[Parallax]

and there was a dip in the housing market. People just gave the key to the bank and left town.

I remember that, too. Again, though; that in itself had no effect.
After the value went down, they were still living in the house, making the same payments. Nothing changed there. The only way they knew the value had gone down was that someone told them.

many felt no incentive to continue paying for underwater loans.

There is a huge part of the problem!
There are some people though, that would argue that the fact that they signed a contract is sufficient incentive to pay the money back; others feel that their word, pledge, promise, etc., should only be valid until it becomes an inconvenience.

[Nesster]

Remember, in talking about the crash of 2008, the big event was not actual defaults (that loss would take time), but from the crash of the market for these CDOs and the ripple through the financial sector.

Which would have made a bottom-up bail out make sense, and actually be cheaper at least initially. The govt got their TARP money back however, so at least that part seems to have turned out cheaper (though we still suffer the overhang, at uncounted cost)...

[GeneV]

I remember that, too. Again, though; that in itself had no effect.
After the value went down, they were still living in the house, making the same payments. Nothing changed there. The only way they knew the value had gone down was that someone told them.

According to the federal reserve, "Slackened underwriting standards—manifested most dramatically by lenders allowing borrowers to forego down payments entirely—combined with stagnant to falling house prices in many parts of the country appear to be the most immediate contributors to the rise in mortgage defaults."
http://www.federalreserve.gov/pubs/feds/2008/200859/200859pap.pdf That is a fairly complete analysis of the reasons for the crisis, and the falling values and high loans to value rates figure very strongly.

Many of the subprime products were never intended to be long term loans. The borrower started off with an interest rate that is comparable to the rate that borrowers with better credit get. These were not dirt cheap, but around 6-7%. In three years, the rate would jump. The borrowers were in fact usually able to pay loans at standard rates, or even a little higher. These loans were sold as being a chance for credit repair, then refinance after three years of good payment history. However, when the values fell, refinancing became impossible, especially since the original loan was often 100% of the original appraised value. Now, the borrower does have a loan that can't be paid.

Again, in 2008, we are talking about an increase from 7% to 14% default rate for the sub-prime sector, only, and much smaller for the industry as a whole. A doubling of the default rate in one type of loan, but not enough to take the banking industry down, if this were just about banking.

These loans were usually not held individually by banks, but bundled into large pools, securitized and sold to the public. When the word gets out that defaults are increasing and that collateral values are down, the price of these securities dives. Then insurance and derivatives (CDS and the like) kick in, making the crash even larger and taking down more players.

Jussi (and Stiglitz) are probably right that it would have been more cost effective to buy the mortgages, turn them into more appropriate products and avoid a crash.

[Parallax]

Many of the subprime products were never intended to be long term loans. The borrower started off with an interest rate that is comparable to the rate that borrowers with better credit get. These were not dirt cheap, but around 6-7%. In three years, the rate would jump. The borrowers were in fact usually able to pay loans at standard rates, or even a little higher. These loans were sold as being a chance for credit repair, then refinance after three years of good payment history. However, when the values fell, refinancing became impossible, especially since the original loan was often 100% of the original appraised value. Now, the borrower does have a loan that can't be paid.

Gene, thank you. That is the only explanation of the issue that I have ever seen that I can actually understand.
Now I get it.

[jeffkrol]

I remember that, too. Again, though; that in itself had no effect.
After the value went down, they were still living in the house, making the same payments. Nothing changed there. The only way they knew the value had gone down was that someone told them.

There is a huge part of the problem!
There are some people though, that would argue that the fact that they signed a contract is sufficient incentive to pay the money back; others feel that their word, pledge, promise, etc., should only be valid until it becomes an inconvenience.

Too simplistic............... Contracts are negotiable, if you believe that or not.. Besides what is the point of supporting a contract where both lose???

I UNDERSTAND your point but extreme circumstances (like pumping the economy to "healthy" )overrides petty legalities......

Few would argue that letting the banks fail would have collapsed the economy completely and we allowed them to not honor their contract by throwing cash at them..
Like some say.. same difference..

Granted the gov. gets some back (some say all) but the same could be said from taxes and revenue pumped into the "little peoples" hands...

Again it's easy to hate an individual, we seem to draw lines at institutions that effectively do the same thing.


I believe one of the statistics was individuals lost 14 trillion in "savings" due to the collapse but big numbers seem to make us numb......

And all that fed money.. "full faith and credit".. nothing real actually.

From a extreme MMT standpoint the fed never needs to collect the money it spends.. since it is it's creator.......... gee, neat concept Fed is the money god...

[Nesster]

I remember that, too. Again, though; that in itself had no effect.
After the value went down, they were still living in the house, making the same payments. Nothing changed there. The only way they knew the value had gone down was that someone told them.

For some, yes, but we lived in Utah at the time, and about 1/2 of the people who moved there to open the new processing center left within a year, and most of them left the house to the bank. (We stayed 1.5 years, and made a little on ours, as we bought a craftsman bungalow, something that was just coming into style, instead of a cookie cutter development)

A major difference is that in '84 Lou Ranieri was still forming the new mortgage pool market; the derivatives and derivatives of derivatives and synthetic derivatives thereof were still far in the future. Thus a spike in defaults mainly hit bank balance sheets the usual way, and only a certain number of mortgage pools.

As Gene says, this last time the sheer amount of dollars involved was huge to begin with, and add to that the derivative manufacturing and pricing, and re-selling, with added leverage at each step, and you end up with a really really big number.

The easiest derivative to understand is the strip: we started this with treasuries but quickly addapted it to other asset classes. With the strip, you clip off each coupon payment, and package these into separate tranches. So you can buy, say, the interest payments that come due next year, or 10 years from now. Obviously, the worth of the 10 year out payments is riskier than the ones that come due next year - not just from default, but the underlying loans may be paid off early etc. Then there's the leftover pieces, the riskiest bits of all, the bits that only get paid off, and get any return, if everything goes just right with the underlying securities. These were the bits that banks ended up holding, as they weren't able to sell them - the money they made off the other tranches *should have* more than made up for any losses here.

And remember, the banks put up $1 for $26 worth of these.

So any decline in value immediately multiplies and amplifies through the system. And mark to market means the banks suddenly have no capital to cover the paper losses... and would YOU lend anything to such a bank, not knowing if you'd get it back?

[Parallax]

gee, neat concept Fed is the money god...

You are a true liberal.

[GeneV]

Gene, thank you. That is the only explanation of the issue that I have ever seen that I can actually understand.
Now I get it.

Thank the Fed. I cribbed the analysis in that report. The linked report is one of the best summaries I've read of what was and wasn't the cause of the underlying mortgage problem. Dropping (or stagnating) values figure at every stage, from locking the subprime borrower in to bad terms, to scaring off the investors and accelerating a crash.

[jeffkrol]

Thank the Fed. I cribbed the analysis in that report. The linked report is one of the best summaries I've read of what was and wasn't the cause of the underlying mortgage problem. Dropping (or stagnating) values figure at every stage, from locking the subprime borrower in to bad terms, to scaring off the investors and accelerating a crash.

Actually the bank/investors may have gone for it (paying off the mortgages) but I assume greed crept in and they can double dip the profits.. Get paid by the fed and collect and sell all the little monopoly houses........

I assume all the brain trusts never drifted into round earth thinking and just kept sailing in circles.........

[jeffkrol]

and for fun

I completed the manuscript for Nickel and Dimed in a time of seemingly boundless prosperity. Technology innovators and venture capitalists were acquiring sudden fortunes, buying up McMansions like the ones I had cleaned in Maine and much larger. Even secretaries in some high-tech firms were striking it rich with their stock options. There was loose talk about a permanent conquest of the business cycle, and a sassy new spirit infecting American capitalism. In San Francisco, a billboard for an e-trading firm proclaimed, "Make love not war," and then—down at the bottom—"Screw it, just make money."

Since When Is It a Crime to Be Poor? | Mother Jones


Well maybe not soo much fun...........

When the Parentes finally got into "the system" and began receiving food stamps and some cash assistance, they discovered why some recipients have taken to calling TANF "Torture and Abuse of Needy Families." From the start, the TANF experience was "humiliating," Kristen says. The caseworkers "treat you like a bum. They act like every dollar you get is coming out of their own paychecks."

The Parentes discovered that they were each expected to apply for 40 jobs a week, although their car was on its last legs and no money was offered for gas, tolls, or babysitting. In addition, Kristen had to drive 35 miles a day to attend "job readiness" classes offered by a private company called Arbor, which, she says, were "frankly a joke."

Nationally, according to Kaaryn Gustafson of the University of Connecticut Law School, "applying for welfare is a lot like being booked by the police." There may be a mug shot, fingerprinting, and lengthy interrogations as to one's children's true paternity. The ostensible goal is to prevent welfare fraud, but the psychological impact is to turn poverty itself into a kind of crime.

Makes me ashamed..

[GeneV]

Our political deadlock with economic suicide threats viewed from the outside. The dysfunction that lies at the very heart of American politics | Michael A Cohen | Comment is free | The Observer

Michael Cohen points out that the party that wants government to do nothing has an advantage in a system which provides many avenues to block action and hamstring the process. As I wine drinker, I can appreciate this quote:

"Republicans understand that if you have a vat of sewage and you pour in a glass of wine you still have a vat of sewage. But if you pour a glass of sewage into a vat of wine, guess what, you now have a vat of sewage. In short, a little political poison can go a long way. "