But first, I did call a friend of mine who works for UBS, to clear up some technical stuff I didn't understand and answer some questions I couldn't clear up with Google.
If the focus is to be on blame, I'll go with industry 60%, consumers 40%. What I'm saying is that for every 100 defaulted (or close to it) loans, loans where the customer is upside down (owes more than the house is worth), etc., in 65 of those cases, both parties are to blame, and in the other 35, it's the industry. So, that's 165 "Blame Points" (BP) to go around, of which the industry owns 100, and consumers 65.
The seed of the problem was planted 15 or so years ago, when banks really started selling off their loans aggressively, and mortgage brokers started becoming a factor in the industry.
For all these examples, I will use the same loan numbers, and ignore time value of money, opporunity cost, etc.
I will be using a $200,000 loan, 6%, 30 years. Monthly payment of $1199.10.
- At this rate, in 30 years, the bank will get its $200,000 back, plus $231,676.38 in interest.
- Now, don't forget, that's not all profit, because the bank borrows money too. From you! ABC Bank only has this money to begin with because your money is there, in your savings, checking, CDs, etc. On which the bank pays interest to you.
- Say the bank's average interest paid out rate is 4%. So that same loan cost the bank $143,739.01 over 30 years.
- Thus, the bank's take is $87,937.37. Over 30 years.
OK, we've got the basis for this lesson.
Let's look at a loan from back in the good old days:
John and Mary walk into their bank, and meet with Bill the loan officer. (Yes, banks used to have loan officers right there in your hometown; or, if not at every branch, a regional guy who would travel between two or three branches with appointments available at each, on a rotating basis.) They want to buy a house for $240,000, and have $40,000 available for the down payment, between savings and (very likely) private loan(s) from their respective parents.
Bill checks their income, their job stability, their credit rating, everything. Do you know why? Because Bill's employer, ABC Bank, doesn't want to lose money. And if Bill approves a bad loan, ABC Bank loses money. Now a certain percentage of these loans will always go bad, and that's all figured into projections of revenue streams, but bad loans are VERY expensive to the bottom line. So, too many of those, and Bill no longer works for ABC Bank. The upshot of all this: Bill might actually say "No." Look, you don't have enough income for this monthly payment, you credit isn't good enough, etc. Maybe look for a cheaper house, or come up with more of a down payment and we can lend you $180,000 instead. Still, "No" was on the table.
Anyhoo, in hundreds of branches, hundred of Bills were giving out thousands of these loans, and ABC bank knew that over the next 30 years, they had thousands of little $87,937.37 revenue streams (minus an estimated percentage of bad loans). And that's how ABC Bank made money. Borrowing money from the accounts at 4%, and lending it out at 6%.
Then, along came mortgage consolidation. Someone figured that if they packaged up thousands and thousands of loans, that's a HUGE revenue stream of "guaranteed" money over the next 30 years. How do they do this? Well, they buy the loans from all the banks.
Let's go back to John and Mary, but move the scenario to the year 2000.
1) ABC Bank writes the loan for $200,000. ABC is in line to make $87,937.37 over 30 years, with a certain percentage chance of risk, of course, but still, that's accounted for.
2) The next month XYZ Mortgage Consolidation offers to buy that loan for 1.02 times the principle right now (in other words, a 2% markup). Now, 200,000 x 1.02 = 204,000. So XYZ, in essence, is offering ABC $4,000 today for that $87K long-term revenue.
3) Peanuts, right? No! Remember, ABC now has its money back, plus $4000. That's a 2% profit. In a month. (Bonus: ABC doesn't give two shits whether John and Mary default.) ABC lends that $200K again. Sells it the next month, now it has $208,000. Let's go and say ABC Bank can lend-and-flip that same $200K every month. At the end of the year, they have $248,000. That's a 24% growth rate on that seed money. With. No. Risk.
What's in it for XYZ?
Why pay $204,000 now for 30 years worth of payments totaling $431,676? Why not just buy some CDs or bonds at 2.62% compounded? Well, that's small thinking. That makes sense for a single individual with $204K to invest, who wants his/her money relatively safe.
Let's think big. Let's do this 100,000 times! First, we raise $20,400,000,000. How? That's where Wall Street comes in. You raise 20.4 billion dollars by securitizing all this crap, and selling bonds and other instruments, most of which I don't understand.* Let's sell bonds at a 3% annual rate. You know, a "safe" investment for those who buy.
(*they don't understand either. Hence, you have what Atrios has aptly dubbed Big Shitpile. It's so sliced and diced it pretty much became a Ponzi scheme.)
So, XYZ "borrows" $20.4 billion by selling bonds, on which it pays out $612 million in interest per year. But it bought 100,000 of those mortgages, which have monthly payments of $1199.1, per month. 100000 x $1199.1 x 12 = $1,438,920,000.
That's a nice profit of $826,920,000. Per year. And that's just THIS year's mortgages. Wash, rinse, repeat. Keep buying mortgages, and paying out less in interest than you collect in monthly mortgage payments, and you're on one hell of a cash-flow gravy train.
Where did it all go wrong?
This only works if bankers are still abiding by the old rules of honestly checking the home-buyers' qualifications. Remember, though, that the bank no longer carries risk. Overnight, their concern went from "how do we ensure an as-safe-as-possible stable of loans for ourselves" to "let's write and flip as many fucking loans as we can for $4000 a pop."
Throw in the rise of the mortgage broker, who works for himself.
John and Mary go to Mark's Mortgage Brokery, tell him how much they make, what they want to spend. He writes up the numbers, and shops that around to banks until one bites and writes the loan. The bank pays him $500 out of their $4000 profit. Now they don't even need to have a Bill staffing every branch, because there are thousands of self-employed brokers doing all the "work" for them. Now, the banks and Mark want to write as many loans as they can.
This is a large part of what created the housing bubble. If the bank won't say no, everyone can buy a house. If everyone can buy a house, you have too much demand for not enough supply. And there you go.
At some point, home values just can't go any higher, and you have a correction. Or crash. And the bill comes due.
PHEW! That was a long way to go to get back to the original question.
Who's to blame?
First and foremost, this is all an industry creation. And it might have made sense, according to traditional lending rules. But they went out the window. Cause and effect.
Like I said at the beginning, in 100% of bad loans, the industry gets a "Blame Point." They're the experts, right? Once they abdicated their responsibility to say "no" to people who OBVIOUSLY couldn't afford a mortgage at all, or who could have afforded $200K but wanted $400K instead, the lender gets a BP. When the lenders created the ARM, when they knew that that $1250 monthly payment would turn into $2500 in two to three years unless the borrower re-financed or sold, they get a BP.
When does the consumer get a BP, along with the lender?
- When he takes out a loan on that stupid McMansion he doesn't need.
- When he does this. This case study is fucking astounding! Don't forget, though: they always found a lender to say yes, as long as the "market value" increased.
- When he signs for an ARM, or interest-only loan, or some other stupid concoction. You can yell about "unscrupulous" or "predatory" lenders all you want, but at the end of the day, John and Mary signed that fucking piece of paper, because they wanted their "dream home," instead of just walking away to let their heads clear.
Aren't there cases where no one is to "blame?"
Sure. Look, even in the old days of well-vetted loans, shit happened. People lost jobs, people got sick and burdened with ridiculous medical bills... shit happened. I don't mean to be callous, but that's life. The bank knew that a certain percentage of its loans would turn out bad, for whatever reason. I feel for those "certain percent" people. And as a good liberal, I certainly believe that FUCKING MEDICAL EXPENSES should never bankrupt you out of your home, but that's a whole other dissertation, handled by people more qualified than I am.
Anyway, I have work to do, so I have to be done with this.
Any comments or criticisms by people who know better, please, I want to hear them. I know I've simplified a lot, and based all these numbers on the same mortgage without even getting into changing mortgage rates, inter-bank rates, Fed rates, etc.
