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Comment by joshhart | Hacker News Reader

There were a lot of signs that we were in a housing bubble. Why is it difficult to understand that subprime mortgages + leveraging & rampant house flipping created inflated, unsustainable prices?

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Bubbles are inevitable. The United States experienced a huge one less than ten years ago in the equity markets. The bubble isn't the crisis, leverage is the crisis. The real lesson from the events of the last two years is not that you have to keep bubbles from happening because you can't. The real lesson is that you have to protect yourself from the consequences of a bubble by avoiding excessive leverage. The last bubble wasn't so damaging to the financial system because there are strict regulatory limits placed on the amount of leverage that you can use in equity investing.

I think leverage made the difference - but at the same time, leverage ratios of European banks are significantly greater than that of US banks. There are others who have also said that it was the bubble in excess capital/credit which made the difference between this one and the tech / real estate bubbles of the past. This excess capital was caused by a number of factors that included the USD as a reserve currency (which is why those like Stiglitz now think that a move away from this is a good thing - though this is happening because of the massive borrowing by the current US Administration) and prolonged low interest rates by the Federal Reserve,

I think the Europeans have problems just as bad as the Americans, but it looks different because of national organization. Most of the problems in America are in California, Florida, and Nevada. If these were separate countries rather than separate states, then the situations would look more similar with some having crushing problems (like Iceland and Britain) and others seeming relatively unscathed locally but affected by the global nature of the downturn. European banks have taken a huge beating, and there have been multiple bailouts. I also consider it likely that there are still unacknowledged problems in other banks that seem healthy so far. The pain filters down more readily to average Americans and Brits because they were the ones borrowing money for houses they couldn't afford and because continental political systems have stronger social support systems. I expect that it will likely take the European economies longer to recover than the Americans unless the US government borrows so much money that it starts to affect its de-facto credit rating.

Not many people bought houses they couldn't afford in the UK. We haven't had huge numbers of repossessions in the UK (fewer than the 1991 recesssion so far). Our banks were more exposed to the american housing market (than europes), and banking is a large part of our economy so we get hit worse when it goes down the tubes.

Perhaps leverage limits on home mortgages are in order? It would cause prices to fall, but the coming inflation could balance things out.

There used to be a bit of a leverage limit as anyone paying less than 20% was required to buy PMI. Somehow taking out a 80% loan and a second loan allowed people to work around this, or in some cases the lender was paying the PMI. In any case, one would have thought that the negative effects to the lenders would have been mitigated by PMI, but it seems to not be playing a role in the unraveling...

PMI only works when a small number of people default at any one time. I would even suggest that PMI makes the system less stable when markets collapse. I suspect that people tend to push the edges of any stable system so structures like PMI don't really help things all that much.

PMI is just a method of moving risk around the system, it's still there, but it does not look like the bank is taking the risk. However people selling PMI know that they will be bankrupted if X percent of mortgages fail at the same time. (AIG) At which point the person / group holding the mortgage get's the rest of the risk.

PS: PMI is part of the derivative market and a large part of why all those bad loans where written.

I don't think you are right to connect AIG financial derivatives trades with this, buyer purchased PMI is very different from CDS. Most of the major providers don't seem to be bankrupt (MGIC, Genworth, RMIC, etc.). It would seem that this should have protected the banks, unless they were buying coverage for less than the loan amount. http://www.nytimes.com/2009/03/01/realestate/01Mort.html

I think a key problem is that people were avoiding paying the PMI by getting piggyback loans, since the interest was deductible. However, the piggyback loans had greatly increased risk, particularly as they were subordinated to the 80% loans.

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