Well, let’s see. The big banks rather clearly lied, at least some of the time:
One of the lingering questions from the financial crash is whether the banks that sold junk subprime mortgage-backed securities were honestly deluded themselves, or consciously misrepresented their product. A new paper from the Center for Real Estate at the Columbia Business School suggests that, at least some of the time, they were lying.
Here’s how we know. During the 2000s, a very large share of residential mortgages were originated by relatively thinly-capitalized “mortgage banks†that held the mortgages only until they had a sufficient number to sell to a money center bank that, in turn, would package them into bonds secured by the underlying mortgage cash flows and sell them to investors. In the later years of the housing bubble, the mortgages underlying such securities were heavily concentrated in subprime properties, since they carried sufficiently stiff interest rates to make them attractive to investors after all the supply-chain players had pocketed their fees.
The study’s authors examine a massive $2 trillion database consisting of nearly all non-agency residential mortgaged-backed securities (ones not guaranteed by Fanny or Freddie) sold to investors between 2005 and 2007. The buyers were sophisticated investors, predominately institutions like pension funds, endowments, or middle-market banks. The authors then compared borrower data provided to investors with data on the same borrowers maintained by a large private credit agency. They focused on two specific data points – whether the home was actually the borrower’s primary residence, and the presence of a second lien. Mortgages on second homes or investor properties and first mortgages on homes encumbered by second mortgages are both historically among the more likely to default.
The researchers were able to pair data from the two databases across a very large sample of the loans. They were conservative in their definition of incorrect data. For example, they did not count a Home Equity Line of Credit (HELOC) as a second mortgage – although it is – and they did not label a property non-owner occupied unless the borrower listed a different primary residence for at least a full year after the mortgage closing.
The results showed that 13.6 percent of all the loans misrepresented one or the other of those two data points. More than a quarter of the loans with non-owner occupants were reported as primary residences, and 15 percent of loans with non-HELOC second mortgages were reported as lien-free. (It’s actually difficult for a bank not to notice a second lien.) As might be expected, default rates on such loans were significantly higher than defaults on loans made to owner-occupants and without second liens.
and were rewarded for their malfeasance. What could possibly go wrong?
This is in no way surprising. In the early days the originators were desperate to unload the assets from their balance sheets. In the later days, they were lying.
This is what you call pulling rank. No one here, except perhaps Dave, or maybe ice (as I gather) understands credit, or how credit bubbles really occur. And these two jokers, um, I mean “authors” have missed the point as well. They have focused on the latter stages of the event. All they say is true, but they have never extended credit, don’t understand credit, and how credit bubbles originate. It starts with bad credit decisions and gathers momentum. Focusing on the very late stages is just childish, and makes one wonder if they are honest, or perhaps politically motivated.
It started in the 90’s and gathered momentum. You can beleive me or not, I don’t really care. But denial is how it happens again.
I think the fact that the banks were pressuring the ratings agencies to spit out AAA ratings for these junk loans tells us everything we need to know. If the mortgage backed securities had actually been sound investments, then no pressure would have been required to get those AAA ratings.
I don’t know if this is the same study Kling commented on — his opinion was that banks know which originators produce good paper and those which are working more difficult loans, and they appear to charge a higher interest rate across the board for risky originators, irrespective of individual risk.
I find this analysis problematic: “they did not label a property non-owner occupied unless the borrower listed a different primary residence for at least a full year after the mortgage closing.”
The sequence of events is the person applying for mortgage is asked to represent whether he intends to live in the house as his primary home after closing. He swears that he does. And then a year later he is not? How do we know he was lying? Maybe a bunch of bad stuff came down and plans changed? How was the bank supposed to know he was lying at closing?
The second liens certainly bear more examination, but not all liens can be identified at closing, which is why title insurance usually precludes them from coverage.
Yes, it looks like the same study; here are Kling’s comments:
http://www.arnoldkling.com/blog/the-new-fraud-paper/
I think stuhlmann makes a good point – none of this would have been possible without the ratings agencies providing the ratings necessary to lure investors. I think the ratings agencies have gotten off pretty well – most everyone blames the banks and “fat cats” on Wall Street and few spend much time talking about rating agency reform.
@stuhlmann & @Andy
The rating agencies fiasco was the result of government intervention. The government required the sellers get a rating from one of approved agencies. Prior to this, the buyer purchased the rating, but it was optional. Any business will serve its customers. The government changed the customer, and the predictable outcome occurred.
I believe they were concerned about the quality of the securities, and they wanted to protect the buyers. Good intentions, road to hell, yada, yada, yada.
“Well, here’s another nice mess they’ve gotten us into.”
Issuer pays has been the model for muni, sovereign and (IIRC) corporate bonds for many years with no problems. The same incentives exist, but the problems have not occurred. You need a better cause.
“It started in the 90′s and gathered momentum.”
The building subprime crisis in California was stopped in the 90s by regulators. Different admin than in the 2000s where attempts by state AGs to stop what were clearly bad loans (liars loans) was stopped by the OTC.
Steve
In one form or another, I have been saying this, and as the months and tears go by, my detractors keep agreeing with me. Well, except they always throw in a “but”.
This was always a financial event based upon credit creation. Housing was where it manifested itself, but the same dynamic is occurring in student loans, government borrowing, and healthcare spending. Money is being forced into areas that it would not otherwise go into.
The government had a large part in distorting the market and in allowing the market to “run wild”. The GSE’s and the rating agencies are two of the causes of the distortion. Repealing Glass-Steagall and not regulating derivatives removed any restrictions that would have kept the problem manageable.
In the 1990’s, traditional banks wanted to get into riskier investments, but Glass-Steagall was preventing them. It was the traditional banks pushing to repeal Glass-Steagall. Rather than running from sub-prime, they were running towards it. The traditional banks were not heavily involved in the CDS market. This was mostly the GSE’s and Wall Street.
The traditional banks were getting the trash off their books, but they were getting a slice of the instruments created from that trash. These CDO’s were kept off the books as SIV’s, but the traditional banks wanted to be able to bring in more of the re-re-packaged garbage.
Anybody familiar with government regulations knows that without fines the regulation is meaningless. The PPACA (Obamacare) has thousands of fines because “jawboning” and “frowning” do nothing. It has sharp teeth, and it has teeth behind teeth. There may be debate over the effectiveness, but the regulations will not be meaningless.
Glass-Steagall was a simple solution to the “Investing Gone Wild” problem. It did not allow the beast to exist. Dodd-Frank allows the beast to exist but tries to tame it. It cannot be tamed. All the wailing about Dodd-Frank is subterfuge. The financial industry will use it in new and innovative ways. I am guessing this is a feature not a bug.
“Any business will serve its customers.”
But if the sellers had to get a rating by government mandate, then the agencies could have given them honest ratings and the sellers would have had to accept them. Instead, the agencies gave them bogus ratings. I’m not clear as to just how the government requirement forced the agencies to act in so nefarious a manner. How did that work?
@sam
The rating is subjective. If it were objective, standards would have been issued. There were models that indicated there were no problems. I am going to guess that the assumptions were standard for seller and buyer, but if somebody has some proof of nefarious acts, it should be brought forward.
The buyers needed AAA instruments for their funds, and they were not asking many questions.
@steve
… muni, sovereign …
I suspect there are a lot of bond holders who would disagree.
” There were models that indicated there were no problems. ”
You elide over the point. They were giving AAA ratings to instruments full of liars loans. Which gets back to a point we have discussed before. Did they really believe their models or was it a scam? If they believed it, they were stupid beyond belief. I would rather it was a scam TBH.
“I suspect there are a lot of bond holders who would disagree.”
It has been working for over 40 years. Could you point me to some bond subprime crisis of which I am not aware. The problems with munis that I know about have nothing to do with the ratings agencies.
Steve
The way that the MBS were structured included a mix of quality mortgages. There were a percentage of each level that would default. The highest quality has a lower percentage, and the lowest quality had the greatest. The real estate was projected to increase in value based upon the existing trends, and this would offset defaults. This was the majority view at the time.
The MBS’s were sold as bonds, and they were split into tranches with similar quality mortgages. The lower tranches were riskier, but they had a higher coupon. The MBS’s were “engineered” to limit risk and maximize return, and a CDS was insurance to make up any shortages in the MBS.
The mortgages sold into the MBS’s were required to be qualified loans. Sub-prime and Alt-A loans are legitimate loans, but they were abused. “No-doc” and “low-doc” loans are used for people who are self-employed, have uneven income, and other conditions. Both sub-prime and Alt-A are required to be able to repay the loan. The biggest problem was combining sub-prime, ARM w/teaser rate, interest only payments.
In 1999, I knew that most of the dot-com companies would implode. As they lost more money, their stock went higher. In 2006, I knew that there was going to be a housing crisis, and in mid-2007, I knew there was going to be a financial crisis. I was not the only one, and I was not the smartest. Few people were interested, and I and others were considered nuts. Groupthink is powerful.
The ratings agencies are not blameless, but they were making the same assumptions as almost everybody.
If I had bonds from Stockton, San Bernardino, Detroit, California, Illinois, Cyprus, Greece, Italy, Spain, I would be worried. I am not familiar with the muni & sovereign bonds, and they may have been sold as junk.
That’s a problem and if ratings agencies cannot be protected from groupthink, then what purpose do they serve? Groupthink is a problem in many areas, which is why outside, independent oversight is almost always necessary. If those who make decisions about the quality of investments are drinking the koolaid then something needs to change.
I think Tasty has come as close to really getting it as anyone. I know its not popular with certain commenters here to believe government wanted risky loanmaking. I’m tired of arguing the point. Ignorance is bliss.
But Tasty makes an absolutely crucial point. Certain large commercial banks wanted to become investment banks, where the big money was. See G-S repeal. They had origination capability. They initially had a government mandate……………and then they had financial opportunity.
That was the sequence of events. I find it bizarre that some deny government’s role an interests back in the 90’s, when all you have to do is look at helicopter Ben today and ask………again?? Will you be denying the eventual collapse in time financed assets when rates rise, and blaming the convenient scapegoat: “greedy bankers?”
@Andy
Groupthink is not groupthink until after it is proven wrong. The outsiders are considered nuts until they are proven right, but there are a lot of nuts that are never proven right.
I question all my assumptions, and I try to falsify them. If there is an objection, I try to negate it, but if I am not able, I rework my reasoning. I suspect I am in a very small group.
There are many things that are basic assumptions: Over the long term, stocks go up. Real estate is a good investment. Real estate eventually goes up. Other things are basic assumptions to one group: Government debt is not a problem. Cutting taxes leads to increased tax revenue.
The US bonds were predicted to have substantial interest increases if the AAA rating was downgraded, but it still has not happened. The reason is usually that it was only one agency. Somebody is wrong, but we will not know until after all three downgrade.
Today, there are many people who insist the housing & financial crises were unpredictable. If the rating agencies had downgraded based upon the coming crisis, they would not have been taken seriously.
It is no different than the Iraq intelligence. Today, everybody knows that it should have been questioned. Everybody has learned this lesson so well that the intelligence about Iran and North Korea is constantly being questioned. Oh! Wait. Those questioning are again being treated as nuts.
@Drew
… I know its not popular with certain commenters here to believe government wanted risky loanmaking. …
This is a vastly different argument than the one you typically make, and I think you could make a far better case for this. I have not thought about it, but I do think there is a lot there to consider.
I do not think (or I do not want to think) the government is advocating risky loans, but the result of various policies results in more risky loans. It would be a circumstantial case, but through the tax code, regulations with penalties, subsidies, etc., the government encourages activities that have negative results.
… helicopter Ben …
You can lead a person to a loan, but you cannot make him borrow. I think this is a point @Ben Wolf makes. For somebody who is an “expert” on the Great Depression (helicopter Ben), he is clueless.
Alan Greenspan was a big problem, but he was the “darling” of the business community. Anybody remember “the Maestro”?
Red Barchetta
I do not do change very well. My stepson thinks I have lost my mind when I refer to the Brooklyn Dodgers, LA Rams, Oakland Raiders, Baltimore Colts, etc.
“This is a vastly different argument than the one you typically make,”
Only if I have made the case poorly, which may in fact be the case.
For one last time…….(and once again, I saw it with my own eyes and ears) There was an explicit policy decision by government to force banks to make poor credit loans. It went to housing, and it went to business development. Both were under the auspice of CRA.
The business of a bank is to make credit decisions and extend credit. Banks knew these were bad credit decisions. They were risking their primary asset, their balance sheet. But at the time the industry was undergoing consolidation, and if you didn’t play ball the regulators would, shall we say, “look unfavorably” on your portfolio (which means increased reserve requirements) and poerhaps your acquisition goals.
I know this offends some peoples sensibilities, especially those who prefer lightweight and superficial analysis like “liars loans.” Balls. Get real, get a business mind and get out of Kansas.
It set the whole ball rolling. Its again lightweight and superficial to look 7-9 years later and do some academic study about loan loss incidence. The game started in earnest in 1996, and when the lenders need to unload bad assets – and they are smart and resourceful……oh, and have political clout – they found a way. Pandora’s Box was opened and the rest is history.
It is simply political expedience to blame “greedy bankers.” As I have noted, bankers are always greedy, as are creditors. But there was no governor. In fact, the politicians of the day were drooling over the notion of these poor credit loans because it served an ideological purpose, and votes. But, as always, the businessmen were five steps ahead of the politicians, and securitization and syndication served their need. And there you have it.
Same as it ever was.
“You can lead a person to a loan, but you cannot make him borrow. ”
Yes, but when the charge for metered money is at, or less than inflation…….its one hell of a bargain to pass up.
“Alan Greenspan was a big problem, but he was the “darling†of the business community. Anybody remember “the Maestroâ€?”
I’m not sure that’s true. There is an “L” in LBO, which is what I do, and well functioning and priced credit markets are important. We are not fans.
How many times have I railed against the destruction of the term structure of interest rates? We are hosing savers. Destroying the savings and retirement plans of the 60+ set. Preferentially subsidizing time finance assets. And all so the politicians can reduce the borrowing costs of their profligate spending.
Thats’ no “Maestro” in my book.
Yes, but when the charge for metered money is at, or less than inflation…….its one hell of a bargain to pass up.
True, but not necessarily the right borrowers. Ben is trying to get the money into the economy. The money is going round and round, but it is not going into the larger economy.
He is trying to throw money at the problem, but the problem is too much money.
Thats’ no “Maestro†in my book.
Then you were part of the minority. The vast majority were cheering him onward.
Many of those now pointing fingers were cheering with the crowd then. Where was the outcry against the bankers, the rating agencies, Wall Street, the Fed, etc. between 2000 to 2007?
For those keeping score, the group I am excoriating one day is the same I am defending the next. There is a lot of blame to go around, and most of the finger pointers seem to exclude their favorites.
I take exception to blaming regular home buyers. The real estate agent should know more than you, and if they say prices are going up, most people would trust them. When the gut/gal lending you money approves you, most people assume they know a lot more.
I would allow some leniency for some of the people in the system. An originating agent who knows the borrowers are getting screwed is guilty, but I can understand they are trying to make a living. Many of those higher up, not so much.
For those playing at home, look up the S&L Crisis. Who do you think cooked up this scheme? Where do you think they went? Do you really believe the banks, in 1995, wanted to loan money at the lowest interest rates possible? Remember, the best quality borrowers pay the least interest. Were these guys really trying to produce the smallest profit margin possible? Finally, do you really think that the guy/gal scared of a scowling regulator is ever going to be in an executive position?
I am tired of the arguing. The home viewers can decide who has made a consistent argument and which one comports with reality.
The real estate agent should know more than you, and if they say prices are going up, most people would trust them.
Tasty,
Real estate agents live on a commission basis. The more they sell, the more they make. So, unfortunately, buyer education often has little to do with their work — it’s all about the silver tongue advantage. And, buyers sometimes get impatient with knowledge. My husband would always carefully prepare a property pros/cons presentation, and some just wanted the bottom line — where to sign.
Like you said, in your opening statement: There is a lot of blame to go around…
@jan
Your husband should be far more knowledgeable about the real estate market in your area than most buyers. People should do more research, but if your husband says that a house should appreciate about x% per year, most people will accept it.
People should question more, but this applies to the mechanic, the doctor, the Best Buy salesperson, etc., but most people do not know enough about the subject matter to ask intelligent questions. How many people buy a computer without any idea of what the specs mean?
I think that there were a lot of guilty real estate agents, but there are also those who were trying to do the right thing. I am guessing that there are agents trying to be honest, but being honest does not get the top seller award. I think a lot of good people were caught in the system, and I think it is more complicated than simply blaming the groups I do not like.
“For one last time…….(and once again, I saw it with my own eyes and ears) ”
Then you worked at a place subject to CRA rules. Only about 6% of subprime loans were subject to them. The other 94% were not. I assume you did not work at a “shadow” bank.
Steve
I think it is more complicated than simply blaming the groups I do not like.
There has to be a lot of ‘willing’ people to make a deal — RE agent, buyer, seller, lender. In the height of the sub prime fiaso all these people just jelled together, without any oversight, in their efforts for each party to get what they wanted — a commission, a house, money, or fees.
Tasty
I would simply ask you to consider the following. Other than housing, what are the three other biggest time financed assets?
The answer is cars, big ticket durable goods (a washing machine), and the good old credit card.
Do “greedy bankers” induce people to buy a car? Do they bamboozle them to run up the credit card? Do they put a gun to your head to buy a washing machine?
No. The “greedy banker” and “Polly Purebread” creditor meme is pure crap. Just pure crap. Those who believe it are boneheads, businesswise, or politically driven in their thinking.
Were the non-housing time financed assets I referred to securitized and sold? No. But those markets are huge, like housing.
There is a non-housing subprime market. Its risky as hell and everyone with half a brain knows it. Its kind of like Payday or Title Loans. It serves an economic purpose, but don’t anyone give me the crappola about innocent creditors. If you do, you go into the idiot businasman column.
People, WTFU. This was government policy driven. And we are doing it all over again.
BTW
steve has decided to “stick to his story” and cite academic studies and reside in Kansas, without – having not been a lender – ever stop to consider that that the label “CRA loan” doesn’t always apply to the actual loan made, so some idiot academic can figure it out.
That is distressing to observe.
@jan
During the dot-com era, people were throwing money at anything with a website. Losing money was considered a winning strategy. The idea was to sell below cost and make it up in volume. If you lose money on each item you sell, you will never make a profit, but few people wanted to hear that it was not going to end well. Stocks would rise forever.
People believe a lot of crazy things.
The stock market is at the levels of 2007, and companies are reporting record profits. Is the 2013 economy as good or better than the 2007 version? It is not going to end well, but few people want to hear it.
There are people who think there should be no limit to government spending or borrowing. So far, they are right. It is not going to end well, but they cannot be convinced. There are other examples – student loans & healthcare.
A lot of people really believed that housing would go up forever, and many of them still believe it. Before housing crashed, they were right.
@Drew
I have never called bankers greedy. I rarely use the word “banker”, and I dislike using “bank”. There are a lot of different types of banks, and many are vastly different. I think there is a lot of confusion, and many people think of the local “First Savings Bank”.
I have defended bankers and the financial industry. In this thread, I have veered from the talking points, and I have irritated the faithful. I have gotten tired of the housing debate, and I have mostly left it alone. I only jumped in because most people do not know the history.
I do have a problem with many of the financial industry’s lending practices, but again, not all banks are the same. Between 2006 and 2008, a lot of people were being approved for loans they never should have gotten. The ARM’s with teaser rates, early payoff penalties, and flexible payments were being pushed. The shill was for the sub-prime borrower to get this loan, but before the reset date, they would re-finance. The three years would allow them to build up their credit score, and they would qualify for a lower rate.
I really do not feel like doing a full take down of the financial industry’s lending practices. If people were falsifying documents, they should be prosecuted.
… Other than housing …
I have only addressed housing. I am not comfortable outside of housing, but on a few points I am comfortable. I agree that many people have questionable/criminal intents when applying for credit. Also, there was/is some credit card securitized debt, but I am not familiar with that market or its size.
The traditional banks are willing to issue credit cards to people with the worst credit rating because they get the biggest return. Traditional banks also would prefer the worst customers because they have a lot of overdrafts.
Again, banks are no different than any other business, and they want the largest profits possible. This only reinforces my position.