The conduit, the market for securitization, through which mortgages and other debts are packaged and sold as securities, has become sclerotic and almost totally dependent on government support. The problems, intensified by bond investors who have grown leery of these instruments, have been a drag on the economy and have persisted despite the exercise of extraordinary regulatory powers by policy makers.
"The mortgage finance system in the United States has been badly damaged," said Anthony Lembke, co-head of investments at MKP Capital Management, a hedge fund firm that is a big investor in mortgages. "There is definitely some reinvention that will need to occur, and that will include some explicit involvement by the government."
Bond investors first stopped buying private home mortgage deals, then shunned commercial mortgages. Now, they are becoming wary of credit card debts and auto loans. In the first half, private securitizations reached just $131 billion, down sharply from $1 trillion in the same period last year, according to data compiled by Thomson Reuters.
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There have been reports for a month or so of students having trouble getting private loans, mostly for things like trade school. And of course, mortgage credit has been tight for a while. An article in today's New York Times sketches just how widespread the collapse in securitization is:
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What will happen when the student loan industry needs a bail-out?
I've been confused all along by the mortgage mess; Megan, if you wouldn't mind, I'd appreciate a post on it, particularly what people were thinking. I don't understand how it got as big and nasty as it did, honestly. Or if it's just hype at this point, trying to milk the Feds for everything they can get.
All along, there've been pieces that seem to be just accepted as true, that I don't understand. First, it was the idea that mortgage fraud, liar's loans, and so on were both common and no one was worried about them. Why didn't the investors crack down on the brokers, or the banks crack down on them, or something? For that matter, why were people ok with no down payments, interest only loans, and so on?
Second, I don't understand the concept of 'too big to fail'. What are the dire consequences of, say, Bear Stearns going completely bankrupt? Or, for that matter, of Freddie and Fannie going bankrupt? Wouldn't that just mean that banks would have to go back to the old policies of holding their own loans, maybe interest rates go up a percent or two? Or new firms would have to form to take their place, with a greater degree of auditing and more honest brokers and such? Does it just mean that companies that can afford to contribute a lot to the politicians get bailouts?
Third, why is everyone so panicked about this? They went from totally convinced that nothing could go wrong in the mortgage market to believing that the world's going to end, when as far as I can see, foreclosures went from 0 to 20 percent, and foreclosures don't even lose the whole value of the loan, so the mortgage holder probably only lost 5-10% of their investment? And the structure of the CDO's, with their tranches and such meant that they didn't even lose that much.
All in all, it seems to me that what happened was someone invented CDO's, they seemed to be risk free for a while, for some reason the entire market jumped into them, and then they discovered that there was in fact a minor risk, and the entire market decided to jump back out. What am I missing? I thought bankers were rational people, but this sounds more like the behavior of a bunch of three year olds.
This is the sort of thing that makes me wonder if market failure might actually be real, honestly, even in the absence of externalities. How can an entire industry, whose main purpose for being is to analyze and manage risk, blow up so badly due to small changes in the fundamental information - a small rise in the Fed rate and small decline in housing prices seems to be fundamentally all that happened, yet we hear of billions and trillions of dollars being lost.
I've been confused all along by the mortgage mess; Megan, if you wouldn't mind, I'd appreciate a post on it, particularly what people were thinking. I don't understand how it got as big and nasty as it did, honestly. Or if it's just hype at this point, trying to milk the Feds for everything they can get.
All along, there've been pieces that seem to be just accepted as true, that I don't understand. First, it was the idea that mortgage fraud, liar's loans, and so on were both common and no one was worried about them. Why didn't the investors crack down on the brokers, or the banks crack down on them, or something? For that matter, why were people ok with no down payments, interest only loans, and so on?
Second, I don't understand the concept of 'too big to fail'. What are the dire consequences of, say, Bear Stearns going completely bankrupt? Or, for that matter, of Freddie and Fannie going bankrupt? Wouldn't that just mean that banks would have to go back to the old policies of holding their own loans, maybe interest rates go up a percent or two? Or new firms would have to form to take their place, with a greater degree of auditing and more honest brokers and such? Does it just mean that companies that can afford to contribute a lot to the politicians get bailouts?
Third, why is everyone so panicked about this? They went from totally convinced that nothing could go wrong in the mortgage market to believing that the world's going to end, when as far as I can see, foreclosures went from 0 to 20 percent, and foreclosures don't even lose the whole value of the loan, so the mortgage holder probably only lost 5-10% of their investment? And the structure of the CDO's, with their tranches and such meant that they didn't even lose that much.
All in all, it seems to me that what happened was someone invented CDO's, they seemed to be risk free for a while, for some reason the entire market jumped into them, and then they discovered that there was in fact a minor risk, and the entire market decided to jump back out. What am I missing? I thought bankers were rational people, but this sounds more like the behavior of a bunch of three year olds.
This is the sort of thing that makes me wonder if market failure might actually be real, honestly, even in the absence of externalities. How can an entire industry, whose main purpose for being is to analyze and manage risk, blow up so badly due to small changes in the fundamental information - a small rise in the Fed rate and small decline in housing prices seems to be fundamentally all that happened, yet we hear of billions and trillions of dollars being lost.
David, did you miss the fact that it is an election year? The slightest problem is going to be magnified into a grave crisis so that the politicians can rescue us from those other politicians who fiddled while Rome burned, who hate children and old people, who are secret socialists and Godless atheists, or whatever,,,,,,,,,,,,,
To answer your first questions, everyone in the line is paid up front in commissions and bonuses. Brokers and Realtors get paid to close deals. They also only hire appraisers who will appraise houses at an amount that guarantees the loan is funded, they are also paid up front. Honest appraisers are blackballed from the industry. Banks get their closing costs up front, and if the house is flipped/sold they get pre-payment penalties and were able to sell the loan to an investor. Bank executives get their huge bonuses up front and don't have to pay them back if things go south. Essentially, nobody responsible for making the loan has a reason to take a long term view.
I can see, foreclosures went from 0 to 20 percent, and foreclosures don't even lose the whole value of the loan, so the mortgage holder probably only lost 5-10% of their investment?
In California, they are losing more like 40%-50% of the loan value. Since the banks are so heavily leveraged, it doesn't take that many foreclosures to wipe out all of their capital. Remember that leverage on the upside means you can double your investment with small gains, but on the downside you can lose your investment with small losses.
These losses have nothing to do with the Fed Funds rate. It has to do with banks lending people money, that had no hope of paying it back, absent double digit appreciation of home prices every year.
David -- Investors were looking for yield and originators and securitizers were happy to oblige, taking their fees and moving on, as Jordan T noted. Many investors accepted that ever-rising real estate values would cover any shortfall in initial quality. For those with reservations, multi-tranche securities provided a further illusion of protection; and the rating agencies obliged by ignoring the unpleasant odor these emitted.
I have a faint recollection of a Firesign Theater skit from long ago:
As for too-big-to-fail, the problem is that Bear Stearns, for example, was counterparty (i.e., either committed to deliver something or pay for said delivery on some future date) in millions of deals. If they went bankrupt, all those deals would be frozen, and all the other counterparties would be stuck with illiquid instruments while the courts slowly tried to unravel the mess. That scares the Hell out of everyone.
ooh, this seems like a key point to reinforce for those of us laymen trying to understand "what's the gigantic deal about a 5-10% drop here and there?"
And I assume his comment about 5-10% wasn't saying that the default was only a 5-10% loss, but rather that a 50% loss on 20% of their business represents only a 5-10% loss for the business.
And I assume his comment about 5-10% wasn't saying that the default was only a 5-10% loss, but rather that a 50% loss on 20% of their business represents only a 5-10% loss for the business.
I see now, he was talking about banks losing 10% of their investment. The problem is banks try to keep their leverage around 1:10. If you're leveraged 1:10 then a 10% loss of the total value of the investment results in a 100% loss of the money you invested.
So it all comes down to leverage turning investments that would otherwise be -5% to +15% into -100% to +300%? And apparently Bear Stearns bet more than the value of their business on just CDO's, through leverage?