The Mortgage Meltdown as I See It

OK. This is how I understand it. Sorry I don't sound more pissed off, I wrote it for a non-pissed off venue. I'll throw a few fucks into the mix to spice it up.

There are two issues regarding these bad loans that are causing such trouble to our economy. The question, to me, is twofold: Why were so many loans written that were going to go bad? Don't banks know how to loan money? Secondly, why are companies like Lehman Brothers going under because of bad loans they didn't even make?

There is a secondary market that buys the loans, but it doesn't guarantee them. This secondary market buys loans or parts of loans as securities - basically like stocks. If I'm Fannie Mae, I take 1,000 subprime loans and bundle them together into a set of securities worth, in total, say, 10 million dollars. The securities, let's say there are 10,000 of them, are sold for $1,100 each - $1,000 for the loan, $100 to cover expenses and a profit. You buy one share, and now you own .01 percent of 10 million dollars worth of loans. This is called Securitization.

Normally a bank doesn't write high risk loans unless it can charge a lot of interest for them, to cover expenses as some of the loans fail at a higher than normal rate. This also results in fewer loans being written overall, because most poor people can't afford the higher interest rates that are normally charged. But Fannie Mae will buy these loans from you as a bank, because it has been instructed to do so by Bill Clinton. Clinton does this because he wants poor people to own houses too. This is not sound business, but it is government, that explains why it is not sound business. Fannie Mae is guaranteed as a company (implicitly) by the government precisely because the government makes them buy these loans that otherwise sane companies would never buy.

I'm not aware of anyone who guarantees these loans other than Fannie/Freddie, and as far as I know, they don't even guarantee the loans, they are simply guaranteed as companies. Maybe other companies guarantee these loans, but I don't know of any.

The central problem here as I see it is that loans were written outside of generally accepted good loan writing procedures. Banks don't write loans that are too risky to make a profit on, because their motivation is profit, unless they can find someone to buy it. And nobody will buy it at a profitable rate unless it can be guaranteed somehow. Enter the implicit guarantee of Fannie Mae and Freddie Mac. (fuck, added for spice)

Guarantee: why the loans exist in the first place. Without the guarantee, people won't write them at the low rates that poor people need to buy a home with. Ergo, less bad loans when everything goes to hell.

Securitization: why the loans are owned by investment companies when they go bad, instead of Countrywide and Wachovia. (fuck, gratuitously included for no reason. Ok, I'm done with the fucks.)

So, the scenario is this:

Clinton says "write bad loans for good rates." F/F (Fannie and Freddie) do so because they operate by different rules, as dictated by the government. The upside is that these "alternate rules" create an implicit guarantee of F/F.

Loan gets made. Poor Guys #1 through #1,000,000 buy houses. Loans get sold to F/F because F/F is buying them because Clinton told them to, and implicitly guaranteed that the company would be covered. It would be Poor Guys #1 through #100,000 buying houses, but these cheap loans are being sold to poorer credit risks, so more people get them. This causes the housing market to grow into a bubble, because a lot more homes are being sold, and builders can't keep up with all this new demand. This creates the illusion that you can buy a house that you can't afford and flip it later on, and come out clean. So a lot of people, not just poor people, buy houses they can't afford as investment vehicles.

Fannie creates a security (basically shares of stock) on a group of loans that it bought. It sells these securities. These are bought by Lehman Brothers, because they have a good rating, because the government guarantees the company that wrote them.

This goes great as long as prices are going up. Even if you can't afford it, you can sell it for a profit, so you're fine. When housing prices go down though, poor people as well as investors get stuck holding houses that are worth less than they owe on them. So the loans start failing in large numbers.

Poor Guys #1 through #600,000 pay their loans OK. Poor Guys #600,001 through #1,000,000 default on their loans. This causes the value of the security to tank, because the government is guaranteeing F/F, not the loan itself (as far as I know). The value tanks so much that F/F go bankrupt, and anyone holding these "toxic loans" suddenly has a lot less money than they thought they were going to have. This causes failures outside of F/F: Companies that own the stock (Lehman, many banks) and companies that insure those companies (AIG). Suddenly companies can't pay the credit that they owe, so the creditors all freak out and raise their credit rates, or issue less credit. Less credit is less economic activity, and other people can't borrow money to pay their bills. Recession ensues.

This is how Bill Clinton's desire for poor people and minorities to own homes resulted in a worldwide market meltdown.

This meltdown has so far cost trillions of dollars in value, and will cost trillions more in inflation due to all the money being pumped into banks to keep them from failing.

At least that's how I understand it.