Saturday, May 17, 2008

Sub-Prime

This week's This American Life was a surprisingly entertaining look at the Sub Prime Mortgage mess and thanks to their simple approach to telling the story, I think I now understand what has taken place.

We have all heard the what the crisis is about: banks and mortgage lenders gave loans to people who did not have the means to pay them back. That part is pretty straight forward. If lend you $100 and you have no job, chances are you are not going to pay me back.

I have a seventeen year-old, I understand this concept.

The question I have always had is why? as in "why did banks give money to people that had no means of paying them back?". Banks and lenders had always been very good at determining whether you had a good chance of paying them back. When I applied for my first mortgage it was understood that you needed a good job, low debt etc in order to get a mortgage.

What I could never get a grasp on was "what changed?" How did reasonable lenders go from guardians of cash to crazy lottery winner?

The answer is supply. The program explains that the supply of money looking for something to invest in doubled between 2000 and 2006. In 1999 there was a 36 Trillion dollar money supply and between 2000 and 2006 another 36 Trillion was added to that.

This giant pool of money was looking for something to invest in so that more money could be made and the US mortgage market was ripe for picking. Investment bankers like Morgan Stanely, Bear Sterns and the likes invented investment opportunities by lashing mortgages together in giant bundle and selling shares. This then drove demand for more and more mortgages and as demand grew, the traditional mortgages dried up as everyone who needed a mortgage pretty much had one and so the standards were slowly lowered, until eventually you could get a mortgage if you had a pulse.

In late 2006 this whole thing began to fall apart as delinquency rates shot up and people along the chain were left holding bad mortgages that they could no longer sell.

The program explains that all along the mortgage money chain, from the investment bankers at the top to the people who borrowed a half a million dollars while making 37k per year, people knew what they were doing was wrong but they continued to do it out of greed. Whether it was greed for a house they could not afford or a crazy get rich quick pyramid scheme, they knew it wasn't right.

The program is worth an hour of you time.

There is also a good synopsis of the program here.

No comments: