Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
S&P 500 – Is a 5% Correction Enough? - 6th Dec 21
Global Stock Markets It’s Do-Or-Die Time - 6th Dec 21
Hawks Triumph, Doves Lose, Gold Bulls Cry! - 6th Dec 21
How Stock Investors Can Cash in on President Biden’s new Climate Plan - 6th Dec 21
The Lithium Tech That Could Send The EV Boom Into Overdrive - 6th Dec 21
How Stagflation Effects Stocks - 5th Dec 21
Bitcoin FLASH CRASH! Cryptos Blood Bath as Exchanges Run Stops, An Early Christmas Present for Some? - 5th Dec 21
TESCO Pre Omicron Panic Christmas Decorations Festive Shop 2021 - 5th Dec 21
Dow Stock Market Trend Forecast Into Mid 2022 - 4th Dec 21
INVESTING LESSON - Give your Portfolio Some Breathing Space - 4th Dec 21
Don’t Get Yourself Into a Bull Trap With Gold - 4th Dec 21
GOLD HAS LOTS OF POTENTIAL DOWNSIDE - 4th Dec 21
4 Tips To Help You Take Better Care Of Your Personal Finances- 4th Dec 21
What Is A Golden Cross Pattern In Trading? - 4th Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - Part 2 - 3rd Dec 21
Stock Market Major Turning Point Taking Place - 3rd Dec 21
The Masters of the Universe and Gold - 3rd Dec 21
This simple Stock Market mindset shift could help you make millions - 3rd Dec 21
Will the Glasgow Summit (COP26) Affect Energy Prices? - 3rd Dec 21
Peloton 35% CRASH a Lesson of What Happens When One Over Pays for a Loss Making Growth Stock - 1st Dec 21
Stock Market Sentiment Speaks: I Fear For Retirees For The Next 20 Years - 1st Dec 21 t
Will the Anointed Finanical Experts Get It Wrong Again? - 1st Dec 21
Main Differences Between the UK and Canadian Gaming Markets - 1st Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - 30th Nov 21
Omicron Covid Wave 4 Impact on Financial Markets - 30th Nov 21
Can You Hear It? That’s the Crowd Booing Gold’s Downturn - 30th Nov 21
Economic and Market Impacts of Omicron Strain Covid 4th Wave - 30th Nov 21
Stock Market Historical Trends Suggest A Strengthening Bullish Trend In December - 30th Nov 21
Crypto Market Analysis: What Trading Will Look Like in 2022 for Novice and Veteran Traders? - 30th Nov 21
Best Stocks for Investing to Profit form the Metaverse and Get Rich - 29th Nov 21
Should You Invest In Real Estate In 2021? - 29th Nov 21
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Subprime Mortgage Mess - Whose Fault Is it Anyway?

Housing-Market / Subprime Mortgage Risks Aug 31, 2007 - 03:59 PM GMT

By: Andy_Sutton

Housing-Market

A few weeks back I did a special edition of my radio program 'Beat the Street' during which I discussed the recent problems in the subprime mortgage markets and the credit arena in general. The broadcast lasted nearly 30 minutes and covered maybe half of what I wanted to talk about, and left unanswered was my opinion of the culprit in the subprime mortgage mess.

To really get at the answer, we have to look at, challenge and either uphold or repudiate some of our assumptions about the roles of the various players and where their motivation comes from.


Where does credit come from?

In the bygone days of more sound credit policy, Mr. and Mrs. Smith would take a drive to their local bank and apply for a mortgage. During this process they were poked, prodded and maneuvered into giving up every nugget of info about their financial lives. If all was well and they had a modest down payment, the loan would be written. The loan itself came from the savings of the depositors of the bank. In other words, the bank acted in its given role as a financial intermediary between the real lender (the depositors) and the borrower. The bank, while holding the note on its books, was not the real lender. This is an important distinction to make. Banks had to be very careful because if a loan went bad, then the bank had to make its depositors whole again. So banks were very careful to focus on the borrower's ability to pay and exercised proper due diligence. Certainly, there were cases where the bank would get burned and a borrower would default, but the property could often be sold to close the gap and keep losses to a minimum. It worked very well.

Guaranteed Loans guarantee trouble

However, in typical fashion, Big Government decided that everyone had some sort of inborn 'right' to own a home and created GSE's (Government Sponsored Enterprises) to 'guarantee' certain types of loans. This served to shift the risk to the GSE from the originator. So the bank which previously had a very good reason to be diligent now had less of a reason to do so knowing that the loan could be dumped on the GSE's. This was the beginning of the moral hazard in lending. The only saving grace was that the GSE's were throttled by their charters and regulators in terms of the types of loans they could buy, the total amount of their holdings, and similar restrictions.

In recent weeks we have seen a continuation of the entitlement mentality as the Federal Reserve and government have now decided that the people who made these poor decisions need to be absconded of their responsibility at the expense of the rest of us, our kids, and future generations. It would seem that the only group of people who are not entitled to anything are those of us who work, behave and act responsibly. Oh wait I forgot; we're entitled to pay for the profligate ways of others, government included.

Wall Street steps in

Then another layer was added: securitization. Loans were sold by originators and chopped up and packaged into pools of CDO/CMO/CLO's and sold to Wall Street firms who then performed acts of magic that would make David Copperfield blush. Fancy computer models were used to 'distribute' the risk and spread it out (sarcasm mine). At the end of all of this, the aforementioned Wall Street bigshots would run to their rating agency buddies who slapped a higher than deserved credit rating on the pools and the shuck and jive was complete.

It is pretty easy to see what the role of the originator had become. Due to loose monetary policy on the part of the Fed, the markets were sloshing with money and the demand for asset-backed securities was voracious. It became as simple as selling as many loans as possible and do it as quickly as possible. The loans never stayed with the originator for more than a few months so who really cared if the borrower could make the payments? If they didn't, the originator didn't have to make anyone whole again. The moral hazard reached fever pitch. Originators no longer worried about the borrower's ability to pay, instead opting to focus on their own ability to sell the resulting loans.

Where does buck stop?

Since the beginning of the year, cries have come out from consumer advocacy groups, watchdog organizations and political action committees decrying the exploitation of the defenseless victims in the mortgage mess. There has been talk of a bailout of consumers unlucky enough to put their signature on something they never bothered to learn about. Where is our sense of personal responsibility? I am not going to advocate or try to justify the unethical business practices of those involved from the originators to Wall Street and the rating agencies. There need to be indictments; and quickly. Some folks need to go to jail for this. Some of the big boys need to be allowed to fail if that is their destiny.

The Fed facilitated this mess with too much easy money and it is asinine to believe that they'll be able to fix it with more of the same. All that being said, at the end of the day none of this would have happened if there weren't people who for whatever reason were willing to sign on the dotted line. Maybe it was greed. Maybe they assumed that the other counterparties were looking out for them. Maybe it was naivete. Maybe it was a lack of education. Maybe it was our new national attitude: buy now worry later. Well, the buying has been done. Now it's time to worry. We do not live in a vacuum. There are immense resources for anyone inclined to exercise due diligence. I just don't buy the exploitation line. The seeds for this mess may have been sown in Washington and on Wall Street, but the blame ultimately lives on Main Street.

 

By Andy Sutton
http://www.my2centsonline.com

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. He currently provides financial planning services to a growing book of clients using a conservative approach aimed at accumulating high quality, income producing assets while providing protection against a falling dollar.

Andy Sutton Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

Rosa
19 Apr 09, 23:46
Synthesized version of this whole economic mess

Andy Sutton,

I have heard this economic crisis several times on the news and still I never really understood the whole situation. Your article makes total sense and love the way you synthesized this whole situation and made a road map of what happened. Thank you for clarifying this economic blunder :)


Post Comment

Only logged in users are allowed to post comments. Register/ Log in