oh man, here we go again! I wonder if Y Combinator will fund my Collateralized Equality Enhanced Swap
...but didn't push banks to lever the loans 10x, securitize, sell and repeat over and over again. Fault for those days lied in a lot of places, and sub-prime mortgages aren't inherently a bad thing.
They didn't.
The banks levered up so much that 7% of delinquencies was enough to crash the global economy.
The delinquencies ended up being less of a problem than the uncertainty around them. 7% delinquencies didn't kill anyone. Investors' fears that 7 would become 20 did.
https://www.chicagofed.org/~/media/publications/profitwise-n... quotes average default rates in the 30+% range on subprime mortgages.
The Collateralized Debt Objects reduced this risk down by being bundled with better credit worthy debt servicing.
The way that securitization works is that you take many thin streams of cash from individual loans, and bundle them into a giant river of money. That river will dry up at some point, and what point depends on how much defaulting there is. You then take horizontal chunks out of that river and sell them off. The first few slices are low risk - they will pay off even if lots of people default. The last one is very high risk indeed and are only worth pennies on the dollar, if that.
The principle is that it is safe not because it is bundled with better debt, but because those bonds still pay even if lots of people default. They may pay late, but they should pay.
However the models quantifying the risk assumed that there was a lot less correlation in defaults than there actually was. So when the housing market moved against the loans at the same time as people lost jobs in the financial crisis, investments that were supposed to be safe suddenly weren't.
I could believe 7% as the losses in bonds that originated as AAA bonds. But not as the losses in AAA bonds.
An RMBS is a portfolio of mortgages financed by multiple bonds, with an order of subordination between them. When a loss occurs on a mortgage, it is allocated to the most junior bond first, until it is fully written down, then the next junior bond, etc. So if you own the most senior bond (often rated AAA), you are really exposed to high default rates and high correlation. Ie if the portfolio of mortgages is diversified (low correlation) some mortages will default but not all at the same time, and there will always be enough mortgages that do not default to avoid a loss on the most senior bonds.
The big fuck up in the financial crisis is that the correlation was misestimated. There had never been a large, US wide, real estate crisis since 1929 and therefore everyone assumed a US wide portfolio was well diversified. That turned out to be wrong in 2006-2007, and delinquencies (ie balances of loans not paying interest or principal) shot up. This led to losses (not 100% of a defaulted loan, the house still had some residual value) that ultimately hit the AAA bonds.
A CDO is the same structure but using bonds in the portfolio instead of residential mortgages. But when people refer to large losses on CDOs in the financial crisis they usually refer to CDO of ABS, which basically uses junior RMBS bonds in the portfolio, so effectively you leverage the mortgages twice, first through an RMBS, and then another time through a CDO.
In those you are even more exposed to correlation. The portfolio is made up of junior RMBS bonds from multiple RMBS transactions originated by multiple subprime lenders across the country, so these structures were playing on not all of these RMBS going bad simultaneously, which is exactly what happened.
So the TL DR is that these portfolio of subprime mortgages and RMBS bonds were of a similar credit quality, but correlation is what got really badly mispriced, they were assumed to be diversified but what we got is a large US wide real estate crisis that hit everybody,
There's enormous competition for people with capabilities of repaying a loan but no thin credit files/scores. Those are credit scores between 575 and 650. There are government programs that target these people administered via Freddie, Fannie and FHA for automatic underwriting. Those are done? No matter, USDA(!) would guarantee loans in rural areas! Banks themselves do manual underwriting for people who barely qualify or on a cusp of qualifying at prime + rates. Those were not the subprime loan customers.
Subprime loans were originated with the same rationality as the loans covering Buy Here, Pay Here car loans: they were originated with a total knowledge that the buyer will fail to make payments and will be foreclosed on - no matter! Buyer would make payments for first 6-7 months, default, get foreclosed on and the house would be sold to someone else for higher amount than the defaulted loan. Housing was an appreciating asset when these loans worked fine on depreciating assets ( cars ).
Structural inequality or not, people who have shitty jobs and shitty financial position typically make shitty financial decisions over the long term. 30 year mortgage is a very long term financial play.
If you are lending money with the unspoken understanding that the note is likely doomed to be a loss unless the real estate market continues to go up, then you are not really in the loan business anymore. You are putting letting your capital ride on the real estate roulette wheel, while enjoying the fat fees in the short term. The fact their were enough greater fools around to move your capital from new bad loans to newer bad loans may let you bank a few more fees, but it still means the originator is choosing to screw up while hoping to be rescued by real estate market forces completely beyond his control.
Correct.
> ...but didn't push banks to lever the loans 10x, securitize, sell and repeat over and over again.
Yeah, but I'm not going to pretend like I wouldn't. Worst case scenario is that my failed bets get paid out by the future productivity of the entire working population, and the distressed assets get transferred to the balance sheets of special purpose vehicles also funded by taxpayers.
And I get to keep all the performance fees.
The only way to avoid immoral behavior is to fix the incentives so that it doesn't pay off. In this situation, that means either make it uneconomical to sell (perhaps by penalties like jail time), or to not allow the sellers to socialize the risks (perhaps by not bailing them out when they failed). The former means that low-income borrowers can't buy homes; the latter means that the financial system would've imploded. Personally I think Obama would've been better off taking the latter course and letting the banks fail, but the point is TANSTAAFL and whichever course you to take will require some sacrifices, whether in equality, stability, or trust.
How? Doesn't buying a house (at market price) have an approximately zero effect on your net worth?
As of the closing date, sure. However, closing on a home allows a renter to become an owner for about the same monthly cost (plus produces some significant tax benefits typically only available to the wealthy). After 30 years of paying a mortgage, if holding all else constant, one probably owns the property. After 30 years of paying rent, holding all else constant, one still owns nothing.
Our calculated repayment on a 20 year mortgage with a 300k down payment on the estimated CV of this house: $1370 NZD pw
Yep!
Beijing is a good example of a place where rents are way lower than sale prices, so you can totally wind up paying $1000/month to rent something that is on the market for $1 million.
I have a fixed 15 year loan at 2.75%, which seems like a pretty good deal to me. Know where I can borrow a few hundred thou at 1%?
Yes, sometimes buying makes sense, but sometimes renting makes sense as well.
Assuming we pay the same for mortgage and rent, who wouldn't want to pay rather mortgage?
But remember, to pay the same, there was a huge downpayment. If you were to invest that rationally, long term returns could be worth it, even while paying rent.
OTOH, rational investing (in a balanced fund portfolio) is hard, and mortgage forces you to save.
YMMV, do your math.
And then I definitely want to own my house before brexit, as an immigrant I will not risk not being able to rent if things go tits up.
Nothing except all the money saved on property taxes, maintenance and repairs, home insurance, etc. And, as another poster noted, this assumes mortgage payments similar to rental prices. The math on home ownership is not a slam dunk in favor of owning in every region and should be considered carefully.
Leverage to the hilt, get a million-dollar home, keep it for three years, pocket a cool 500k.
Obviously this time it's different, and housing shall continue it's spectacular bull run forever.
Populations are migrating to cities en masse, which creates huge demand for city housing. And most cities haven't really been keeping up with the supply side since the 1930s or so.
How so? Subprime mortgages were largely not sold to government entities, but to private investors as CDOs. And government banking regulations about investing in low income communities never required making subprime loans.