"Let's hope we are all weathly and retired by the time this house of cards falters." - Internal email Wall Street 12/15/2006
I just watched a great CNBC documentary by David Faber that recaps the origins of the global economic crisis. For replay:
http://www.cnbc.com/id/28892719Some key points:
- 911 disaster causes Fed to cut interest rates
- Mortgage rates dropped to lows not seen since the 1970's.
- Wall Street saw an opportunity to get into Mortgage Backed Securities (MBS) and compete with Freddie Mac/Fannie Mae
- Chasing the American dream, Americans bid up real estate prices, but they didn't read the fine print of their loans, overstated their incomes, and planned to withdraw equity from their future home values or planned to refinance at a later time.
- Wall Street's demand for mortgages allowed lenders to get creative and loose with "Stated Income" and "No Money Down" loans. (Lenders would give a mortgage to anyone.)
- While there was concern on Wall Street, imposing stricter standards would have effectively put any firm out of the market.
- People refinanced and tapped the equity in their homes to fuel home improvement and retail spending.
- Wall Street's MBS business exceeded expectations and foreign demand increased.
- Highly unqualified people became loan officers and were highly incentivized to close loans and refinance. Homes became ATM machines.
- Loan originators "never made a mortgage that Wall Street didn't want to buy."
- In 2004, President Bush brags about new home ownership rates. Greenspan encourages mortgage industry to come up with more creative loan alternatives.
- Negative Amortization Loans allowed buyers who couldn't afford loans to buy. In fact, these toxic loan had balances that increased over time.
- To attract institutional buyers, ratings agencies rate "investment grade" securities. Rating agencies had a conflict of interest to properly rate investments, for fear of losing future business.
- Banks created Collateralized Debt Obligations (CDO's), allowing investors to own small pieces of many properties to diversify their risk.
- CDO's were a vehicle to package bad loans with highly rated ones in order to give them AAA rating.
- Salesmen, lawyers, and investors alike did not understand what a CDO was. However, the investment pitch was convincing - It's safe, it's a sure thing with low risk. The AAA rating was more important than knowing what the investment was.
- Greed was prevalent. Buyers wanted their dream home. Lenders couldn't say no. Bankers asked for more mortgages and more loans. Investors sought higher returns.
- Lack of oversight by SEC and Federal Reserve. Greenspan says even if he had known the extend of subprime mortgages (representing 20% of all new mortgages in 2005), Congress probably would have stopped him, since new home ownership is a good thing.
- Warning Sign #1 - Mortgage Origination is a trillion dollar market that touches consumers without regulation.
- Warning Sign #2 - Housing Prices were going up significantly higher then Median Income.
People and even rating agencies assumed that housing prices would continue to go up in perpetuity.
- If Greenspan with hundreds of PhD's on his side, could not understand CDO's, how could the majority of the world understand them?
- In 2006, Subprime loans began to default and bankrupt lenders. MBS's delinquency rates rise and Wall Street stop buying mortgages from Subprime lenders. Mortgage credit begins to dry up and there are fewer qualified buyers. Home prices stop rising. People can't refinance out of adjustable mortgage rates. People fall behind on the payments that they didn't understand. Many are foreclosed. When people discover AAA rated investments are junk, wall street confidence is shattered and the global economic crisis begins.
The American Dream is shattered.
"If it sounds too good to be true, it probably is."
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