Phoesune

I have been listening to a podcast of This American Life entitled “#355: The Giant Pool of Money.” It is a very succinct and poignant description of how the current Housing/Credit crises came about and the factors that led to the bursting of the bubble. I would encourage every person to take the time to listen to the podcast and contemplate the why’s and wherefore’s of this catastrophic economic event. I have made copies of the podcast on CD and given to several people and each seems to have a similar response, that of disgust, shock, and one a stupefying fear.

I myself had several questions that my naturally inclined analytical mind brought to the forefront.
How did this happen?
Who was responsible?
How or simply can we recover from this disaster?
How can we prevent this from occurring in the future?

To bring everyone up to speed I shall give you a brief explanation of what happened. I would rather you listen to the podcast as any summary would be like trying to give a brief summary of a cliff notes book. Such as it is, I shall do my best.

Let’s begin with Top and work our way down. At the top were the world’s vast stores of savings. This group included everything from governments, to banks, to 401k’s and to a lesser degree your average investor. Now this group had at its disposal over 70 trillion dollars of money to invest and garnish a return. The problem was that this money had grown suddenly and was nearly double the amount not 4 years earlier. The money was so large that most of the world had no place to invest the cash and there was a demand for low risk moderate return investment. It was at this moment that Alan Greenspan decided to lock the Fed Interest rate at 1%. What this did was remove the US Treasury Bond as a palatable option for these investors and they started to shop around for other options.

Along came the Collateralized Debt Obligation (CDO) and the Mortgage Backed Security. You see the idea here was to take the safe secure Mortgage with the 5-10% interest rate and package it in such a way that the investors would not have to deal with any of the work of maintaining a home loan. You see these CDO’s would buy millions of home loans from mortgage brokers and then repackage these into a security and sell little pieces of each loan to the investors. So you have the stability of the US housing market packaged into a familiar format for investors. Well as soon as the investors saw this they bought up all the securities they could find and started begging for more.

So the CDO would call his mortgage broker and buy up all the loans they had. Soon the mortgage brokers ran out of loans to feed up to the CDO. So they looked around and realized that at that time and place there were not enough people qualified to get loans to support the demand of the investors. It was at this point that the mortgage brokers then came up with a genius idea…lower the requirements to get a loan and then more people can get loans.

I am going to stop here and explain the loan types and how they were setup. In the beginning, Banks would only loan money to people for whom they could verify their income and their assets. Basically they would check to see if they could afford the loan before giving them a loan. This was called a Verified Income Verified Asset Loan (VIVA). So the brokers and banks saw this as a hurdle to more loans and decided to loosen the requirements. They began to offer Stated Income Verified Asset loans (SIVA). This meant that a person could walk in and say I make 100,000 dollars a year as a truck driver and I have 10,000 dollars in the bank. Prior to this, the bank would have checked their pay stubs or 1040 or whatever to verify the income. Instead they now would ask an accountant if it was possible for a truck driver to make 100,000 a year. If the accountant said it was possible then the loan would be offered. For a SIVA loan the bank would still check their assets to make sure they were real at least. I believe this was the point that it began to unravel because in a very short order they found that a SIVA did not provide enough and very shortly they went to a Stated Income Stated Asset loan (SISA). Then they all looked around at each other and said “Screw it…Lets offer a No Income No Asset loan (NINA)!” The NINA loans were just a check on your credit report to make sure you met a minimal credit score. They never checked the person’s income or assets. Soon banks were loaning money left and right to anyone that walked through the door.

Back to our story… Soon the loans were flowing up to Wall Street and into the jaws of the hungry investor world. What happened on the streets was that there were so many buyers that the housing market itself could not handle the demand for property and the property values began to skyrocket. So the banks that were offering the NINA loans thought to themselves, hey I can be comfortable with this because the worst case scenario is that the person defaults on their loan and we now own a house worth twice as much as the loan. This was a win win win situation to everybody in the chain. The person taking out the loan got a house, the bank had a loan that they could turn over to a mortgage broker in about a month and that mortgage broker could turn it over to Wall Street and then to the investor in a nice tight package that limited all the risk from top to bottom.

That is until all the NINA’s began to default and all the sudden the market was flooded with homes that no one could afford to buy. The property values collapsed and now the loans were more than the value of the homes. All the money the investors had put into these Mortgage based securities was now gone. The “safe” aspect of the mortgage industry was gone. The money that was flowing freely now dried up.

Now let’s talk about the reverse ramification of this issue. So all along the banks were lending money left and right, hand over fist. They were lending more money than they had. That meant the banks and mortgage brokers were borrowing money to lend to the homeowners. When it crashed these institutions were left with debt they could not cover and not only were the home loans defaulting but so were the brokers. So without any of this money returning to the lenders they had no more to lend out. This froze the world credit to a crawl. So much money was drained out of the system that now some countries were looking at 15% interest rates to get loans to cover their deficits.

So where do we look for blame. Do we blame the homeowner for falsifying their loan applications? How about the mortgage broker for offering something they know they should not? Do we blame the pressure of the investors’ demand for creating an environment that begged for the market to fudge the rules for more? Do we blame the government for lacking the vision and oversight to regulate the industry properly to mitigate this disaster? Do we blame Alan Greenspan and the Fed for keeping the rates so low for so long? Does the fault lie in the nature for a free market society?

I think the blame here is the lack of moral fortitude. When the brokers started loosing the requirements on the loans they were offering and specifically designing them to allow people to defraud they knew it was going to happen. They acted on greed and with a complete disregard for sound principle. The home owner that took the loan for 540,000 dollars but only made 24,000 a year, knew it was wrong or at the least fishy. The CDO’s buying up the loans knew these loans were bad and yet they repackage them in such a way to hide the risk to investors. The government was fully aware of this process and failed to act accordingly. The Fed failed miserably and is now stuck in a Chernobyl financial situation where no matter which they move the interest rate it makes it worse and doing nothing is going to result in a complete meltdown.

If they men and women in charge of these companies had stopped and said to themselves, “This is not right. This is wrong. I should enjoy what is here and fight for the best but not at the cost of cheating my clients or lowering my principles.” All it took was moral fortitude and strength of character to prevent this. They say hindsight is 20/20. I say a firm moral fiber allows you to see the present in 20/20.

Oh yeah…do you want to know where the investors went with the rest of their money? Just follow the financial pain in the world. Have you seen the price of gas recently? I find it interesting that the “speculators” started to really drive up the price of oil at the same time that they were fleeing the housing market. That money is working on a limited resource that is showing a steady stable increase and return on investment. It is actually a safe place to invest with a very high rate of return, all without the greedy middlemen to screw it up. Instead you have a small group of organized countries (OPEC) that basically control the world’s oil reserve and production.

One last painful poke in this drama is that there is a person that owns a share of his loan that he is defaulting on through his 401K. Yep, someone is shafting himself by not only losing his house but ruining his 401K at the same time.