Foreclosure-abuse settlement reached with major banks

[Deleted]

From what I remember and someone with more knowledge help me out but in most of these cases the banks would resell the mortgage to someone else. I would have to think they got their full amount bank so yes I do think they made out like bandits. It sure as hell wasn't the homeowner that made out like a bandit.

Homeowners got to live like kings for a while, as their real estate value increased annually by double digit percentages. Reality did catch up to them, as it caught up to the banks, the illusion was over.

One of my favorite scenes from the movie "Margin Call" about the mortgages:

[Badpaladin]

It's also a bit more complex than that.

Investment banks took these horrible mortgages (that couldn't be realistically repaid) and bundled them into packages to sell to investors. Banking groups took part in credit default swap betting, making a very lucrative "business" out of it from simple scheming to flat out lying (telling investors that bad investments were actually high quality), and they were allowed to do so because there was a fucking explosion of rating agencies that could be referenced. So yes, a small group of people absolutely made bank out of this situation. And the hilarious part is our Government didn't do a thing to keep this from happening, then turned right back around and bailed them out when it crashed and burned. This doesn't even really begin to touch the surface of what happened.

It's a hairy situation. Should we blame people for taking offers they couldn't pay, or the institutions that gave these offers to said people? Should we blame the banking groups and investment banks? Should we blame the Government who allowed this to happen, and then bailed out these collectives?

[Archangel Tyrael]

That's (one of) the main reasons the economy fucking flopped -- it really wasn't required.

http://en.wikipedia.org/wiki/Subprime_mortgage_crisis

uh oh >_<

well... thanks for that article Pala, it's really helpful. And i never thought it wouldn't be required (back then) to prove it... Crazy stuff !

[Deleted]

It's also a bit more complex than that.

Investment banks took these horrible mortgages (that couldn't be realistically repaid) and bundled them into packages to sell to investors. Banking groups took part in credit default swap betting, making a very lucrative "business" out of it from simple scheming to flat out lying (telling investors that bad investments were actually high quality), and they were allowed to do so because there was a fucking explosion of rating agencies that could be referenced. So yes, a small group of people absolutely made bank out of this situation. And the hilarious part is our Government didn't do a thing to keep this from happening, then turned right back around and bailed them out when it crashed and burned. This doesn't even really begin to touch the surface of what happened.

That's a really meager explaination of why it happened. Your explaination sort of gives us insight into why some financials crashed, but not why and how the bubble was created.

Banks have been able to engage in that sort of activity for decades. They could have created these shady MBS bundles at any time before. Why did this suddenly become a problem?

The answer lies in US government housing policy. Their objective was to increase homeownership in the US, especially among those who could not get a mortgage. Their policy was thus to somehow provide mortgages to people who could not normally recieve them from banks for various reasons. So the HUD used its power over GSE's Fannie Mae and Freddie Mac, as well as the Federal Housing administration and Subrime Mortgage lenders to encourage greater subrime and other high risk lending. The GSE's were government backed so they could take on incredibly risk as the taxpayer would be ultimately on the hook anyway. Furthermore the newly empowered Community Reinvestment Act forced lenders to lend to persons who they normally would not lend to due to higher risk.

A very low Federal Funds Rate (1%, set by the Federal Reserve) in the early 00's fueled borrowing and pushed investors seeking higher returns into buying these packaged mortgages.

So the banks were pushed by the government to lend to people who could not have afforded loans under normal circumstances. Alan Greenspan assured the markets and the banks that he would save the day if things got hairy, by providing liquidity and keeping low interest rates. The "Greenspan put" created an athmosphere of moral hazard, which pushed risk taking even further.

In the end of the day, it was a classic government policy created bubble. The reason the financials were so hard hit though, was due to shadow banking and other issues of risk management (thanks Greenspan), which destabilized the system but didn't cause the housing bubble.

[Archangel Tyrael]

That's a really meager explaination of why it happened. Your explaination sort of gives us insight into why some financials crashed, but not why and how the bubble was created.

Banks have been able to engage in that sort of activity for decades. They could have created these shady MBS bundles at any time before. Why did this suddenly become a problem?

The answer lies in US government housing policy. Their objective was to increase homeownership in the US, especially among those who could not get a mortgage. Their policy was thus to somehow provide mortgages to people who could not normally recieve them from banks for various reasons. So the HUD used its power over GSE's Fannie Mae and Freddie Mac, as well as the Federal Housing administration and Subrime Mortgage lenders to encourage greater subrime and other high risk lending. The GSE's were government backed so they could take on incredibly risk as the taxpayer would be ultimately on the hook anyway. Furthermore the newly empowered Community Reinvestment Act forced lenders to lend to persons who they normally would not lend to due to higher risk.

A very low Federal Funds Rate (1%, set by the Federal Reserve) in the early 00's fueled borrowing and pushed investors seeking higher returns into buying these packaged mortgages.

So the banks were pushed by the government to lend to people who could not have afforded loans under normal circumstances. Alan Greenspan assured the markets and the banks that he would save the day if things got hairy, by providing liquidity and keeping low interest rates. The "Greenspan put" created an athmosphere of moral hazard, which pushed risk taking even further.

In the end of the day, it was a classic government policy created bubble. The reason the financials were so hard hit though, was due to shadow banking and other issues of risk management (thanks Greenspan), which destabilized the system but didn't cause the housing bubble.

Is that on a federal level? Every state ''had to accept'' that? Sorry i don't quite understand how things happen in the US.

[Badpaladin]

In the end of the day, it was a classic government policy created bubble. The reason the financials were so hard hit though, was due to shadow banking and other issues of risk management (thanks Greenspan), which destabilized the system but didn't cause the housing bubble.

I consider it an instance of crony capitalism rather than just bad government. Banking Groups and the Government at the time had established a clear relationship such that this could be allowed to happen. While banks have been able to "bundle and bet" against mortgages at the investor's behalf before, it was never to an extent that this was. The massive sums of money they were able to rake in because of this is precisely what drove the housing bubble up and up. Borrowed money was far surpassing a bank's own assets because CDO's were increasingly being backed by subprime mortgages, which kept increasing because of the insane market in betting against these CDO's. Perfect case of a snowball rolling down a hill.

This sort of stuff is what the federal government is supposed to suppress, or rather regulate effectively and not have some schlub (Greenspan) get up on a pedestal and tell everybody it's alright.

[Laize]

It's also a bit more complex than that.

Investment banks took these horrible mortgages (that couldn't be realistically repaid) and bundled them into packages to sell to investors. Banking groups took part in credit default swap betting, making a very lucrative "business" out of it from simple scheming to flat out lying (telling investors that bad investments were actually high quality), and they were allowed to do so because there was a fucking explosion of rating agencies that could be referenced. So yes, a small group of people absolutely made bank out of this situation. And the hilarious part is our Government didn't do a thing to keep this from happening, then turned right back around and bailed them out when it crashed and burned. This doesn't even really begin to touch the surface of what happened.

It's a hairy situation. Should we blame people for taking offers they couldn't pay, or the institutions that gave these offers to said people? Should we blame the banking groups and investment banks? Should we blame the Government who allowed this to happen, and then bailed out these collectives?

To understand the complexity of what happened, some background in finance is necessary.

You are mostly accurate except for a few details.

It wasn't the investment banks that bundled the mortgages into Mortgage Backed Securities/MBSs for short (Also called Collateralized Debt Obligations or CDOs for short). Fannie Mae and Freddie Mac did that.

A few reasons for this. Fannie and Freddie made money one of 2 ways.

1) Fannie and Freddie would purchase mortgages from banks to free up bank capital (Which was otherwise tied up in holding these mortgages) to re-lend out to prospective homeowners. The government's goal with this was to make housing funding available for every American (Fannie and Freddie are government sponsored enterprises). They would then bundle the mortgages into securities for further resale called a Mortgage Backed Security (MBS for short). Combined, the idea was that a pool of mortgages was less risky than an individual mortgage itself. Thus they could make money reselling the pool by mitigating risk. (There were other things that got Standard&Poors and Moody's involved called tranches, but their involvement was purely incidental. It did nothing to really cause the collapse).

2) They would sell guarantees on mortgages of a certain quality. Something like insurance, the guarantee was a government backing of a loan meeting their approval.

What happened next was, again, not the cause of the housing collapse, but what caused the collapse of major investment banking and insurance firms. In order to understand it, one must have a basic comprehension of derivatives.

A derivative is a new security created from thin air whose performance is directly tied to another security (Called the "underlying"). If I make a contract with you to buy 100 shares of Apple for $600/share and that contract is good for 3 years, we have just created a derivative. The value of the contract (called an "option" in market parlance) is directly tied to the value of Apple's stock. If the stock goes up, the value of the contract goes up. If Apple stock goes down, the value of the contract goes down.

The nature of derivatives is zero-sum. Since they are created from thin air and have expiration dates, they will eventually cease to be. The net effect of this is that for every $1 a party makes on a given derivative, another party will lose $1.

If I'm losing you feel free to ask questions.

Investment banking firms have a job that is completely unlike a standard bank you and I use. It's a wonder they're even called "banks". Their job is to come up with "financial products" that provide innovative ways for people and corporations to invest (they do other things, but for this post, pretend they don't).

What the investment banking firms found was that there were many holders of Mortgage Backed Securities who wanted to protect ("hedge") against a decline in value of their securities. Years earlier due to (I believe) the Exxon Valdez oil spill, investment banks had come up with a product called a Credit Default Swap. What this essentially was was insurance against a debt being defaulted on. The CDS' primary purpose was as follows.

1) Party A wants to hedge against a debt they hold being defaulted on.

2) Party B wants a way to make money without actually doing anything actively.

3) Investment bank joins these 2 people together and suggests a Credit Default Swap. They agree.

4) Party A (The "short party ") will pay Party B (The "long party") a percentage of the underlying debt's principal every quarter (3 months). If the cost to insure the debt is 5 basis points (0.05% in regular people speak), then it costs $500 for every $1,000,000 of debt being insured.

5) If the debt never defaults, Party B gets to keep the premiums paid to it.

6) If the debt DOES default, Party B must pay an amount enumerated in the contract. It still gets to keep the premiums, but the payout they must dole out is far greater than the premiums will return.

What wound up happening is that large investors got ahold of these CDSs and began using them "Naked". That is to say, they were purchasing CDSs tied to the mortgage market without holding any mortgages or mortgage backed securities.

Firms such as John Paulson's saw the housing crash coming and purchased tremendous numbers of credit default swaps. Other firms who thought the housing market would continue going up were more than happy to jump on board with a (what they considered to be) free gravy train of premiums every quarter. Instead what happened was that the housing market crashed and these firms found themselves on the hook for billions upon billions of dollars in payments to their counterparties. Firms like AIG who had bet wrongly that the housing market would continue its upward trend found themselves with severe liquidity crises (Which meant they still had positive equity, but it's tied up in long term or illiquid investments such as real estate) when their counterparties demand more collateral/cash be put up or held in reserve to ensure their payments are safe) and could not meet their obligations. These firms were forced to declare bankruptcy.

[Grummgug]

There's so much finger-pointing and lies about what happened that everybody in congress at the time the bubble burst should be held accountable as well.

[Deleted]

I consider it an instance of crony capitalism rather than just bad government.

Crony capitalism and bad government go hand in hand.