Slideshow: How SubPrime Really Works
posted at 3:50 pm on February 15, 2008 by Bryan
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My friend Chris sent this along to me. He’s been emailing me alarms for months on subprime and we’re in the thick of the problem now. This little slide show that’s been circulating around Wall Street for a few days now explains how we got here. I’ll confess that this isn’t a subject I have much deep knowledge or thoughts on, so if any of you economics types in the crowd see any holes in the show’s tale or have any thoughts on it, chime in.
Content warning, especially on the last couple of slides.
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looks pretty good to me…the SPV’s part was a little oversimplified but that was the whole point right?
ernesto on February 15, 2008 at 4:00 PM
They left out the part where with all the frenzied buying going on contractors were jacking up prices and crooked agents were running scams to get buyers to sign onto massively inflated prices.
pedestrian on February 15, 2008 at 4:02 PM
Interesting how sneaky they are. Reminds me of the shell game.
Geronimo on February 15, 2008 at 4:03 PM
I can’t wait to see the slides where the gubmint steps in and fixes everything.
sleepy-beans on February 15, 2008 at 4:09 PM
They left out all the crooked or imcompetent appraisers that made it happen with pieces of crap appraisals.
peacenprosperity on February 15, 2008 at 4:10 PM
Yep… pretty much sums it up.
Nineball on February 15, 2008 at 4:13 PM
Given that appraisals are based in part on the prices of the homes sold in the general area; those went up because of other reasons. Appraisals is part of the effect; not the cause.
lorien1973 on February 15, 2008 at 4:14 PM
I didn’t see the part where the gubmint enabled all of it in the first place.
RushBaby on February 15, 2008 at 4:15 PM
Far from the real cause. As with most things the MSM reports on, they are wrong on who is to blame for the subprime meltdown. They are wrong in even calling it a subprime meltdown. It is more accurately called a credit meltdown.
The crisis has spread from subprime to Alt A to even prime loans. It is now spreading to installment loans and credit cards. Home equity lines of credit are becoming obsolete and those who have them already, are finding some banks in some areas are freezing the line or reducing it.
The recession isn’t cyclical in nature as most recessions are. It is due to a systemic break down of our debt markets. Lenders don’t lend unless the loans can be securitized and sold to investors. Investors aren’t buying the paper anymore so securitization is almost non existant. More and more people are finding out they can no longer borrow money.
Without savings or wages that keep up with inflation, real inflation not the phony numbers put out by the government, credit was/is the only way consumers can keep spending. Now that credit has dried up, the consumer is dead. Consumer spending makes up 70% of Gross Domestic Product (GDP).
But getting back to the cartoon, the biggest blame doesn’t go to the buyers, realtors or mortgage originators. The most blame belongs to the securitizers who turn mortgages into investments. They fraudulently rated subprime loans as AAA in safety, spread them around the world only to see the truth about them, rise to the surface through defaults.
It was this Wall Street fraud, with the blessing of the credit ratings agencies (collusion on the fraud) that allowed for the crisis to get to the point where we are today. Which is a total seizing of our credit markets.
This is the reason why rate cuts and stimulus packages won’t work this time to revive the economy. You can drops rates to zero but if people can’t borrow money the zero rates don’t do anyone any good.
Can anyone say “Grapes of Wrath”? That’s where we are headed unless the government and regulators wake up to the real issue of frozen credit markets which no longer have integrity.
Here is a post on who deserves the blame and why. Finally! The REAL Criminals are Being Targeted
voiceofreason on February 15, 2008 at 4:16 PM
Homebuilder profit margins are sky-high because of illegal labor. The homebuilders pressured the mortgage companies to approve questionable loans. In fact, most large homebuilders own their own mortgage companies.
jaime on February 15, 2008 at 4:17 PM
Perfect illustration of why government regulation is needed, and also shows why we need to preserve the freedom to sue the people who screwed you.
indythinker on February 15, 2008 at 4:18 PM
I went browsing for new houses a few years ago…
Homebuilders profits are sky high cuz they charge you $5000 to add on something that you can buy for $50 at lowes.
lorien1973 on February 15, 2008 at 4:19 PM
And people were stupid enough to buy them.
lorien1973 on February 15, 2008 at 4:20 PM
Yeah, that too.
jaime on February 15, 2008 at 4:21 PM
Awesome. Thanks for sharing, Bryan!
Dave Shay on February 15, 2008 at 4:23 PM
I think they left out the part about the borrowers knowing that real estate doesn’t always go up but they wanted something they couldn’t afford so they bought into it any way.
Ann on February 15, 2008 at 4:27 PM
I worked for a guy who was worth over $200 million and even he did his own plumbing because of the rates they were charging. That part of the problem is because kids are funneled into college prep programs when they should be learning a trade. So then we need to import Mexicans to do the jobs Americans don’t know how do.
pedestrian on February 15, 2008 at 4:30 PM
I was a loan officer before the shit hit the fan. I sold a lot of those subprime loans. There are a couple things about the slides I would take exception to. First, if a client told me flat out he couldn’t make the payments, I’d send him packing. This is because the commissions paid to mortgage brokers have to be refunded if the loan defaults in the first year. Second, I don’t know about other loan officers, but I always told every subprime client exactly when the payments would start going up (two years). I had analyzed their credit report and gave them a written plan on getting their score up so they could refinance at that time. Third, at the height of the mortgage boom, I could get 100% financing for people with a credit score as low at 570. However, if they wanted the “liar’s loan,” their score had to be 640. Since poor credit is 620 and below and good credit is 680 and above, one had to have fair credit to get that kind of a loan.
jaime on February 15, 2008 at 4:17 PM is right. Not only do they own their own mortgage companies, but they effectively shut out the competition by offering big incentives if the buyer will use their mortgage company. I might still be in the business if not for that. There was a bill in my state capitol to outlaw that behavior but it never got out of committee.
Kafir on February 15, 2008 at 4:38 PM
This might have had a little something to do with it:
http://www.nypost.com/seven/02052008/postopinion/opedcolumnists/the_real_scandal_243911.htm?page=0
jukin on February 15, 2008 at 4:39 PM
I think the bean is under the middle shell.
davidk on February 15, 2008 at 4:48 PM
No real point in digging much past the “I have no money and can’t make the payments” line. You could sum the whole debalce up into a children’s book called “What Happens When Johnnie Can’t Do Simple Math?”
Faith1 on February 15, 2008 at 4:55 PM
There is one significant error in there. It’s not “Caymen Islands”, it’s “Cayman Islands”.
Midas on February 15, 2008 at 5:18 PM
Plenty of blame to go around for this disaster. Sadly, we’re all going to be paying for it for many years to come.
AZCoyote on February 15, 2008 at 5:25 PM
So that’s how my mortgage broker friends played golf while I worked M-F and Saturday.
gabriel sutherland on February 15, 2008 at 5:48 PM
I make mortgages for a living, but I don’t have the time or patience to tell you how stupid that little circle jerk was. Needless to say, anyone who believes that any of that silliness represents reality deserves the government who thinks they can “fix the problem”.
Jaibones on February 15, 2008 at 6:10 PM
You are 100% correct. It all starts with the borrower and their lack of financial education. You can blame it on advertising, culture, banks, brokers, investors and the tooth fairy if it makes you feel better.
Bottom line is “Stoopid is as Stoopid does”.
When I stand behind a 300 lb mother in sweat pants with 3 disheveled kids at 7:30 a.m. at the gas station and she’s buying a lotto ticket along with the yoo-hoo, hostess pies and mountain dew for her kiddies breakfast, then hops in her weekly buy here pay here car to get them to school late, I am not the least surprised to read in the foreclosures section of the local paper she’s 90 days behind on her mobile home that’s financed at 125% LTV.
Nobody takes responsibility for anything anymore.
Tim Zank on February 15, 2008 at 6:13 PM
Don’t worry. Hope is on the way.
Audacity too.
And change.
Oh boy oh boy!
Obama will fix this. He’ll give a speech about it.
Montana on February 15, 2008 at 6:57 PM
On a serious note, many of the forecosures are on spec houses–or “second homes”, aka flippers. People who saw easy credit and played the game of buy and sell–with houses…
That said, the loan products being sold in the last five or so years were just waiting to implode.
Anytime you see “introductory rate” or “interest only” or “adjustable” in the price page of any product or service…the pricing policy can be loosely translated as “yer screwed in a few years buddy, haha!”
The problem has several key areas:
1. Government intervention and regulation in building (that always equals higher costs thus higher priced homes). At the same time, Govt wants to encourage home ownership.
2. Bad loan products (as I summarixed above). These are essentially loans made to make the sale with the calculated risk of x% defaults. This is not uncommon and should not be discouraged. But it should also be closely watched. If it’s “easy” money, something will go wrong.
3. Home flippers. These people over-extended themselves debt-wise in hopes of selling homes at outrageous prices. In my home town, you can’t buy a shack for less than $250,000. It’s silly–but people figured they could go in way over their heads n debt and still come out richer.
4. The selling of loans. In decades past, a bank usually kept a loan over its lifetime. This meant that in order to recoup their costs and to make a profit, a bank needed to see a loan make it to term–it had to be paid off. Banks were careful with the risk policy.
Today, a bank can sell a loan to a risky consumer (interest only loans, adjustable rates, etc etc) and quickly sell that loan to downstream buyers (Wall Street being the newest buyer). In one way, this is good, it created more access to capital all around–but the hazard is in the risk taking. Banks are experts in understanding the risks of a mortgage, but the buyers of those bundled mortgages are not–at least not yet. In sum, they bought lemons. Couple that with the inevitable downturn in house values, a surplus supply of homes thanks to flippers and builders, and BAM, things get ugly.
Once Wall Street and other sources of finance improve their understanding of mortgages, they will force banks to return to a more restrained risk policy.
Ths return to better risk assessment is already happening. But it will take awhile. Yet rest assured, the losses suffered by banks and financial institutions are large–and the market economy will respond accordingly. You’ve seen the huge layoffs, what you don’t see are the slashed internal budgets, the cancellation of risky products, and efforts to better assess risk.
What we don’t need are demagogues and Govt bureaus…
Montana on February 15, 2008 at 7:15 PM
It’s actually laughable to think Wall Street doesn’t understand mortgages.
Wall Street understood them well enough to misrepresent the credit quality of the loans sold. Therein lies the fraud that allowed this whole debacle to happen.
Who wouldn’t want an investment that is as safe as a US Treasury bond with a yield that is twice as high?
The answer is everyone. Why? Because in reality, such an investment doesn’t exist. Yet that is what Wall Street was selling.
The buyers of the paper for the most part were/are institutional investors. If they don’t understand mortgages and how they are packaged for investment, no one does.
It was Wall Street fraud, with the blessing of the ratings agencies, that caused this crisis. Everyone else is a bit player.
voiceofreason on February 15, 2008 at 7:40 PM
Kafir on February 15, 2008 at 4:38 PM
Wait, isn’t that where the magic balloon payments come in? It seems the teaser rate exists so the mortgage broker can make the commission on loans which are unlikely to go to term.
The whole mortgage and financial market stinks the same way the legal profession does. The lobbyists and agencies work with the government apparachiks to craft a favorable bidness environment. Then sometimes the public has an outcry and then the system gets even more frakked up with supposed fixes. Blah, best not to think about any of it.
Viscount_Bolingbroke on February 15, 2008 at 7:55 PM
And I can’t take that job in Texas because I can’t sell my house which was not financed with a subprime loan, but its value has nonetheless fallen with the rest. And even if a buyer came along who could qualify, I can’t compete with the foreclosures.
Shay on February 15, 2008 at 10:01 PM
Baloney. Any property that gets a mortgage gets an appraisal. Unfortunately most appraisers are more concerned about making their clients happy then they are of doing an ethical job. The problem is that there are no checks and balances. Appraisers get tons of state regulation but the people reading the appraisals have no idea what they are looking at and no one regulating them so the lousy appraisals get accepted. Property values in the US aren’t declining, they are correcting. The lenders are tightening restrictions and looking harder at appraisals and the market is correcting. Just because someone got an appraisal last year that their house was worth a certain amount doesn’t mean their house was really worth that. It was smoke and mirrorrs perpetrated on the public by dishonest brokers and unethical appraisers. If you believe the opposite then I’ve got some nice swampland to sell you.
peacenprosperity on February 15, 2008 at 11:02 PM
You are absolutely right about that. Here is how the scam works. Couple looks at a model home and then sits down with the agent and starts modifiing the specs for their new home. Wife says, “I don’t like those cabinets can I get these cabinets?” Agent says, “Sure but those will cost $8000.” Wife emakes eyes at the husband and he says, “Sure, go ahead, we can afford it.” So they tack $8000 on to the base cost of the house. One problem. The base cost already included the cost of kitchen cabinets and they don’t back that number out. It just stays there. Wife picks a different color paint, counter top, etc. Same materials, same cost to the builder, but they keep jacking up the cost. Next thing you know, same house basically as the model but $50,000 more expensive. Mortgage broker sends it out to the appraiser who want to keep the client happy and he goes and finds comparables that are legitimately $50,000 higher and compares the proposed house to them. Some entry level underwriter plugs the appraisal into a computer program, no red flags appear and suddenly the market starts to artificially move upward.
peacenprosperity on February 15, 2008 at 11:13 PM
Go to your state appraisal board and ask them who their consultants are. Hire one to do an appraisal as of the effective date of the appraisal you got when you refinanced. If the value is significantly lower, have them do a full review of the previous appraisal.
peacenprosperity on February 15, 2008 at 11:21 PM
No. It isn’t laughable. It’s true. Wall Street (and I use that term to refer to buyers and sellers of bundled loan investment packages) was a new comer to the mortgage world. Their entry into the market opened up a new source of financing for loans.
I work in the business. That doesn’t mean I am expert, but I am, I believe…a “voice of reason”.
The key difference between bundled loans and Wall Streets normal fare of products is that bundled loans are actually many individually owned assets (or liabilities depending on your view point). Joe Smith down the road is the cash source. And Joe Smith was a sub prime borrower who took out a loan far above what his income allowed.
Montana on February 16, 2008 at 2:35 AM
We’ll have to agree to disagree then.
voiceofreason on February 16, 2008 at 7:19 AM
That depends. Do you consider 8% a “teaser” rate? That was pretty much the average I could get for someone with a FICO less than 600. The plan was to get a mortgage you could afford, hold it for two or three years while you got your credit issues resolved (Usually, adding a mortgage and paying your bills on time was enough to accomplish this), then refinance to a 30-year fixed.
As for the loan going to term, in what world do you live in? I lived in my first house for seven years, so that mortage didn’t go to term. I’m in my second house and have refinanced twice. My parents lived in the house I grew up in for twenty-one years. Bottom line: mortgages very rarely go to term.
The one thing that did concern me is that the lenders were allowing very high debt-to-income ratios. In some cases, borrowers were allowed a payment that was 55% of their gross income. When I had a client that was going for a loan with that high of a DTI, I spelled it out for them and asked them again if they felt they could swing that kind of payment.
Kafir on February 16, 2008 at 9:47 AM