Tuesday, October 14, 2008

Mortgage Crisis Explained?

For some, this whole mortgage / stock market / bailout crisis is a fuzzy gray area and they just don't seem to get it. That, I get.

I've been trying to figure out the most terse way to represent the scenario and I think I discovered a Cliff-Notes version of the scenario that breaks it down to the raw form for those of you who are shrugging your shoulders and wondering why your 401k's are shrinking:

  • People looking to buy homes, the "American Dream", who normally couldn't afford some scenarios, were offered loans that somehow, they could afford according to the mortgage broker, by the myriad of mortgage lenders out there. (Does "interest only" sound familiar to you?)
  • Mortgage brokers also dispensed subprime loans to anyone who would eat them up. (Cheater, no-doc loans that knowingly could not be backed by the home owners real financial situation.)
  • The brokers then sold the loans to third parties. (Par for the course, and they're usually larger financial institutions. My loan was bought by SunTrust. So they made their monies off of you, then sold them for more money. Wow, hope they're enjoying their bread and butter now!)
  • Once bought, these "securities" were used to sell mortgage backed securities. More or less like bonds with a fixed rate of return because supposedly, someone is paying their mortgage off each month, and hence, it's a guaranteed income fund / bond, so to speak.
  • Somewhere over 90% of the securities were not backed by real assets, and insurance was bought, as it normally is, to cover these securities. (The No-Doc loans approved via generously estimated levels of income, not real income.)
  • Bond rating agencies ignored the fact that these non-backed securities were speculation and rated them non-commiserate with their risk factor.
  • This collection of risky securities was never looked at as a whole, but individually. This overlooked the co-dependence of one security upon another.
  • Because they were rated high, the insurance rates (premiums) were low. Too low.
  • As the cheater / no-doc loans started to come due, people could not afford the loans and were unable to pay them*. (IE: The super low, attractive interest rate and payments changed to much higher terms after the initial 3 - 5 years)
  • When this bucket of risky securities started to topple, there was not enough insurance to cover the disaster we are now in.

Like I said, this is an outline that might give you a feel for the scenario, as it stands.

And as it stands, we still have a lot of these risky loans still coming due from the heyday of the market momentum in 2005-06. They were 3 and 5 year loans that people took out, thinking they would be OK and be able to re-fi before they had to pay the steeper mortgages. They didn't bank on their loans being more in value than their houses at the time of re-fi.

*This is why I point the finger at lenders and continually "thank" the lenders of America for this situation. They baited people with loans that upfront, looked incredibly attractive and yet had a term of only 3 to 5 years. After that term, the rates would go way up, making them less affordable to the loan takers, but the lenders never really made that completely apparent to the clients in the best, plain English statements they needed to make.

Related rants and insights:

So Who Is To Blame For The Market Travesty and Such?

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Hi - sorry for the confirmation but I need to weed out the noise from the well intended comments. Thanks for leaving a note... - Bruce