Basically the transformation is effected by feeding the loan to a civet.
More than that you probably don't want to know.
My uninformed impression is that pretty much anything can become a security these days.
I think what happens is that they bundle up a bunch of loans and sell them as an investment. People would buy them because they are like bonds with a higher interest rate (although they are riskier).
you can securitize pretety much anything really.
especially with places like mortage companies that don't have the resources that a bank might. they just act as middle men for the capital
Snarkout posted this link in the Ali Larter thread. It's the most concisely informative explanation I've seen.
Basically, joeo gets it right. Mortgages have certain attributes - like interest rates, amounts, credit rating of the people who have taken them out, etc. However, the big stumbling block before the 1980s was the fact that people could prepay their mortgages, and then the investment is over.
What happened in the 1980s is that people figured out that if you group a bunch of mortgages with similar characteristics together, you can also figure out which percentage of those mortgages will end early, and so you can package them together and sell them as investments. Basically, it involves statistical calculations about income, credit history, and so forth, but basically, the mortgage securitizers figured out ways to package mortgages so that they'd have the attributes of other securities, things like bonds.
It's really a complicated scheme, but one that greatly increased liquidity, made a number of people rich, and made it a lot easier for people to get mortgages and buy their own houses. Because banks were no longer stuck with all these mortgages, and could sell them off to other investors, they could diversify and not be so bad off if a number of their mortgages went bad. And for the most part, people who needed mortgages were better off, because banks could offer more attractive rates for good risks, and offer better rates for marginal risks.
But since this is America, a little bit of a good thing is great, so a lot of it must be great, right? Unfortunately, no, and we'll continue to see the fallout from this in the future.
If you have a pizza where every slice has a different topping it makes sense to separate the slices, bundle them with similar slices and sell a whole pepperoni pie.
Substitute pie with mortgage and topping with Risk/Return profile. It won't make sense, but it will sound funny.
Trickster Paean gets it right. The other key innovation in making bundles of mortgages behave like normal bonds was to create "tranches" of securities by pledging different cash flows to different parties. For example, a Tranche A could have first recourse to all interest payments, while subordinate tranches get paid only after the Tranche A has received its due. This has the effect of making Tranche A a very low risk investment, while the subordinate tranches can offer a higher return at lower risk.
The mortgage securitization market emerged in the 1980s in response to the mismatch between available savings and demand for home loans in certain regions. The Rust Belt was depopulating, the Sun Belt was exploding, and there needed to be a way for savings from the former to finance home purchases in the latter.
Michael Lewis documents the whole story in Liar's Poker, a book that still rewards the reader 20-plus years after the fact, both for the explanation of the securitization market and for the documentation of the raucous Wall St. environment in which said market emerged.
Basically it means your mortgage money is a tiny part of a big stream of money going to, e.g., a bunch of german dentists and their retirement fund.
Basically, it involves statistical calculations about income, credit history, and so forth, but basically, the mortgage securitizers figured out ways to package mortgages so that they'd have the attributes of other securities, things like bonds.
In my continued efforts to make myself more boring: Bruce Carruthers and Art Stinchcombe have this nice article, The social structure of liquidity: Flexibility, markets, and states about how this happened. What's interesting is the way that houses -- which, of all assets, are have lots of very specific, individualizing qualities -- get turned into a homogeneous bundle of assets with known risk.
Even simpler; you are a bank. You have a big pile of cash people put in the bank. You want to make more cash. So you lend it to house-buyers at a higher rate of interest than you pay the depositors. You now have a pile of assets (the loanbook) and a pile of liabilities (the total credit balances of your depositors).
You need to keep some fraction of the liabilities on hand in cash, and you would like to get the capital tied up in the loans back so you can go and do more business with it. So you sell the rights to collect on the mortgages, in chunks, to other investors. They now have the asset, and most of the cashflow from repayments (less the turn you take on the deal to make a profit).
They also have the risk that the house-buyers won't repay it. You, however, have the pile of cash back, and you can now do the whole thing over again.
Refinements: you can, as discussed above, classify your loanbook by various criteria and then chop it up, so you can sell your rock-solid loans to investors who want security and your dodgy ones to investors who want high returns, as well as using this process to maintain a balance of risks in any pool of loans you're keeping on your own books.
with known risk.
Or so they thought.
13: ... and if the buyers of these securities suddenly realize that they underestimated the risks, they stop participating in the market and the whole system seizes up.
Unfogged's commenters: surprisingly good at explaining things!
"[W]hile the subordinate tranches can offer a higher return at lower risk"
s/b "higher return at higher risk".
Didn't mean to imply there was a free lunch there.
15: this is no different, however, to the situation where the bank finances its mortgage lending conventionally. If nobody wants to buy the bank's bonds/deposit more money in the bank, the bank can't lend money out.
There are a couple other things going on, too. As described in that Times graphic, investment banks (those clever little monkeys!) figured out that if they could make billions of dollars bundling up hundreds of mortgages and slicing them various ways to make bonds, they could similarly make gajillions of dollars gathering up hundreds of mortgage-backed bonds and slicing them various ways to make "collateralized debt obligations".
Just as mortgage-backed securities are sliced into tranches (so that you can accept less money to make sure that you're first in line to be paid off if a chunk of the mortgages default), the CDOs are sliced up the same way (so that a pension plan can still be first in line to be paid off if a chunk of MBSs default). Companies like Standard and Poors and Moody's assign these guys rankings based on the likelihood that you won't get your money back; the safest are called AAA, and because of a recent international banking agreement called Basel II, there's been a big demand for AAA bonds in banks across the world, so these are going to start turning up in all sorts of places just in time for the discovery that the models everyone was using to call these AAA instead of something less likely to pay off was completely wrong. And that's how grandma's mortgage ends up owned by a European bank.
This is no different, however, to the situation where the bank finances its mortgage lending conventionally. If nobody wants to buy the bank's bonds/deposit more money in the bank, the bank can't lend money out.
There is one very meaningful difference: a bank that holds a portfolio of home loans made out of its own deposits has every incentive to do intensive due diligence on the borrowers and on the collateral asset.
By contrast, mortgage brokers who are getting paid by the transaction or mortgage lenders who plan to hive off the loan to bondholders have a moral hazard problem: they have every incentive to give the borrower the money even where a prudent lender would be skeptical of the asset valuation and/or the borrower's ability to repay.
The bank that issues the mortgage-backed security prices the default risk based on historical experience. If mortgage products are getting ever riskier, and there is no empirical record of how these loans perform in an economic downturn, that's a recipe for disaster.
That's what we are seeing now.
The other other thing going on is that junk bonds (bonds rated C or below, so asessed by the ratings companies as likely to fall apart) has suddenly become unpalatable, as a result of the gajillions of leveraged buyouts of the last few years (which are paid for using junk bonds; this is how Michael Milken made his money). Interest rates were low, so buyout companies like KKR and Blackstone bought everything that wasn't nailed down, and the junk debt they used to do it gradually had worse and worse terms because nothing had gone wrong yet.
Then the mortgage stuff happened, people got more gunshy, and the banks (major banks, your Bank of Americas and Citibanks) who made "bridge loans" to the buyout companies were stuck with junk bonds they couldn't turn around and resell. They'll probably lose money on them, so they've drawn back from that particular game (everyone remembers Ohio Mattress from the last time this happened). Meanwhile, everyone knows that it's a buyer's market and everyone is nervous, so the bond markets are seizing up. This is what led the European Common Bank to start injecting money into the system yesterday.
All I could do, without actually thinking or working, is provide links. Barry Rittholz & Nouriel Roubini, besides the posts, have comment sections that will give a hint as to what the traders are thinking. I think they are funny.
The usual econoblogs are on this, in their usual manner. No fun.
This is what led the European Common Bank to start injecting money into the system yesterday
The workers control the means of capitalization!
This is what led the European Common Bank to start injecting money into the system yesterday
The workers control the means of capitalization!
Finally, a thread I'd be halfway good at, and I get pre-pwned about 17 different ways.
Good final tie-in to CDOs and the Basel II capital requirements, snarkout.
My impression from reading Liar's Poker was that a bank selling its mortgages was actually illegal, and Congress changed the law to give Savings and Loans a chance to recoup some of their losses as a way of dealing with the S&L crisis.
You guys are good at explaining things. Thanks, folks. But I might be back with questions once I've thought about this!
There was a financial wizard in Portland OR, Andrew Wiederhorn, who bought large parcels of bad debt, borrowed money using the bad debt he owned as security, reinvested the money, and then solicited investors and invested their money for him. He eventually went to jail for a few months, as did the president of the union he bribed and one or two of his partners. The union lost a big chunk of it pension fund.
With an effort it's possible to dimly understand the non-criminal part of his business, but it has a smoke-and-mirrors house-of-cards feel to it. A lot off the big scandals and disasters of the 90s (LTCM, Enron, shock therapy in Russia) were engineered by state-of-the-art highly sophisticated financiers (including two Nobelists who were lucky to stay out of jail).
As a Luddite leftist I am in favor of sturdy and unimaginative finance.
22 -- but you didn't actually provide links.
Ogged must be feeling like a Senator now, with a staff of people who can explain every issue in the world to him.
So, when all these people foreclose on their mortgages, how likely is it that there is no entity on earth who will admit to actually owning the mortgage and therefore owning that tiresome actual house? Seems like a bonanza for squatters.
30: the house is the security at the top of the chain -- if the loan is in complete default and all the paper money falls away the house is the only real asset. Absolute zero chance it's unclaimed--whoever's first in line gets it.
Oh, so in situations like this and this each house has a known owner who finds it more profitable to abandon the house than to pay to restore it and try to sell it.
31- But the value of the asset will usually be way below the debt. In some cases, the carrying costs (taxes, leins, etc) might exceed the value of the asset and everyone will walk away.
Okay, everybody, let's get the crowbars out! Next stop, the Unfogged squat! It'll be just like War in the Neighborhood only funner!
Somebody knows how to hook up electricity, right?
33 - and after two years of occupancy and five years of abandonment, the house can be torn down and thrown away, and another one built! The home-building companies may not suffer from the bursting of the bubble after all.
Am I correct in thinking that the end result is, overall, a wealth transfer upwards, with some winners and losers at the top, but only losers at the bottom? And with few real losers at the top, if there's a gov. bail-out.
Also, how did the spike in interest rates play into this?
Whee! Turns out you all should have taken my investment advice after all.
Here's a link to the
NY Times summary . IMO, the most salient feature is that the several mortgages that make up a risky loan pool can be repackaged such that those who hold the first-in-line mortgages after the foreclosure have a AA rated security, which allows access to insurance companies and retiremend funds. In otherwords, shit is trasmuted to gold, just trust us, the issuers. The blog calculated risk is interesting reading. The ABX indexes are a measure of how the resulting securities are priced. There's debate over how good a measure, though.
32/33: well yes the value of the house does have to be positive or the analysis falls apart. But I think that's an issue entirely separate from securitization -- we'd have the same problem if the local bank was holding the loan.
The WSJ has a nice map of how the credit tightening has spread around the globe leading companies to postpone or cancel planned debt auctions.
My impression from reading Liar's Poker was that a bank selling its mortgages was actually illegal
Sort of right. This was true of savings & loans (thrifts), which are very different institutions from a legal and regulatory point of view. The Garn-St. Germain Act lifted the various restrictions on how savings & loans could invest their deposits. Before Garn-St-Germain, S&Ls were sitting on huge portfolios of low-interest 30 year mortgages from the pre-inflation era at a time they had to pay 14% interest to attract deposits. Deregulation allowed them to play a game of double or nothing at no risk to themselves, thanks to deposit insurance. Taxpayers got stuck with the bill, naturally.
Am I correct in thinking that the end result is, overall, a wealth transfer upwards, with some winners and losers at the top, but only losers at the bottom?
The real killing was made in the middle - the guys packaging these loans who took advantage both of the borrower and the folks who bought the mortgage securities. There may be legal recourse, but I wouldn't bet on it having a big impact. (Don't be confused by the fact that the middleman companies are going bankrupt. Their principals have already collected a lot of cash, and I bet they're largely beyond the reach of the law.)
I think that the "top" of this chain - the buyers of the securities - contain more "little guys" than you might imagine. Think pension funds.
We'd have the same problem if the local bank was holding the loan.
Once again, a lot of those loans never would have been made if the lenders had borne the default risk.
Don't get me wrong: I think securitization is a great financial innovation, by and large. But combine an abuse-prone system with greed and lax regulation and you get trouble.
Ok, let's do another one for the economists who want to feel useful. The fed target overnight funds rate is 5.25%- that's a target that they shoot for based on how much money is distributed to the regional reserve banks. (They used to not even announce the target, people had to guess whether the rate had been changed based on their actions.) But what exactly are those actions that get money to commercial banks? When they say the fed injected $24B into the banking system, how does that work? They don't just wire free cash to Bank of America- is it a short term guaranteed loan or what? Is the money from the treasury, in which case it's really just more government bonds that have been issued and have to be bought by someone (ie, China just gave us another $24B)?
44: the fed injects $24B into the banking system buy buying $24B worth of gov't bonds.
Erm, no. There's a multiplier. But they buy bonds.
I think that the "top" of this chain - the buyers of the securities - contain more "little guys" than you might imagine. Think pension funds.
This is something I was overlooking. So the net result is even more a transfer from "little guys" to "big guys" (on the individual income level), since the "big guys" are themselves beyond legal recourse. "Little guys" paid exorbitant mortgage rates and/or defaulted and lost their homes and/or lost their pensions.
http://en.wikipedia.org/wiki/Open_market_operations
In otherwords, shit is trasmuted to gold.
That's more or less true. Or, put another way, some gold dust can be filtered out of the shit. The system breaks down when the ratio of shit to gold dust turns out to be higher than expected, which unfortunately tends to be the case when house prices are inflated and credit is extended to financially unstable borrowers on terms that carry a high risk of default.
That's where we find ourselves today.
It would seem that all sophisticated finance provides opportunities both for fraud and for disaster. The more complicated something is, the fewer people are able to understand it, and the greater the opportunities are for the people who do understand it to take advantage of the ones who don't. And it's never possible to work out all of the possibilities of a complex new system in advance, so the workings will always be unpredictable.
So if one person finds a glitch in the system and profits from before anyone else knows what's going on, with the result that the system collapses, it has the effect of a crime without actually being illegal.
There are many areas where visionaries are a good thing, but I don't think that finance is one of them.
50 is precisely true and is a feature, not a bug. This is why landed aristocrats were so dubious about the rise of credit in the 18th century. Look at John Law's Mississippi Bubble (successfully used by the crown to loot the French aristocracy and middle class -- those wily Scots!), f'rinstance.
See Delong on the distributional consequences of the mortgage-backed security meltdown.
Subprime borrowers who put no money down and so have no equity and live in non-recourse states have done rather well over the past five years: they have gotten really cheap rent for several years, and now can decide whether to renegotiate or move.Many subprime borrowers in recourse states, or who had substantial equity, are in trouble as the teaser rates expire--but in foreseeable trouble, it's not as though long-term dollar interest rates have spiked (although they may yet)--unless the terms of their contracts were fraudulently misrepresented to them.
Some little guys will be winners, some losers.
45- Ah, I see- they are buying back securities for cash with an agreement that the people getting the cash will reclaim the securities (+ pay interest) at a later date. That explains where the money comes from, it's repaid by the people who are taking the instant cash out.
But now I call bullshit- via atrios:
The Fed accepted only mortgage-backed debt as collateral for this morning's weekend repurchase agreement.
unless the terms of their contracts were fraudulently misrepresented to them.
I think the kicker is here. Sure, we don't have debtors' prisons, so people who had nothing didn't lose much. But people who signed up for variable rate mortgages because they trusted the broker and who had something to lose, lost it.
At this point I know three people losing their homes. Two are subprime borrowers. One had job problems. I also know someone who got a non-sub-prime loan, whatever they call them ("prime loan" I suppose) who really seems to be deeper in debt than she can afford, and if home prices go down much she'll be stuck with no way out.
I know three people losing their homes
You're not using the correct terminology. Our economist friends call this an "adjustment."
I'm positive I don't want the thread to go this way, but I can't stop myself: some people are getting screwed, some people screwed themselves--it wasn't a mystery that adjustable rate mortgages were very risky for borrowers.
if home prices go down much
The crazy radical in me thinks this should happen more often. People can rent; why shouldn't homeowners be subjected to the same kinds of ups and downs as equity investors?
Here's another one. Well, I thought "S&L" and "bank" were synonyms. What's the difference?
I'm positive I don't want the thread to go this way, but I can't stop myself: some people are getting screwed, some people screwed themselves--it wasn't a mystery that adjustable rate mortgages were very risky for borrowers.
Were people lied to or misled in order to buy mortgages they couldn't possibly afford or which were worse than their current mortages? Of course they were, that's what salesmen do.
I tend to agree with you. But it's no mystery that cigarette smoking is bad for you, yet we have laws to curb it and medical insurance to pay for its outcomes; it's no mystery that you ought to save for retirement, yet we have Social Security. We have many laws based on the assumption that people, in the main, are irresponsible. Possibly because we are.
I've never really understood the fetish of home ownership*. Houses seem to be a lot of trouble. Money spent paying interest goes down the drain the same way money spent paying rent does. A lot of the capital gain of home ownership comes from extra work you do maintaining and improving it. Someone with a paid up $100,000 house paid far more than $100,000 for it, plus a lot of sweat equity, and houses don't necessarily appreciate. Homeowners also are tied down in ways that renters aren't.
I understand that from many points of view home ownership is unquestionably the way to go, but people seem to go beyond that. I knew someone once who was spending something like 60% of her paycheck on a 3-bedroom house for one person.
*Except in Elgin, N.D., with a $40 monthly payment.
The difference is in the charter, Ned. By law, S&Ls (also called "thrifts") have to have the majority of their lending be in the form of (local) mortgages. Banks don't have the same restriction and can have the majority of their lending be to condo construction loans in Miami or startups in Silicon Valley.
John agrees with me. Renters unite!
if one person finds a glitch in the system and profits from before anyone else knows what's going on, with the result that the system collapses,
Not a necessary result. A second effect of imaginative finance is access to credit for people without collateral. This can backfire, but it certainly helped me when I needed to pay for college and when I wanted to buy a house. Thare have been times and are places where the financial system is much more closely regulated than here, though not ceteris paribus; the end result is often shitty interest on savings for the little guy as well as no way to borrow money legally without collateral. The most culpable villains in the current situation IMO are storefront mortgage brokers.
fetish of home ownership
Inflation hedge.
fetish of home ownership
So as to not have to pay rent after retirement.
it wasn't a mystery that adjustable rate mortgages were very risky for borrowers.
It wouldn't be a mystery for you or me, but it would be a mystery for the typical sub-prime borrower. Unless you want to pretend we all have equal access to information and have the same intellectual confidence to ask questions.
Isn't that like Microsoft or GM or Google dropping 95%
I think a better analogy would be a bank run. I don't have much sympathy for the individuals getting bailed out, but I worry about the system.
69 gets it right. I don't want to buy a car because I know I have no idea how to negotiate or what information would be useful. Reading books is no help, what matters is experience. Eventually after I buy a couple cars and learn from my mistakes I will know how to do it.
I'm not looking forward to buying a house for the first (only?) time, either.
I'm positive I don't want the thread to go this way, but
Why not, you got your question answered.
LET THE BOSSES TAKE THE LOSSES
Unless you want to pretend
No, I don't, which is why I said some people got screwed. Minor point, really.
Though my crankiness about homeownership as an investment has a lot to do with the endless cries of "protect our property valuuuues!" that come up around other development projects or changes. I guess I'm assuming that such people are mostly interested in their property values, and not using that as an acceptable public face on more basely motivated NIMBYism or BANANAism.
Depends on the market. At least if you're paying off a mortgage, you end up owning something, which isn't the case with tossing away your monthly rent.
And Ned's retirement point is a good one. When my parents managed to pay off their house I certainly breathed a sigh of relief.
Yeah, but for the first ten years or so of a thirty-year mortgage you're mostly just paying interest and accumulating equity very slowly.
it wasn't a mystery that adjustable rate mortgages were very risky for borrowers.
Actually, it was something of a mystery - both to the unsophisticated folks borrowing money, and to the financial sophisticate who were lending it.
Knecht deals with this issue in 20. Moral hazard is the short answer. There were people in the system with a stake in obscuring the risk.
my crankiness about homeownership as an investment has a lot to do with the endless cries of "protect our property valuuuues!" that come up around other development projects or changes
Welcome to the story of how the white middle class became Reagan Republicans. (1) GI Bill and postwar tax code, among other laws, encourage home-buying. (2) Big move to suburbs. Americans become suburbanites rather than city-dwellers, their houses their most important investment. (3) "I'm not racist, but I don't want black people in my neighborhood, because it will drive down home values." No more middle-class support for public education or transportation.
73: minor point, agreed. I retract the snark.
On the other hand I think it should be normal for retired people to move into their children's homes instead of being ghettoized with other old people (partially because you know, they have to pay rent on those places instead of keeping their savings). I hope I can do that for my parents if they want to.
tossing away your monthly rent
But often you're tossing away a very similar amount of money in interest, property taxes, and maintenance. Sure, you end up owning something, but you need to do a fair comparison, where you contrast the home equity with the same money saved somewhere else. I think I'd rather rent and own a big brokerage account after 30 years.
69: I think people sometimes overrate the stupidity of other people. If you're a poor credit risk--or, you know, poor--you might take a big risk on a mortgage for the same reason you might buy 10 lottery tickets rather than one: you have a reasonable expectation that the "prudent" thing to do isn't going to change your life one bit. If there's a lack of information, I suspect it's over how much room there is for negotiation when you find yourself in a bad situation, and how to go about it.
BANANAism
Chief proponent: Gwen Stefani.
81: That's true, but there's a forced saving effect in paying off a mortgage. Many people who do reliably pay their mortgage, and thus accumulate a substantial financial asset, wouldn't reliably contribute the same amount to a brokerage account.
It would seem that all sophisticated finance provides opportunities both for fraud and for disaster. The more complicated something is, the fewer people are able to understand it, and the greater the opportunities are for the people who do understand it to take advantage of the ones who don't.
It doesn't have to be complicated. It just requires people who's jobs depend on making deals with a short time horizon. Liar's Poker offers some good stories about Savings and Loans officers coming to Wall Street, the traders telling them "we'll do the trade I want to make" (meaning that the trader makes a lot of money and the S & L takes a lot of risk) because the S & L has to make some trade.
Michael Lewis essentially describes the S & L bailout as an enormous transfer of government money to wall street traders.
Does everyone else already know that William Shatner did an album with Ben Folds? And some of it is actually kind of awesome?
82: If you're a poor credit risk--or, you know, poor--you might take a big risk on a mortgage
This sort of argument gets deployed in the context of healthcare all the time. "People choose to go without insurance because the risk/reward ratio makes that rational."
The challenge for society is to adjust the risk/reward ratio so that people aren't rolling the dice this way.
(SCMT - to be clear, I wasn't suggesting that you are insensible to this point.)
87: But I think we think of home ownership or getting rich as different from receiving healthcare. (It's not clear that we treat home ownership and healthcare all that differently, however.)
86: Yes, and yes. It was at the top of the college radio charts for a couple months.
And it has Joe Jackson on it. Why doesn't Unfogged tell me important things?
81/84: Not to mention the substantial tax advantages of the mortgage interest deduction. Take that away and your point makes a lot of sense, Nathan. But with that many people would be hard pressed to find as advantageous a way to save that much money.
Well, I think that even *with* the mortgage interest deduction it's not a forgone conclusion that homeownership makes sense, especially on the lower end where the interest deduction is going to be close to the standard deduction. But I also think the mortgage interest deduction should die.
Yeah, but for the first ten years or so of a thirty-year mortgage you're mostly just paying interest and accumulating equity very slowly.
If only that were true, John, it would have been a helluva lot easier to buy out the Ex's interest in the marital home. Stupid appreciation.
It's definitely more of a benefit for higher-end homes, no question about it. And yes of course it should die.
CERTAIN UNDERTONES IN A FEW OF DI KOTIMY'S RECENT COMMENTS GIVE A SUBTLE SUGGESTION OF MARITAL DISCORD
It depends on where you are, too. I suspect that my parents' mortgage + property taxes + maintenance, when it existed, was equivalent to my monthly rent or near enough.
Paging Standpipe B. I don't understand the Stefani -- BANANA joke. I don't even understand BANANA.
ogged in 58:
I'm positive I don't want the thread to go this way, but I can't stop myself: some people are getting screwed, some people screwed themselves--it wasn't a mystery that adjustable rate mortgages were very risky for borrowers.
My doctor friend got screwed when he recently bought a condo. He's stuck with an ARM. He'd been promised a 30-year fixed [bad broker!], but then--days before closing--they said that something was wrong with his credit report, and he could only get an ARM. He thought that it was his fault, but then he discovered that the credit thing was wrong and that it had already been corrected in his report. The broker was just using it as an excuse. He tried valiantly to get the terms of the loan changed, but what was he supposed to do days before closing, when he couldn't?
BANANA as I used it is a more-extreme version of NIMBY. "Build Absolutely Nothing Anywhere Near Anybody".
Some people screwed themselves by taking out ARMs when they shouldn't have but there was definitely fraud or misrepresentation, it sounds. Like the person interviewed by the NYT the other day who they called up and asked why she went with an adjustable rate mortgage instead of a fixed rate and she had no idea she'd been sold an ARM.
It's just a question of what the ratio is of fraud vs. sunny American overoptimism ("I'm sure rates will still be low and my salary will double in 5 years by the time it readjusts") vs. people having no clue about money.
BANANA = Build Absolutely Nothing Anywhere Near Anyone
When people buy homes it takes over their whole life. Almost always they become more boring, at least if buying a home has been a major goal. (Some people can buy homes easily.)
Bought homes are just places to live in, their places to show. Sometimes whole rooms are dedicated to looking good and can't be lived in. At the moment my sister's house isn't ready to show, so we can only invite a few trusted friends over.
So as to not have to pay rent after retirement.
This also seems to have been completely lost on people, witness all of the people taking out home equity for stupid stuff. It annoys me when people brag about owning their home. Dude, you don't own shit. You have no equity.
One type I hate is the wilderness pioneer homebuilders. They want to build a house somewhere unspoiled, but they spoil it. Someone else comes along, and then they whine.
If you want to live in a wilderness, you have to buy the whole wilderness, not just one lot on it.
Let's recall that that partisan hack Greenspan was encouraging people to use ARMs at the worst possible time, about two years before interest rates started going back to normal. What a fucking toad.
"Bought homes aren't just places to live in, they're also places to show. "
We regret the error.
It annoys me when people brag about owning their home. Dude, you don't own shit. You have no equity.
Well, okay, but most banks are also significantly less restrictive than most landlords in terms of what you can do with it the place you're living in. If you want to update the kitchen, that's your prerogative and it's your asset you're improving. And you don't have to worry about potentially needing to move or having your rent jerked around every year. Etc. etc.
That said I agree a lot more people should probably rent.
So what's the stated rationale for the mortgage interest tax deduction? Without it, 81 would make sense. With it, 81 would be much better off taking a big a mortgage as his credit would allow, renting the house and investing the proceeds, and then renting an apartment or becoming a hobo or whatever. What is the state's interest in this operation?
My mother has been known to say that she can't have people over because the house is a mess when by 'a mess' she means 'clean, but looks like the owners were too busy raising children to redecorate.' It's very silly when you bought a house with a nice flat backyard so you could have people over, but then have to be talked into holding the graduation party (say) in the backyard.
Some of us will never want to redo a kitchen.
Fucking kitchens. Don't get me started.
Cala, 110: My understanding is that your mother and my sister are statistically normal, but crazy.
re:105:
A related issue is when someone builds a home on the outskirts of Tinderbox National Forest. Come August, they expect to be saved. Come November, we get something along the lines of a "Healthy Forests Initiative" to combat arboreal malice.
109: There's no stated rationale. It was an accident of the tax code (all interest payments used to be deductable, because only businesses had them, and they were a business expense). Iit was the only one that was kept for individuals in the 1986 tax reform, because it was already too entrenched to fool with. Before 1986 there were all kinds of weirdnesses where you were encouraged to use various store credit to buy things because you could then deduct the interest....
Way to go, Ogged. Post on a topic I write about for a living while I'm asleep, why don't you?
If anyone still has any questions, I'll try to answer them, but bear in mind I'm much more familiar with the European market, which works on the same broad principles but is very different in practice. For instance, here variable rate mortgages are the norm, and we're not having the same crisis at all (in the underlying mortgages anyway - the securities markets have caught the American bug). The real problem is the combination of risky features such as variable rates, discount starter rates, low or no documentation and high loan to value ratios. These became very common in the States but are very rare in Europe. The UK has the most developed subprime market by far, but there is also a legal requirement for lenders to assess affordability, so the problems have been limited and so far no mortgage backed securities have suffered any losses.
78:Also cheap energy and intentional de-urbanization/suburbanization. It was a political plan in addition to economic, part of post-Nixon coalition of Wall Street and the South screwing Main Streets. Nice pictures yesterday of Detroit turning into a forest.
Stirling Newberry ...explains it all for you. If y'all wanna know where I am coming from.
I believe Alan Greenspan was the man of the last half century, from his early Randite days to helping end the draft to the FICA ripoff scam to engineering the feudalization of the world at the Fed.
82:Persistance of Poverty ...Tyler Cowen on the lower quintile and risk-taking
Buying a house, renting it, and investing the proceeds only works if rental payments are close to mortgage payments. The fact that mortgage payments have, in many areas, shot well past rental payments is one of the older signs that this whole arrangement wasn't going to last.
109: the rationale is that they can't get rid of it without causing riots. It's an artifact that crept into the tax code backwards, not as a deliberate policy. It's sometimes justified as encouraging homeownership but that is jst post-hoc justification.
But, ya know, this is what Unfogged does with "liquidity event?" More dirty jokes over at Rittholz's and at Roubini's.
This is a truly perverted blog.
Some of us will never want to redo a kitchen.
Fucking kitchens. Don't get me started.
Holy shit, tell me about it. My parents are one of the happiest couples I know, but the renovations of two kitchens have been the biggest strains on their marriage ever. Unless you have valium in your veins, do not ever renovate the kitchen while living in your house. Rent or move somewhere else for that six months to a year (because that's what it will take, even if they say two months tops). Jeez.
Ginger Yellow--Are you in the UK or on the Continent? I know that UK mortgages are mostly adjustable rate, but is this true of the rest of Europe. I don't know anything about German banking, but I have a hard time imagining Germans, who like to pay large sums of money in cash rather than by check, would go in for anything so risky as a variable rate mortgage.
snarkout in 19:
There are a couple other things going on, too. As described in that Times graphic, investment banks (those clever little monkeys!) figured out that if they could make billions of dollars bundling up hundreds of mortgages and slicing them various ways to make bonds, they could similarly make gajillions of dollars gathering up hundreds of mortgage-backed bonds and slicing them various ways to make "collateralized debt obligations".
Just as mortgage-backed securities are sliced into tranches (so that you can accept less money to make sure that you're first in line to be paid off if a chunk of the mortgages default), the CDOs are sliced up the same way (so that a pension plan can still be first in line to be paid off if a chunk of MBSs default). Companies like Standard and Poors and Moody's assign these guys rankings based on the likelihood that you won't get your money back; the safest are called AAA,
I apologize for quoting such a long segment, but comment 19 is far enough back that I don't want to make people scroll back too far.
I don't understand what the benefit of CDOs is over regular bonds. Rating agencies can rate bonds. Why can't people (and pension funds et al.) just buy the bonds. The I-bankers get extra fees for coming up with a new instrument, but what does this financial innovation do for lenders and borrowers?
As an aside, if you want to know what sounds really risky to me, it's project finance. No collateral at all, totally non-recourse debt funding projects in a whole bunch of different countries.
"The worldwide central banks are not stepping in with cash held under the mattress for a rainy day - this is paper printing at its finest - more like Weimer Light.
The actions show the greatest fear of all central banks is not inflation - as inflation is a necessary component of fiat finacial ponzi schemes - the great fear is and always has been deflation." ...Winston Munn, in comments at Rittholz
Rittholz has trying to dig out the numbers since the Fed stopped tracking liquidity, and says M3 has over 10% for a decade. Recessions and inflation aren't so bad, except for rentiers, and are a necessary cost of avoiding bubbles, panics, depressions. I grew up thru a lot of recessions, and generally most excellent times.
I don't know nuthin, but I believe that Malthus vs Ricardo on Say & the "General Glut" is like the key to everything. Everything.
I don't understand what the benefit of CDOs is over regular bonds. Rating agencies can rate bonds. Why can't people (and pension funds et al.) just buy the bonds. The I-bankers get extra fees for coming up with a new instrument, but what does this financial innovation do for lenders and borrowers?
If anyone comments here who works on Wall Street, I'd like to know the answer more definitively. I believe that it's simply yield-chasing -- by bundling together a bunch of more-risky things, you can carve off the less risky slices that pay better than any individual less-risky underlying asset. (Overcapitalization comes into play. That is, a certain amount of default was assumed in the CDO setup and $116 of underlying assets were sold as a $100 CDO, so that 15% of the crappy-ass subprime IO strips or whatever can boil away before there's any impairment whatsoever.) But the models were off in several ways, and now everything's pancaking. Grandma's not going to be able to refinance her house and, more importantly, a bunch of 26-year-old inventment bankers won't get their bonuses.
Actually, this used to be called "Home Land Security" but with so much soverign debt (China, among others) on the books, it is now more appropriate to call it "Home Loan Security."
I know next to nothing about all of this, but even if it is the fault of the home buyer for not being informed, it's surely also the fault of the lender who knows that the buyer is a bad risk and gambles that it won't matter that the buyer is a bad risk.
I typed 124 but then deleted when I saw that snarkout also wrote it.
I don't understand what the benefit of CDOs is over regular bonds. Rating agencies can rate bonds. Why can't people (and pension funds et al.) just buy the bonds. The I-bankers get extra fees for coming up with a new instrument, but what does this financial innovation do for lenders and borrowers?
What I want to add to 124 is that CDOs also drastically expand the amount of high-rated debt out there. There are huge piles of institutional money (banks, pension funds, certain mutual funds, etc.) that are restricted to the highest-rate bonds: AAA and possibly AA. That pretty much restricts them to government bonds; I believe there are only 4 corporations (excluding government-backed agencies like Fannie May and Freddie Mac) currently rated AAA, and they only got that way by issuing very little debt. If an institutional investor American and they don't want to take on currency risk, they're limited to US government bonds or bonds. So these investors are incredibly happy to purchase anything with yield even slightly higher than the rock-bottom rates paid on T-bills and US bonds, which is where CDOs come to the rescue.
I still feel like I'm missing a step, though. Aren't the first level of mortgage-backed bonds already risk-sorted, providing some AAA and AA-ratable paper? The first round of chopping up meat and making various grades of sausage makes sense, but CDOs seem like chopping up sausage to make more sausage.
It's a way of chopping your sausage links and sorting the result by grade, in order to squeeze a few more high grade links (and some residual pet-food grade garbage) out of the sausage you just made.
129: No, it's explained pretty well here. The gist is that there are plain old original mortgage-backed bonds which were just big bundles of future mortgage payments that belonged to a single lender and were sold off together. These were then bought up by investment banks who combined them with other mortgage-backed securities and sliced them up into new bonds based on payment order, resulting in the "tranches" of varying credit quality. The latter are usually referred to as CMOs, or Collatoralized Mortgage Obligations, to distinguish them from the old big bundles of payments on semi-random mortgages held by one lender (which thus tended to have much less diversification).
I don't think anyone answered 54. Yes, it's bizarre and abnormal and arguably troublesome. They usually just buy and sell gov't debt. But the mortgage-backed security market is in trouble and the fed fears it could cause widespread problems if it tanks, so they're doing what they feel they need to do to protect the economy. That's not unprecedented.
and accumulating equity very slowly
Depends. Pretty much everyone I know who bought in Portland 10-20 years ago has seen a faster return than they could have expected from, say, securities. Some of us (coughmecough) got very lucky, buying the only houses we could afford on retail wages only to find ourselves a few years later living in the most rapidly gentrifying neighborhood in the country.
It also helps that I do my own maintenance and improvements, but home ownership has been bery, bery good to me.
Unfogged meetup at Jesus McQueen's gentrified house! Wine tour to follow.
Aagh, guests! Now I have to remodel the kitchen!
Bostoniangirl - I'm in the UK, but it's even more true on the continent. There are only a handful of lenders in the UK who offer fixed rate loans beyond five or ten years. On the continent, I don't know if there are any. Lenders charge prohibitive prepayment fees, and (in the UK at least), borrowers are attracted to the lower headline rates of variable mortgages. It's hard to tell how much of it is inertia on the part of lenders - banks fund at a variable rate and almost all of the continental bond market is floating rate - and how much is genuinely lack of consumer interest. Gordon Brown is trying to push fixed rate mortgages, but he's not really getting anywhere. It's also the subject of an EU consultative process.
"I don't understand what the benefit of CDOs is over regular bonds. Rating agencies can rate bonds."
Here's the positive spin: the main advantage is that it allows you as an investor to gain diversified exposure to, say, corporate risk or the asset backed securities market, without having to go out and buy the individual bonds/loans yourself. The European ABS market is much less liquid than the US one, and credit default swaps on it have only just been introduced, so it can actually be very difficult for an investor without a lot of cash to take a punt on the market without betting on the performance of individual bonds. This argument is less valid in the US, but the idea is somewhat the same - you can easily take a punt on, say, the subprime market, without betting on a particular lender's assets.
In reality though, as mentioned above, it's very often about yield. CDOs, because they're more complex and less liquid, yield more than just about any other security with the same rating. Some investors have just looked at the yield and the rating and not really delved any deeper - a big no-no in structured finance. Furthermore, in recent years, CDOs have been used to take bets on what's known as correlation risk - ie whether it's more likely that an entire sector will tank or whether individual companies will. A lot of the people who've been caught out in the last month or so were betting on idosyncratic risk when they should have been betting on systemic risk.
"Around the turn of the last century, a famous Austrian economist,
Eugen von Böhm Bawerk, declared that the cultural level of a nation is
mirrored by its rate of interest: the higher a people's intelligence and
moral strength, the lower the rate of interest. He was speaking of free
market rates of interest, not of controlled rates of interest. In his time,
market rates of interest throughout the principal trading nations of the
world were historically low: 21⁄2 to 31⁄2% for long-term prime credits. " ...Homer & Sylla, History of Interest Rates, 4th ed
Tax relief on mortgage interest "the rationale is that they can't get rid of it without causing riots."
Well Thatcher and Major got rid of it in the UK. No riots, although we did riot over the poll tax.
The rationale was that it was a distorting investment subsidy. Dropping it had hardly any effect on house prices.
Today's FT suggests that a lot of these loans are fraudulent - on non-existent properties, and organised crime is behind it. Seems likely to me.
When those foreclosures are sold into a market where nobody can get a mortgage we're really going to see house prices plummet. Then the foreclosures will appraise at far lower values so that even the best qualified borrower will only be able to get a mortgage for a far smaller amounts, pushing prices down further. Then the people who have been propping up consumer demand by borrowing against their equity will discover that they're way over their heads and upside down, demand will collapse, and we're all in deep doo-doo.
That's when the smart money will be glad it went into BBBD&Os. These are the new form of high yield collateralized security. Far safer than mortgage backed securities, these Beanie Baby Backed Debt Obligations will provide steady high yields despite the broader market collapse. All markets are cyclical, and the Beanie Baby market is no exception. Having gone down as far as it can go, it is poised to rebound sharply. By partitioning the Beanie Babies according to desirability - heads, in one group, rumps in another - BBBD&Os an offer the full range of risk/yield ratios.
IF you wait long enough, that $7000 house in Elgin will probably drop to $3000. Don't rush.
OG -- I tried and tried to figure out the point of your comment. I concluded it was just that you're such a good person. Thanks for the kindness.
George Orwell said that the financial news was the only straight news...
There was a letter in the FT Saturday from a guy who used to be a plastic surgeon in SoCal a couple of years ago. He said his clinic was associated with a loan bureau that lent money to people who wanted plastic surgery. But because you can't foreclose on a nose job, the bureau did a little rudimentary credit checking. And spotted two women with incomes about $18 000 p.a. who wanted to borrow $10 000 for plastic surgery. They presented fake IDs and were outraged when theywere turned down - they'd paid $45 in the street for those IDs and had already got loans for 2 cars *and a house* on the strength of them.
In fact they were so aggrieved they came back the next day with 2 more fake IDs.