[Instead of simply complaining about who does not "get it" I've decided to explain my reasoning behind who the real culprits are for our current financial situation. I originally planned to make it one big post, but it was becoming unwieldy, so I've decided to break it up. Please enjoy and feel free to comment]
A review of the press surrounding the current economic woes will reveal a bevy of culprits. Borrowers are at fault for either buying houses that they cannot afford, lying on their loan applications, or speculating on the housing market. Mortgage brokers are at fault for selling loans to people that could not afford the loans, and offering "teaser rates" that did nothing but get the borrowers in trouble. Underwriters are at fault for actually writing the loans, and ignoring traditional industry guidelines regarding "low" down payment loans. Fannie and Freddie Mac are at fault for suborning this behavior by purchasing many of these "bad" loans. The "big" banks are at fault for creating new financial instruments out of these loans and then foisting them off on unsuspecting investors (including other "big" banks). The SEC is at fault for ignoring the whole thing (among many other crimes during this process).
And so it comes to pass that whatever your bias is, you can find someone to blame for the "credit mess". Conservatives blame the individual, and liberals can blame either the government for not doing its job, or the "evil" corporations that allowed this to happen. However, in order to get a clearer idea of where the blame actually belongs, we need to take a close look at how the process worked. While intelligent people can differ in opinion, it is simply not possible for any one of the failings stated above to have created the mess that we are in. In fact given the way the markets work, theoretically all of those things could have happened and we would not be in the condition we are in today. What I will do here is follow the loan though its life and show where things went wrong.
Let's say it's June of 2006 and Mr. and Mrs. Jones, who are newlyweds, decide to buy a new home. They have good credit, but they are a little light on cash for a down payment. They have already been turned down for a "traditional" fixed mortgage because they don't have the money for a down payment, and the PMI (private mortgage insurance) would put the payment out of their reach. "No worries," says their mortgage consultant, "we can get you into that house." They happily agree and then close on their house. They end up with two loans. The first loan is a 30 year fixed interest loan for 80% of the value of the house. Their second loan, which is actually an equity loan is a 5/1 interest only adjustable rate mortgage (ARM), and they've got a great rate of 2.9%! The ARM will go up in 5 years to "normal" rates, but their mortgage consultant explains that by simply making larger payments, against that loan, "it shouldn't be a problem five years from now." They can also refinance the whole thing under one loan in five years, which should not be a problem given housing prices of late. Also, if they really have problems making the payments, they can always, sell, after all the way housing prices have been going for the last several years, they are certain to be able to turn a profit and get out of their house with a nice gain. This is a sub-prime loan.
To summarize: The Jones' have a house they really like, but they have to stretch to afford it. They are comfortable with this as they have seen that the housing market has been doing nothing but going up for years. They are comfortable that when their ARM comes due for an increase, they will be able to work it out.
So now that they Jones' are happy homeowners, they pay their mortgage to their underwriter, ACME corp. This income stream combined with all of the other mortgages they have issued represents a pretty nice income stream. The only problem is that ACME won't see its profit for many years, and the CEO is under pressure to grow the business today. So he puts together a group of mortgages, including the Jones' note and sells it to a secondary lender, Big Bank. Big Bank is happy to have the income. Plus, Big Bank has other things it can do with this mortgage to make more money.
[End Part One]
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