A Sub-Prime Primer

[livius drusus]

This is the best explanation for the mortgage crisis I've seen, and it's done in stick figures.

I found the bits about the Wall Street guys using the shitty mortgages as collateral for a security particularly enlightening. I didn't really know anything about the traunches and the bond insurance garnering the "good" traunch high ratings.

[Clutch Munny]

Beautiful. Now that's a public service.

[LadyShea]

That rocks! I love the "I demand transparency and accuracy..." with the response of "Blow me"

[Sauron]

Originally Posted by LadyShea

That rocks! I love the "I demand transparency and accuracy..." with the response of "Blow me"

Great article I was reading in The Atlantic the other day, about the prevalence of easy mortgages and the financing of overly large homes. If you're a fan of well-cooked schadenfreude, this article is for you.

The decline of places like Windy Ridge and Franklin Reserve is usually attributed to the subprime-mortgage crisis, with its wave of foreclosures. And the crisis has indeed catalyzed or intensified social problems in many communities. But the story of vacant suburban homes and declining suburban neighborhoods did not begin with the crisis, and will not end with it. A structural change is under way in the housing market—a major shift in the way many Americans want to live and work. It has shaped the current downturn, steering some of the worst problems away from the cities and toward the suburban fringes. And its effects will be felt more strongly, and more broadly, as the years pass. Its ultimate impact on the suburbs, and the cities, will be profound.

Arthur C. Nelson, director of the Metropolitan Institute at Virginia Tech, has looked carefully at trends in American demographics, construction, house prices, and consumer preferences. In 2006, using recent consumer research, housing supply data, and population growth rates, he modeled future demand for various types of housing. The results were bracing: Nelson forecasts a likely surplus of 22 million large-lot homes (houses built on a sixth of an acre or more) by 2025—that’s roughly 40 percent of the large-lot homes in existence today.
[...]
As conventional suburban lifestyles fall out of fashion and walkable urban alternatives proliferate, what will happen to obsolete large-lot houses? One might imagine culs-de-sac being converted to faux Main Streets, or McMansion developments being bulldozed and reforested or turned into parks. But these sorts of transformations are likely to be rare. Suburbia’s many small parcels of land, held by different owners with different motivations, make the purchase of whole neighborhoods almost unheard-of. Condemnation of single-family housing for “higher and better use” is politically difficult, and in most states it has become almost legally impossible in recent years. In any case, the infrastructure supporting large-lot suburban residential areas—roads, sewer and water lines—cannot support the dense development that urbanization would require, and is not easy to upgrade. Once large-lot, suburban residential landscapes are built, they are hard to unbuild.

The experience of cities during the 1950s through the ’80s suggests that the fate of many single-family homes on the metropolitan fringes will be resale, at rock-bottom prices, to lower-income families—and in all likelihood, eventual conversion to apartments.

[LadyShea]

So people fled the cities for the suburbs for years, and are now fleeing back to the cities. I wonder if there was anything to predict such changing trends...and if in another 20-30 years people will run back to the suburbs again?

In researching real estate in Merida Mexico, the "going to the suburbs" thing is going on there with the wealthier Mexicans, leaving the El Centro district open for American retirees and Ex Pats.

[Sauron]

Originally Posted by LadyShea

So people fled the cities for the suburbs for years, and are now fleeing back to the cities. I wonder if there was anything to predict such changing trends...and if in another 20-30 years people will run back to the suburbs again?

In researching real estate in Merida Mexico, the "going to the suburbs" thing is going on there with the wealthier Mexicans, leaving the El Centro district open for American retirees and Ex Pats.

Well, probably the demographic trends could have foreseen it - but that depends upon Americans have the foresight to plan on the scale of 30 years. There's no evidence that American business plans for more than six months in advance.

[Crumb]

I think US business do some long term planning, but it goes something like "if all this good stuff that is happening continues forever into the future then ..." and "After all this bad stuff is over with in six months ..."

[Stormlight]

Originally Posted by Crumb

I think US business do some long term planning, but it goes something like "if all this good stuff that is happening continues forever into the future then ..." and "After all this bad stuff is over with in six months ..."

And of course the ever-popular "this good stuff will only last if we don't have to pay taxes/social security/higher wages!". Yup, that's in no way, shape or form limited to the US.

[Garnet]

They fucked up.
They fucked up.
They fucked up.
You fucked up.

Priceless.

[ShottleBop]

Basically, I don't think anyone was minding the store. Theoretically, the model should work: if lenders adequately diligence their borrowers and make loans only to qualified people, historical default rates had a good chance of being accurate. You dump a whole lot of mortgages into a pool, and have an idea of what percentage of them will default. Based on that, you can divide interests the pool into different pieces, or tranches: a lower-quality piece (the B piece) that will pay interest at a higher rate, but will be affected first by any losses, and one or more higher-quality pieces that pay interest at the lower rates paid by good corporate credits.

What may be an apt analogy is the concept of "allowable filth" adopted by US food regulators: Food Defect Action Levels: Levels of natural or unavoidable defects in foods that present no health hazards for humans. The fact that a certain level of filth may be unavoidable, and harmless to health, however, does not mean that you knowingly allow it into the food chain (from this Training Manual:

In looking for insect or rodent activity, inspect areas most likely to produce results.

It is general opinion of enforcement agencies that a plant will be clean and free of contaminants regardless of what must be done to prevent them. No system is permitted to be insect infested, even a raw grain handling system. While a court case may not evolve from such an infestation, this will appear on an “I Observe” form (Form FDA 483, Inspectional
Observations) for which the operation can be held accountable.

Concepts in the amount of allowable filth in any food operation have changed drastically in the past few years. This had diminished from a shovelful to a teaspoonful, and now even a potential contaminated situation must be looked upon with alarm.

In the subprime market, too many people were looking at a contaminated situation and failing to take alarm.

[Sauron]

Originally Posted by ShottleBop

Basically, I don't think anyone was minding the store. Theoretically, the model should work: if lenders adequately diligence their borrowers and make loans only to qualified people, historical default rates had a good chance of being accurate. You dump a whole lot of mortgages into a pool, and have an idea of what percentage of them will default. Based on that, you can divide interests the pool into different pieces, or tranches: a lower-quality piece (the B piece) that will pay interest at a higher rate, but will be affected first by any losses, and one or more higher-quality pieces that pay interest at the lower rates paid by good corporate credits.

What may be an apt analogy is the concept of "allowable filth" adopted by US food regulators: Food Defect Action Levels: Levels of natural or unavoidable defects in foods that present no health hazards for humans. The fact that a certain level of filth may be unavoidable, and harmless to health, however, does not mean that you knowingly allow it into the food chain (from this Training Manual:

In the subprime market, too many people were looking at a contaminated situation and failing to take alarm.

Your analysis misses a few things:

1. People had an economic disincentive to take alarm - they were paid based upon closed loan commissions which are not linked to default rates.

2. Lending agents were allowed to off-shoulder the risk and avoid the true scrutiny that would have placed rock-bottom ratings on these loans.

3. It isn't that the system did not work. The system DID work. It's just that nobody realizes that the system has been deliberately set up to permit this exact kind of wealth transfer. System worked as designed - but it was designed to make some people rich at the expense of everyone else. The mortgage industry and the accounting industry lobbied Congress hard for the precise kinds of changes that allow such loopholes and off-the-book accounting to take place.

The problems with the US mortgage, banking and finance industry do not demonstrate a good system gone bad. Instead, they demonstrate what a bad system in balls-to-the-wall overdrive looks like.

[1Samuel8]

This slide-show is funny but it misses the biggest piece in the puzzle: The Fed.

The Fed increases the money supply -- effectively printing money -- so that the banks, through fractional reserves, can lend out more money.

Originally Posted by ShottleBop

Basically, I don't think anyone was minding the store. Theoretically, the model should work: if lenders adequately diligence their borrowers and make loans only to qualified people, historical default rates had a good chance of being accurate. You dump a whole lot of mortgages into a pool, and have an idea of what percentage of them will default.

The trouble is that the banks had more money in their vaults. It was to their advantage to create more loans. Money that is not lent is not making as much profit as possible. Therefore, they lend out money under less strict conditions and lower interest rates.

Why? because the Fed was willing to lend the banks money at lower and lower rates. That is the same as giving them free money.

[Sauron]

Originally Posted by 1Samuel8

This slide-show is funny but it misses the biggest piece in the puzzle: The Fed.

The Fed increases the money supply -- effectively printing money -- so that the banks, through fractional reserves, can lend out more money.

The Fed has 3 tools to affect money supply:

1. Open Market Operations

2. The Discount Rate

3. Reserve Requirements

During the time period in question, #2 was high - much higher than it is now. #3 hasn't changed. I'm not aware of the Fed doing much about #1 either.

So I guess I don't see where the Fed did anything special to cause this crisis in the mortgage industry.

[Stormlight]

Originally Posted by Sauron

So I guess I don't see where the Fed did anything special to cause this crisis in the mortgage industry.

That's because it didn't. This whole "the banks had too much money in their vaults" is silly (to put it mildly).

[Dingfod]

I wish I had too much money in my vault.

[Farren]

I wish I had a vault.

[ChuckF]

I wish I had dignity

[Stormlight]

[Farren]

Originally Posted by ChuckF

I wish I had dignity

I wish you had dignity too.

[1Samuel8]

Originally Posted by Sauron

During the time period in question, #2 was high - much higher than it is now. #3 hasn't changed. I'm not aware of the Fed doing much about #1 either.

So I guess I don't see where the Fed did anything special to cause this crisis in the mortgage industry.

You are kidding, right?
The interest rate during the time period in question is irrelevant. The interest rates and actions of The Fed before the time period is relevant.
Nevertheless, you quote nominal rates -- rates that are not corrected for inflation.
Now, before you go look up the inflation rates over the time period in question, realize this: The Fed and the government has a vested interest in mis-representing inflation. Now, run along.

Originally Posted by Stormlight

That's because it didn't. This whole "the banks had too much money in their vaults" is silly (to put it mildly).

Do you copy your parrot or does your parrot copy you?

[Sauron]

Originally Posted by 1Samuel8

You are kidding, right?

No, I'm dead serious.

The interest rate during the time period in question is irrelevant.

No, it is not.

The interest rates and actions of The Fed before the time period is relevant.

Which only makes it worse for you. The start of the housing boom was approximately 2003. During the years prior to that, the Fed Funds Rate was at least as high as it is now:

2003
June 25 ... 25 1.00

2002
November 6 ... 50 1.25

2001
December 11 ... 25 1.75
November 6 ... 50 2.00
October 2 ... 50 2.50
September 17 ... 50 3.00
August 21 ... 25 3.50
June 27 ... 25 3.75
May 15 ... 50 4.00
April 18 ... 50 4.50
March 20 ... 50 5.00
January 31 ... 50 5.50
January 3 ... 50 6.00

Nevertheless, you quote nominal rates -- rates that are not corrected for inflation.

Demonstrate that any such correction would meaningfully change the results.

Now, before you go look up the inflation rates

That would be your job, since you're the one claiming that they materially impact the results.

over the time period in question, realize this: The Fed and the government has a vested interest in mis-representing inflation.

The problem with that tinfoil-hat theory is that the Fed and the govt are not the only bodies determining inflation. Several such bodies are independent or based in universities. So if the govt numbers for inflation were tampered with, these other institutions act as a safeguard.

None of which you knew, apparently.

[1Samuel8]

Originally Posted by Sauron

The problem with that tinfoil-hat theory is that the Fed and the govt are not the only bodies determining inflation.

Excellent!!!! The Fed needs more advocates like you!
Do you at least get a wrap-around?

Originally Posted by Sauron

None of which you knew, apparently.

Yeah, I am completely ignorant. You got it!

----

This is absolutely hilarious. You look at one single thing that the Fed does (nominal interest rates, NOMINAL at that) to increase the money supply and draw stupid conclusions.
Well, now I have a question for you: did you know that the Fed buys mortgage securities?? are you honest enough to admit publicly that The Fed buys them with printed money, backed by absolutely nothing??
How does that enter into your drone-like equations???????????????????


"Quick Dark Lord! Quick! Get down from your Dark Throne and start googling the securities tables for the last decade! Quick! "

[Sauron]

Originally Posted by Sauron

The problem with that tinfoil-hat theory is that the Fed and the govt are not the only bodies determining inflation. Excellent!!!! The Fed needs more advocates like you!
Do you at least get a wrap-around?

A rather non-obvious dodge of my point. Care to try again? And address my point this time?

Originally Posted by Sauron

None of which you knew,
apparently. Yeah, I am completely ignorant. You got it!

You haven't done anything yet to convince me otherwise.

----

This is absolutely hilarious. You look at one single thing that the Fed does (nominal interest rates, NOMINAL at that) to increase the money supply and draw stupid conclusions.

1. No, I simply pointed out that your excuse didn't square with the history of FFR increases;

2. You have yet to demonstrate that inflation makes a material difference;

3. Mortgage rates aren't tied to the FFR anyhow.

The rest of your playground questions will be answered if and when you patch the holes in the statements you've already made.

Good luck - you'll need it.

[Garnet]

Pssst...Sauron...you might want to fix the quote tag in your last post. It looks like you are arguing with yourself.

[1Samuel8]

Originally Posted by Garnet

It looks like you are arguing with yourself.

He is.

Originally Posted by Sauron

A rather non-obvious dodge of my point. Care to try again? And address my point this time?

You are kidding again?
YOUR point?? I never disputed it. In fact, I linked a quotation in a previous thread whereby I say specifically: "The value of the dollar is influenced by other aspects of monetary policy too."
Given your demonstrated ineptitude at using the quotation function, it does not surprise me that you get arguments mixed up.
I do not dispute the different strategies exist. I am pointing out that they all arise from the Fed. The ability of all lenders comes from the Fed.
Not mentioning the Fed in any discussion of the debt markets is the height of stupidity.

Originally Posted by Sauron

You haven't done anything yet to convince me otherwise.

Coming from you, a person who thinks that inflation has no bearing on real interest rates and goes to the naive effort of quoting NOMINAL rates, I will take that as an obvious demonstration that you lack the capacity to understand monetary policy.

Originally Posted by Sauron

1. No, I simply pointed out that your excuse didn't square with the history of FFR increases;

Irrelevant.
You quoted nominal interest rates to "prove" your point. That is stupid.
You went through a lot of effort to even highlight them in different colors.

Originally Posted by Sauron

2. You have yet to demonstrate that inflation makes a material difference;

That is easy. [Sorry, I assumed most people were clever enough to figure out simple arithmetic. I also assumed you could tell the difference] Here goes:
If the nominal interest rate (shit that you quoted and you insist matters) is 10% but the inflation rate (shit that you deny matters) is 15%, your real interest rate is negative 5% -- you will lose. You are going to have to do something else to make money. It really is that simple.

Not only is the principle really that simple, anybody -- that means YOU -- who denies its importance over investments is misleading.

Originally Posted by Sauron

3. Mortgage rates aren't tied to the FFR anyhow.

When somebody chooses a home-equity line of credit and spends money from that equity, that person adds to the money supply. The mortgage market has a major influence over the choices people offered to consumers -- it has everything to do with the sub-prime market, the money supply and inflation.

Originally Posted by Sauron

The rest of your playground questions will be answered if and when you patch the holes in the statements you've already made.

Done.

Originally Posted by Sauron

Good luck - youll need it.

That was easy.
Inflation must be taken into account in interest rates. Nominal rates are for accounting, not economics.