath/financing/index.jhtml): - You may qualify even if your credit is less than perfect (which according to [this article](http://www.housingwatch.com/2010/09/07/fannie-mae-to-sell-foreclosed-homes-with-subprime-lending-terms/?icid=main%7Cmain%7Cdl6%7Csec4_lnk2%7C169171) can be as low as 660-700) - Available to both owner occupiers and investors Down payment (at least 3 percent) can be funded by your own savings; a gift; a grant; or a loan from a nonprofit organization, state or local government, or employer - No mortgage insurance This is awesome. I thought I couldn’t afford a house right now considering 20% is beyond me by thousands, but I could totally swing 3% of up to a $150,000 morage for a house sold as-is and my credit is way higher than 700, so I could buy house tomorrow. What could go wrong? :dubious: ---
**Author:** ![yorick73](https://avatars.discourse-cdn.com/v4/letter/y/b5a626/32.png) [@yorick73](https://boards.straightdope.com/u/yorick73)\ **Post date:** [September 11, 2010, 9:09pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/79 "2010-09-11T21:09:40Z")
> [@Damuri\_Ajashi](#): > > I thought I’d chime in because there is one poster who seems to be just barely well informed enough to be dangerous. > Many of the facts are true but how these facts are applied to the mortgage crisis is patently ridiculous. > > Fannie Mae has been around since the new deal providing a secondary market for home mortgages. Then in the late 60’s We created Freddie Mac and Ginnie Mae. Freddie mac was the kinda sorta private company that enjoyed an implicit federal guarantee and Ginnie Mae was an actual government agency. > > They promulgated standards for conforming mortgages, which described everything about the mortgage from the down payment to the size of the mortgage to the creditworthiness of the borrower and their ability to pay. Conforming mortgages enjoyed better interest rates because banks were able to flip these mortgages to Fannie and Freddie and make a spread without tying up any of their capital. > > They still made mortgages to folks who wanted larger “jumbo” mortgages but they generally required all the paperwork, credit scores, loan-value ratios, income verification, etc. that you would expect with a conforming loan but they charged a higher interest rate because they would have to carry your loan and that required tying up some of their regulatory capital and they charged you for that. > > They also made mortgages to folks who didn’t quite meet the documentation criteria because there were cases where the verfiable income didn’t really reflect the person’a ability to pay a mortgage. For example, the local banker knew that the local car dealer could afford a million dollar home but didn’t have enough historical income to qualify for a mortgage because they were either not taking the money out of the business or they were cheating on their taxes. So they would let them write a mortgage on stated income without documentation. > > Then in the late 70’s they passed the CRA which was meant to deal with things like redlining (which was actually started by the FHA). This pressured banks to start writing subprime mortgages in poor neighborhoods, they cherry-picked what they could but most of the borrowers failed at least one requirement for conforming mortgages. So then they passed another law that required Fannie Freddie and Ginnie to dedicate some of their resources to creating a market for these mortgages. They basically threw the credit scores out the window but they maintained everything else (from the loan to value ratio to the income and down payment requirements). > > Then during the Clinton era, they started deregulating the banks and banks started to merge like crazy. One of the things that folks needed for these mergers was approval from the Department of Justice anti-trust department. One of the criteria that the Justice department looked at was compliance with the CRA. All of a sudden your mergers became more viable if you made subprime mortgages and everyone either wanted to buy someone or get bought by someone. Before you knew it, banks started lending in black neighborhoods and selling the mortgages to Fannie Mae. > > Now I should have mentioned that Freddie Mac and Ginnie Mae basically created the securitization industry. They securitized their mortgage portfolios and used the money to buy even more mortgages. It was all conformings mortgages and it was sold to insurance companies and pension funds. It was more of a financing vehicle than a profit center. > > Up until then the market for private label mortgage backed securities was a fairly small portion of the mortgage securitization market because the market for these securities was largely stodgy old pension funds and insurance companies. Then people started adding credit enhancement to their securitizations and all of a sudden these securitizations were producing tripleAAA rated securities and the market exploded. > > Now, over time the banks had compiled data on how subprime mortgages performed and relative to the interest rates they could charge for these mortgage, it was profitable, default rates were not really very high and the underlying collateral always seemed to be enough to make the lender whole. This meant that if they took a bunch of this stuff and chopped it up just right, they would be able to collect their spread while creating enough tripleAAA rated securities to replenish their lending capacity. People just couldn’t get their hands on enough of the stuff. > > The collapse was caused by several failures across the system but it was all driven by huge never before seen profits in this sleepy little corner of the finance world. > > It wasn’t the CRA, the CRA had been around for decades and there were no legislative changes during the relative time period that would have contributed to the problems we saw. You would have to be on some sort of mission to blame the CRA to come up with an argument that blamed the CRA and that is exactly what folks who wanted to blame a Democratic construct did. > > It wasn’t Fannie mae/Freddie mac/Ginnie mae. These organizations had been around more or less in their present form doing what they have always done for at least 30 years. > > It wasn’t even securitization which has been around almost as long as freddie mac has been. > > It was a confluence of non-bank mortgage lenders (like countrywide), a deep demand for even slightly higher tripleAAA yields, a relaxation of regulation and oversight, an administration with an unpopular war with an economy that seemed to be running solely on the housing boom, an Ayn Rand worshipping Fed Chair that didn’t see any problem with the situation and most of all greed and the lack of political will to temper it. You haven’t gotten to the root causes of the meltdown. For starters, government land-use restrictions in quite a few places artificially drove up property values to such a degree that many potential homeowners NEEDED banks that provide riskier mortgages. Banks were in the business of providing riskier mortgages thanks to the CRA which DID in fact change in ways that contributed to the problem. Clinton beefed up the CRA and put the full force of Justice behind this previously obscure and lightly enforced regulation. Also, the problem of redlining was a local issue. As you mentioned banks started merging like crazy and had to show CRA compliance in order to merge. Now a local issue confined to a local bank and neighborhood becomes a national issue with national implications. Banks with no redlining issues are now required to make risky loans if they wanted to do business at all. Add to this the fact that Fannie was required by HUD to dedicate 50% of its business to low and moderate income families. They purchased over $400 billion in securities backed by subprime loans between 2004 and 2006. This created the market for subprime loans in the private industry. HUD failed to make sure people were able to pay back these mortages. Why should the banks care if people can afford to pay back their mortgages if the banks are not responsible for the losses? The greed that so many people complain about was made possible by your government. The conditions that allowed people to borrow with little or nothing down was made possible by your government. Lax lending standards were made possible by your government. ---
**Author:** ![GIGObuster](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/gigobuster/32/421_2.png) [@GIGObuster](https://boards.straightdope.com/u/GIGObuster)\ **Post date:** [September 11, 2010, 10:17pm UTC](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544/80 "2010-09-11T22:17:10Z")
> [@yorick73](#): > > Now I should have mentioned that Freddie Mac and Ginnie Mae basically created the securitization industry. They securitized their mortgage portfolios and used the money to buy even more mortgages. It was all conformings mortgages and it was sold to insurance companies and pension funds. It was more of a financing vehicle than a profit center. > > … > > Up until then the market for priAdd to this the fact that Fannie was required by HUD to dedicate 50% of its business to low and moderate income families. They purchased over $400 billion in securities backed by subprime loans between 2004 and 2006. This created the market for subprime loans in the private industry. HUD failed to make sure people were able to pay back these mortages. Why should the banks care if people can afford to pay back their mortgages if the banks are not responsible for the losses? The greed that so many people complain about was made possible by your government. The conditions that allowed people to borrow with little or nothing down was made possible by your government. Lax lending standards were made possible by your government. The time line that you are mentioning is really an attempt to rewrite history. > **[Analysis - Roots Of The Crisis | Inside The Meltdown | FRONTLINE | PBS](https://www.pbs.org/wgbh/pages/frontline/meltdown/themes/howwegothere.html)** > [@](#): > > The important thing in '07 is that almost everyone who has a head on their shoulders is saying, “I think there might be a problem here.” But there’s one fundamental response that everyone takes faith in, which is the price of an American home has never consistently gone down since the Great Depression. … > > But here’s what’s happened in the meantime that not a lot of people are paying attention to. … From 2004 to 2007, Fannie [Mae] and Freddie [Mac] are all of a sudden under assault from Wall Street. Wall Street is trying to take over Fannie and Freddie’s business. And Fannie and Freddie, to compete, basically start saying, “We’re going to start buying riskier and riskier loans.” … > > So there’s this fundamental thing that happens between '04 and '07 which is that all of a sudden, all of the data that was the ballast that supported this belief that homes will never lose any value, the underpinnings of that have disappeared. But not a lot of people have paid attention to it. Once again, Fannie and Freddie were a factor, but not the main reason of the meltdown. [Previous page](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544.md?page=3) [Next page](https://boards.straightdope.com/t/what-was-the-cause-of-the-mortgage-meltdown/552544.md?page=5)