Here’s the bullet point summary of Megan McArdle’s exegesis of the housing crisis of the Aughts:
- Sub-prime loans only account for about half of defaults.
- Ordinary prime loans account for the other half.
- The crisis wasn’t caused by villains breaking or bending the laws. Not evil lenders. Not evil borrowers.
It was just ordinary people on both sides of the transaction pursuing the incentives they had. Here’s the problem: the incentives haven’t changed.
And the 11,000 appraisers who claimed the banks threatened their jobs unless they inflated values? The millions of mortgage applications which were altered to inflate incomes after the applicants filled them out? The ratings agencies which based their analyses on how much they were paid? The investment banks which knowingly packaged rotten mortgages and told buyers they were just great? Did McArdle fail to notice the $250 billion in fines for blatantly illegal activities leading up to the crash?
It doesn’t matter that defaults were half this and half that: the problem began wholely in the sub-prime market and from therr the effects spread to prime mortgages as values fell and 800,000 people per month were thrown out of work. Lehman was, as a matter of public record Megan, a giant Tobashi scheme hiding its liabilities from shareholders and regulators.
Nope, it all just happened, act of god etc.
You do not determine the cause of an event by the final destruction. If so, Mrs. O’Leary’s cow would surely have been exonerated. The Twin Towers had more monetary damage on other floors, and therefore, al-Qaeda must be exonerated.
If you legalize something, nobody can break the law, but that is a trite observation. If breaking legs were legal, loan sharks would not break the law when collecting from deadbeats.
I do not have access to the paper, but they apparently stretch out the crisis to 2012. The first thing anybody with any sense should ask is why. It is obviously a setup. Why not 2014, or why not wait until 2026 to get a better picture? The housing bubble burst in 2008. Period. We can argue over the date if they would like.
Unless the authors of the study and Ms. McArdle intend to change the way normal people analysis events, the problem started in sub-prime ARM mortgages with low teaser rates resets set for 2007 – 2008. The first waves were beginning in late 2006, but these were just the warning signs.
These sub-prime ARM’s would be Mrs. O’leary’s cow, and as the fire spread, it would take out more expensive buildings in the better sections of town. Nobody with any sense would claim that the Chicago fire started in the ritzy sections.
Ms. McArdle, bless her heart, lays out her thesis which is based upon banks lending money to people for houses. I guess she envisions Bailey Brothers’ Building and Loan on one side of town and Mr. Potter on the other side. You plead your case to one or the other, and whichever deigns you worthy will grant you a loan.
Honestly, we are well beyond the abacus. A person in a call center (who knows where) enters your information, and your credit score determines your interest rate. You need a W-4 and a few pay stubs (maybe).
If you are a prime borrower, the originating bank might keep the mortgage. Otherwise, it is sold. It goes into an MBS, and the bank gets a cut in the form of a CDO. Or at least, they did. They may be getting an ETF or some variation.
Are there predatory lenders? Define predatory. A predatory lender does not lend you money just to lend you money. There has to be some reason for them to lend you money. You must be trying to purchase a house, and in order to be able to afford that house, you must need creative financing.
First there must have been a predatory realtor, but I have not seen anybody bring this up. The reason is quite simple. The people bloviating about liar loans or deadbeat borrowers do not have the foggiest clue about how anything works, and they do not have any intention of learning.
If you only qualify for a sub-prime mortgage, you are probably are not the most sophisticated borrower, but the builder, realtor, and mortgaging company knew that. The area was developed for this buyer. The McMansions are not being bought by with a sub-prime ARM low teaser rate, and everybody in the industry knows it.
The only people who do not know it are the people who are too stupid or lazy to rub a couple of brain cells together. Let us not let the politicians off either. They were allowing themselves to be lobbied into doing whatever the industry wanted, and being the good little knob-bobbers, they generated whatever excuse they could invent.
Democrats invented redlining, and Republicans invented ownership society. After removing the last barrier to another Great Depression, both encouraged the GSE’s to buy every mortgage they could, and the discouraged the regulating agencies from enforcing anything that would hamper the party. Mr. Timothy Geithner is exhibit A. He did his job so well running interference that he was promoted to Secretary of the Treasury.
Ms. McArdle and possibly the study authors seem to confuse the housing crisis with the financial crisis, and they do not seem able to understand that both are brought about by free money. Banks only risk their money on prime lenders. The other mortgages they get paid fees for various services, but they do not lose money. They may even make extra money handling the foreclosure.
The financial crisis was built upon the housing bubble, and today there potential problems in auto, student, and margin (investment) loans among others. In student loans, there is no chance of selling the degree to another student, and autos resale value sinks immediately. In a panic, most investments will not have any resale value. Therefore, her thesis that houses being easily resold leads to irrational exuberance seems unfounded.
What all of these things have in common is that the lenders are not lending their money. With unsound money, there is no requirement to lend money that exists, and therefore, there is little downside risk. Ms. McArdle and others like her cannot seem to grasp that all of her beautiful theories are based upon sound money.
For those who understand how number systems work, it would be like mixing number systems. A simple example would be mixing decimal (base-10) and hexadecimal (base-16). Anything past 9 would be unknown.
9 + 1 = 10 or
9 + 1 = A then
99 + 1 = ?
The Fed believes it understands and has control of what is happening, but it does not. One day Ms. McArdle might turn around and see that it is only shadows being cast on the wall. She may even leave the Cave, but more than likely, she will run back to her seat as fast as possible. Instead of leaving the Cave, it is easier to digest the pablum.
With Glass-Steagall, the commercial banking system was forced to be transparent with how it conducted business, and they were required to follow certain rules. One could determine what the answer to 9 + 1 was. The investment side was allowed to run wild, but they did not have direct access to the Fed. Unfortunately, the grandchildren often forget why the grandparents created rules.
Instead of rescinding the repeal that facilitated about much the carnage, Sen. Dodd and Rep. Frank decided it was too good to let go, and they decided to regulate it. Regulations allow you to keep your friends close but your enemies closer – think about it.
@Ben, the linked piece (and the study discussed) are about the issue of causation. There is a difference btw/ crimes revealed by an economic downturn and an economic downturn caused by crime.
@Tastybits: There are ungated copies of the study around. Try this pdf. They looked at the market from 1993 to 2012 in order to evaluate how prime and subprime loans differed over time, both before and after the crisis.
They are basically pointing to the economic cycle as being the cause, and the factors that determine home foreclosure were negative equity and borrower illiquidity. Housing prices stop rising, the borrower loses a job, either of which might be more likely in a subprime loan context, but are not unique occurrences to subprime loans.
PD,
The study doesn’t even mention the word fraud. When it assumes something doesn’t exist it’s bound to reach a conclusion on causes which reflects this. There is simply no evidence that this event was due to cyclical factors. Their “key finding”:
<i.The crisis was much less of uniquely subprime event than is recognized by scholars and policy makers. Subprime distress did spike first as previous research has showed. And, it occurred at
relatively and absolutely high rates. However, distress and home loss among prime borrowers occurred with a lag and became quite
extensive itself.
See the incoherence? They claim the event was much less about sub-prime but then admit sub-prime was the leading crest of the wave which is the conventional view among economists. All this paper does is suppress the role of criminal elements.
@PD Shaw
I just skimmed the paper.
Again, the cause of the Chicago fire was Mrs. O’Leary’s cow, and studying all the fireplaces, coal burning stoves, and oil lamps for the decade before and after the fire would not help determine the cause. Studying cows, married women, Irish, or any number of other official sounding things would help.
Sub-prime borrowers meet all the same requirements as prime borrowers with the exception of credit score. In the past, they have missed payments or had some other credit issues. They have an income, and that income must be adequate to cover the monthly payment.
The problem was a specific type of sub-prime, and when the recession hit, it probably took out the same type of prime borrowers. The problem mortgages were sub-prime ARM’s with low teaser rates, and the problem was not in the individual borrowers.
When an MBS is created, it is engineered according to a model, and there are a certain percentage of interest rates with varying risks. The thing is designed for a certain amount of defaults. There are a certain number of sub-prime ARM’s with low teaser rates to be had, and the rates depend upon the MBS which depends upon when it was created.
In addition, you cannot start at 1996 because of my favorite bugaboo G-S. You also have the GSE’s gobbling up mortgages at different rates. Finally, the riskier mortgages have higher interest rates, and anybody wanting the highest returns would want the riskiest borrowers.
This makes the year (vintage) of the loans important. In about 2003, the financial institutions were getting more creative, and the products were including more sub-prime ARM’s with low teaser rates.
In late 2006, industry insiders saw these starting to default, and importantly, they knew why. These borrowers were put into these loans under the pitch that by paying on-time they would repair their credit score, and when the reset came, they could refinance the loan.
For the most part this is true. The bank does not own the mortgage, and they get paid for processing monthly payments or refinancing. If the borrower paid ALL their bills not JUST their mortgage on time, their credit could be repaired, but if they missed a cellphone payment or other credit report event, the reset would kick-in.
The insiders saw that these were happening, and knew why they were happening. They knew that the resets coming in 2007 and 2008 would be worse not better, and because there were too many who were able to refinance, they had added penalty clauses for early pay-offs. These people were truly screwed.
The initial rates were usually two years, and I think they were backing off by late 2007. Any sub-prime problems after 2010 would probably non-crisis related.
The low teaser rates meant a low mortgage payment, and this resulted in a low Debt-to-Income (DTI). When the resets hit, many of the monthly payments almost doubled, and there was no way these borrowers could make the payments. It was as simple as that. The down payment, LTV, neighborhood, or any other factor was beside the point. When the payment was due, they did not have enough money to cover the note. Period.
There were probably some prime borrowers who were having the same problems, and when the recession hit, it just made everything worse. During any recession defaults increase, but combined with the sub-prime ARM low teaser rate reset, it was a cat-5 storm.
What was not realized until about early was how much the housing bubble was supporting the financial sector especially in the shadow banking area. So, this cat-5 housing storm took out a lot of the supporting structure of the financial sector.
What these guys should do is to study what is now going on in the stock and bond markets, the petrodollar and eurodollar cycles, ETF and the variations, auto sub-prime, and student loans. They could be ahead of the curve instead of behind it.
I know this is OT, but this is something I’ve thought about a lot for the last decade, what with trying to understand honor cultures and all, but it ties in with modern America. I think it’s a bit of a simplistic theory, but I think its better than other explanations of how we got to where we are:
http://scholars-stage.blogspot.com/2015/09/honor-dignity-victimhood-and-death-of.html
Thanks for the link. Yes, it’s interesting. I’ve read T. Greer’s comments at Zenpundit for years but never been to his/her blog. Did you know that I nominated the post that the post you cited used as a jumping off point as my pick for Post of the Week at the Watcher’s Council last week? It came in second.
@tastybits, but Mrs. O’Leary’s cow didn’t cause the Chicago fire, that was anti-Irish scapegoating. Bad things happen and people round up the usual suspects, in this case those with bowler hats and waxed curly mustaches.
A huge percentage of those loans that failed were liars loans. How can you not call those evil? Those were loans that were guaranteed to fail.
Steve
Ms McArdle is closer than commenters.
Economic conditions and their attendant effects will take down subprime and higher quality borrowers. Subprime simply have quicker triggers, and god forbid your equity is thin, as it changes the calculus on handing over the keys dramatically.
MBS buyers were not idiots. The ratings agencies carved up the tranches and rated them as just that, tranches. Some investors chased high yield tranches, and loss in deemed Black Swan housing price declines took them down. Others bought low yield and properly rated AAA tranches. It’s no different than every corporate cap structure in existence.
Borrowers were equal participants, filled with beer laden hotdog cookout stories of ever rising home values. Let’s not even talk about speculators.
Interest rate kick-ups in debt service pale in comparison to asset price declines and loan to value maintenance tests, or job loss. Do the math.
Glass-Steagall simply removed the banks from the discipline of using their own balance sheets, no more and no less. Bad decision. Of course the government was busy doing the same thing with Fannie and Freddie. The regulators were bitch slapped by Dodd and a Frank for questioning the practice.
I could go on, but not much credit analysis in comments tonight. BTW – the housing bubble has been largely reflated, and Obama has “saved” the auto industry on the very same suspect credit policies being castigated here. Of course now it’s”different.” Yeah………..
in this case those with bowler hats and waxed curly mustaches.
Come on, PD, you know those guys have to be guilty of SOMETHING nefarious. Bowlers and waxed mustaches!
Somehow, each new excuse Ms. McArdle and others can generate is deemed the correct one, but somehow, they need to keep generating new excuses.
The sophisticated investors were tricked by the first time home buyers, but these tricky borrowers could not figure out a way to trick the banks a second time. Ms. McArdle and those like her spend their entire life looking for someone to shovel bullshit down their throat, and it is actually much harder than one might think. The bullshit requires a modicum of internal consistency. Otherwise, it is just bullshit.
When rates resets kick-in, a new monthly payment is set. When the due date comes, the only thing that matters is whether you can pay the bill or not. Period. All the niceties are great and wonderful prior to approving the loan, but once the money has been lent, it is only relevant in bullshit land.
In the quick version of the 1929 stock market crash, bank failures, and Great Depression, commercial banks were using depositors funds to finance investor banks, and this was enabled because they had access to the Fed’s money printing spigot. When the party stopped, the house of cards came tumbling down. (sound familiar?)
Glass–Steagall placed a wall between commercial and investor bank balance sheets. If investors wanted to invest in MBS’s, they would need to use actual dollars to do it, and when it comes to using their actual dollars, Wall Street is a little more cautious. Hence, they needed to get rid of G-S.
When they are making money, business people are f-ing geniuses, but when they are losing money, they are little lost lambs. I would think they would have a modicum of self-respect. I find it astounding, but I guess I am from a different world. There is no street hustler who would ever admit to being somebody’s bitch whether true or not.
If the bankers feel they were being used like two-bit whores by first time homebuyers, they are in the wrong game. Get a pimp, and hit the streets.
@PD Shaw
I considered adding a disclaimer. I know there was some controversy over the story, but it fit too well. I considered using 9/11 and the Twin Towers with the fire retardant insulation, but it would have been more convoluted and probably more offensive.
White Europeans are most likely the cause of anything bad, and it is even more likely because they blamed the cow. The cow is evil because it farts, but it was owned by a female. Females are good, but owning an animal is slavery. In any case, Mrs. O’Leary was the victim of a misogynistic society, and she cannot be held accountable for her actions.
What we can conclude is that George W. Bush is or would have been the cause of the Chicago fire, and even if not, he represents the animal enslaving, misogynistic, white, European males who have started at least a campfire.
Just go to a mortgage calculator, TB, and look at the monthly payment and payment increase for a three point jump in rate on a $260k mortgage. Then look at rental rates for living space even remotely comparable.
There are only two possible conclusions. The purchase was done with razor thin debt service capability. To conclude that potential home buyers are sophisticated enough to buy and evaluate the financial implications for cars, vacations, clothing, entertainment like eating out, general household budgets etc but not sophisticated enough to provide financing cushion in their home, their single largest budget item, is ludicrous on its face. Blaming rate resets and banks is just inane blame shifting. Next look at rental rates. Your will find that somehow the rental market customer (with, interestingly enough, monthly obligations in the same if somewhat less ballpark but with smaller footprints) was able to see that the rental option was still the only financially viable choice for them……………………as long as their greed and lust for the prospect of get rich quick housing price increases they heard bragged about by friends and in the press didn’t cloud their judgement.
I would note, again, that the housing market has been re inflated by the interest rate manipulation and the auto market by subprime lending and it seems just fine by those who want to tout economic strength by the current political leadership. Nary a word about greedy bankers. That will come only after the bust.
@ Guarneri: I am skeptical of the sophistication of buyers. I doubt most know the meaning of caveat emptor, understand who involved in a real-estate transaction is working for them, or that home prices can go down.
The places that were at the heart of the crisis had prices drop by more than twenty-percent. If they lost their jobs, they were going to be in trouble, even if they had followed Dave Ramsey’s advise to set aside 3-6 months of emergency savings. That’s the 1-2 punch that the linked study indicates is the primary dynamic.
@Drew
Let us establish a few things first. I have never called bankers greedy except in the context of being facetious, ironic, or over-the-top. I really do not like the term “banks” for lending institutions or “shadow” for opaque/private banking. To my knowledge, I have never accused Wall Street, bankers, lenders, the housing industry, or anybody involved of criminal actions. Some of it was immoral and possibly unethical.
If it has not been clear, my position is that the housing bubble was the logical result of the factors leading up to it. The biggest factor was large pools of free or almost free money made available, and the government is mostly to blame for this primarily through repeal of regulations, de-regulations, non-regulations, and refusal to regulate. The GSE’s and the Fed, both quasi government agencies, are close behind. This was the push action.
Any action requires an opposite action, and this would be a pull supplied by Wall Street. For the most part, Wall Street operates according to its own rules with some regulations, and anybody who wants to play there should be prepared for the consequences.
As I stated in an earlier comment, lenders were not just lending out of thin air. There was a process, and if there was massive predatory lending, there must have been massive predatory real estate development, house building, marketing, and sales.
The problem with blaming the first time homebuyer is that the lender knows which type of borrower is likely to default, and unless the borrower commits fraud, the lender has tax returns, pay stubs, credit references, other references, etc. The lender is the professional, and out of the two parties, the lender should be the expert. If the lender is acting in the bank’s best interest, the borrower can be absolutely certain that they are fully qualified for the loan. Period.
The housing problem started in a specific area, and it is rarely that I simply state sub-prime or sub-prime ARM’s. It was sub-prime ARM’s with low teaser rates, and when the rate resets kicked-in, it was not a 2-3% increase. The teaser rates were well below what they should have been. (I do not remember the actual numbers.) These were sub-prime, and many were on the lower end of sub-prime.
You are well aware that a lower credit score means a higher interest rate. When the resets hit, the rates for this group were going to increase from 50 – 90%, and they could not afford it. The people who were helping them to get these loans included real estate agents, possibly builder representatives, and lender personnel, and the borrowers were told what I stated in an earlier comment.
Should a borrower who knew that they would probably be late for something over two years have some idea that they were not going to be able to refinance? Yes, but I am going to cut them a little slack. I have never advocated letting anybody off the hook, but this includes both parties.
Could the people helping the borrower not understand how crippling these rate increases would be? Yes, and I am willing to cut them some slack. I would like to see some free-market way of fixing the problem, but there is nothing remotely free about the market.
Could these same people helping the borrower believed that they were actually helping the borrower to build a better life or live the American Dream? Yes. I do not think that you can create a scam that would require this many people and keep it from becoming known.
I no longer follow housing, but I have no doubt that President Obama and his clowns want to get the party started again. For one thing, housing provides a large portion of the elusive “aggregate demand” critter. It is also a way to demonstrate their compassion before condemning entire areas to eventual serfdom, but when the undesirables are tied to the ghettos, the white liberals never have to see them in their gated communities.
Some time back you pointed out the neighborhood impacts of approving mortgages to people who eventually default. You think of it as a bug and think it should be discouraged, but others think of it as a feature and think it should be encouraged. The majority of these mortgages will end up in a MBS or other instrument, and that instrument will end up in a 401(k) or a pension fund.
Democrats, liberals, and progressives only yell enough to ensure the useful idiots that they are still working for the good of the common man. Keynesian policies (or whatever you call them) require free money, and unless the just send out checks, they need Wall Street and banks to make the money creation seem legitimate. The useful idiots from both parties cannot grasp this simple concept.
So, the left will loudly rail against greedy bankers using predatory lending practices to ensnare unsuspecting borrowers, and they will also quietly encourage those same bankers to use the practices they have deemed predatory. Since the informed voter can only understand a binary world, they cannot fathom this possibility, and the right never catches on to the scam.
I meant home-buyers are not necessarily sophisticated.
TB. Nope. Those on the left actually tried to stop the liars loans. Several state AGs tried to stop them. Feds overruled. Also, large amounts of cheap or expensive money is irrelevant. There was no one forcing banks to make loans w/o verifying income, what should clearly be considered fraud.
Steve
@steve
Sorry to break the news to you, but Timothy Geithner was a major factor in the housing bubble. When Mr. Hope and Change got the chance to shake up things, he promoted one of the evil doers, and he did nothing about one of the biggest conduits of money from the Fed to Wall Street. It is no mistake that the rich have been getting richer.
As to “liar loans”, neither you nor the political hacks that you are getting your information from have any knowledge of how banking, lending, or financing works. These experts somehow could not figure out what the hell was going on at the time, and they do not even know the correct terminology.
Alt-A loans are legitimate loans and have been around long before the housing bubble. I have been over this, and I am getting tired of it.
Cheap money is what fuels all bubbles, but if you would like to find out what happens when there is sound money, eliminate the Fed. Banks will be able to engage in fractional reserve lending, but they will need to issue banknotes. We can see how fast or slow or if any housing bubbles emerge.
The fastest way would be to reinstitute the 1933 Banking Act, but of course, nobody on your side was willing to do that. I guess they were all brainwashed by greedy bankers or evil Republicans. No, they know that they need cheap and easy money to implement the welfare state, and so, they have made a deal with the devil, so to speak.
You obviously do not have a clue, and whomever you are getting your information is clueless as well. This is not surprising. Everything that has been predicted by the computer models has returned garbage. They are not working, and anybody with a few brain cells would be able to conclude that these models have always been worthless. They never worked. Like the little girl in the backseat with her plastic steering wheel, it was simply coincidental that the car went in the same direction when she turned the wheel.
Cheap money is not really technically correct. In a credit based system, money and credit are mostly interchangeable. I would go into it further, but anybody who cannot grasp the simple concept of Alt-A loans is never going to understand how our monetary and financial system actually works.
You can blame the greedy bankers, and you can rail against evil Wall Street. It does not matter. Your side will sell you out every time. Elect Bernie Sanders, Elizabeth Warren, Ralph Nader, or anybody else as president, and they will all sell your side down the river. Period. They need Wall Street more than Wall Street needs them, and Wall Street knows it, whether or not you do.