In part one, I detailed how, amongst businessmen like Michael Bloomberg and Conservatives universally, the misguided swore the stupid government forced lenders to loan to undeserving poor folks and minorities, causing the housing bubble and the subprime crisis. This liberal ‘social crusade’ was to blame for the collapse of the economy.
In part two, I demonstrated how perfectly wrong that was. The U.S. data on all loans originating in 2006, at the height of the subprime loan frenzy, showed that those banks most highly regulated and government-constrained to make loans to lower income and minority borrowers, the Community Reinvestment Act (CRA) banks, were far less likely to offer risky, ‘high-cost’ subprime loans. It was the government-independent institutions that generated the vast majority of subprimes. And, when they did, the brokers manufactured loans at higher APRs across the economic strata.
Federal Reserve Governor Randall S. Kroszner summed it up nicely:
Our analysis of the loan data found that about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods. Such borrowers are not the populations targeted by the CRA. In addition, more than 20 percent of the higher-priced loans were extended to lower-income borrowers or borrowers in lower-income areas by independent nonbank institutions–that is, institutions not covered by the CRA.
Putting together these facts provides a striking result: Only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes.
There it is. Only 6 percent of subprimes went to poor people. The crisis wasn’t because of the darkies. And it wasn’t because of the government.
So, the question becomes: Why were fatal, risky loans being made? Why did so many lenders do something so dumb? Why didn’t anyone flag the dangers? Bitterly, we know now it was the high-risk, high-cost loans that couldn’t be re-paid. When the loans died, the houses died, the banks died, the financial institutions and markets died, and the great recession was on.
So, who would be prompted to make loans that default? If you’re only going to be a stupid lender, you’re only going to get hurt, right? You would think. But thanks to Bush administration-era ‘business innovation,’ the answer was “No.”
For the first time in the history of lending, you could make all sorts of stupid loans and escape the consequences. You didn’t have to worry about whether a penny got paid back from the borrower to the bank. How? Why? Because lenders were the last people on Earth responsible for their own lending. Within days of making the loans — bon voyage — they sold them allthem.
Home loans were boxed up and sold to giant secondary financial players. Those guys cut them to pieces and cabbaged them into “risk averse” bundles (mortgage-backed securities [MBSs] and collateralized debt obligations [CDOs]), and the bundles were then sold again, this time to ordinary American investors. They told Ma and Pa America that cutting and bundling made a losing investment impossible. ‘Trust us, people, there’s no harm in sight’ they said, and they put their ‘good’ name on it. Goodnight, thanks for shopping with Goldman Sachs. And, honestly, before everyone got hip to the game, they would have been right.
The problem began in the early 2000s when business types everywhere got smart. The government-independent players were running away with the industry. The Government Sponsored Entity (GSE) giants, Fannie Mae and Freddie Mac, whose job it is to buy home loans and then sell them elsewhere in order to keep the loan market moving, went cold. Mortgages by the thousands were being bought up, bundled and sold by outsiders:
Then in 2003-2004, the subprime mortgage crisis began. The market shifted away from regulated GSEs and radically toward Mortgage Backed Securities (MBS) issued by unregulated private-label securitization conduits, typically operated by investment banks.
Government-independent secondary market operators were making a killing buying up days-old loans, stewing them and selling them to investors across the world. The investors had such faith in the financial giants of the world that they didn’t ask why the loans wouldn’t tank.
So the market for loans, any loans, green-gilled loans, walking on club-feet and mumbering loans, went white hot. Lenders were handsomely rewarded for anything they managed, including mortgage dogshit. Especially dogshit.
Lending became an open-ended game of paperwork and profit: it didn’t matter how you got someone to agree to a loan, you simply had to get them to do it. An explosion of stupid, crazy-ass fire sale and discount loans got plastered across America’s retail windows.
The mortgage qualification guidelines began to change. At first, the stated income, verified assets (SIVA) loans came out [got removed from the high-standards loan pool]. Proof of income was no longer needed. Borrowers just needed to “state” it and show that they had money in the bank. Then, the no income, verified assets (NIVA) loans came out. The lender no longer required proof of employment. Borrowers just needed to show proof of money in their bank accounts. The qualification guidelines kept getting looser in order to produce more mortgages and more securities. This led to the creation of NINA. NINA is an abbreviation of No Income No Assets (sometimes referred to as Ninja loans). Basically, NINA loans are official loan products and let you borrow money without having to prove or even state any owned assets. All that was required for a mortgage was a credit score.
Another example is the interest-only adjustable-rate mortgage (ARM), which allows the homeowner to pay just the interest (not principal) during an initial period. Still another is a “payment option” loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal. Nearly one in 10 mortgage borrowers in 2005 and 2006 took out these “option ARM” loans, which meant they could choose to make payments so low that their mortgage balances rose every month. An estimated one-third of ARMs originated between 2004 and 2006 had “teaser” rates below 4%, which then increased significantly after some initial period, as much as doubling the monthly payment.
All of these bargain-fumbling fancies were designed to do one thing: get someone to bite on the front end of a deal destined to crash at the back. Regardless of the menial APRs at the beginning of the mortgage, these were big, high-cost deals. These were horrible to live with, even for the financially healthiest Americans.
But, my gosh, didn’t the sales pitch work:
The ratio of lower-quality subprime mortgages originated rose from the historical 8% or lower range to approximately 20% from 2004-2006, with much higher ratios in some parts of the U.S. A high percentage of these subprime mortgages, over 90% in 2006 for example, were adjustable-rate mortgages.
One-fifth of mortgages became “You’re out of your mind, you can’t possibly pay this back” gambles. All because the loans weren’t really loans — they were investments to be sold to suckers to be re-sold to other suckers.
Of course, a multi-trillion dollar system gone ravenous for toxic debt is suicidal. Such irresponsibility can’t survive. A violent crash was inevitable.
In the third quarter of 2007, subprime ARMs making up only 6.8% of USA mortgages outstanding also accounted for 43% of the foreclosures which began during that quarter.
The foreclosures, sadly, had only begun. You can fill in the rest of the story, you know what happened after that.