Thanks to SCSL for one of the very few rational descriptions of current events. Excellent summary. And I agree -90% of what you hear in the news is wrong.
A couple of additional points:
1) Not all mortgages behaved exactly according to the model. No/Low doc, 80/20 deals defaulted much faster and earlier than predicted. These 80/20 no doc loans were the initial snowball that started the avalanche rolling down the hill.
Most other products were right on pace. Make no mistake though - there is a huge database available to the quants to make models from. The models are actually extremely good.
2) Ratings agencies "leaned" on their models a bit to win deals, in response to the dealers and loan sellers that were shopping ratings. The worst job in the world is to work for one of the ratings agencies. If you are Fitch and assign higher subordination/credit enhancement levels to a deal (i.e. "I can rate only $900 million of this $1 billion pool as AAA") than your peers over at Moody's and S&P get the deal and about $2 million in fees. Obviously, there's pressure to lean on the models a bit. There's a basic conflict of interest at the ratings agencies that has to be addressed. If you earn money by rating deals, but nobody hires you to rate deals if you are too conservative, bond ratings will drift into very aggressive territory that may not be justified by the facts. AAA bonds will eventually be something less than a real AAA. That's one thing we've been seeing.
3) With some mortages going belly up faster and earlier than predicted, investors lost confidence in ratings altogether and backed away from buying those asset backed bonds.
4) That impacted my market (commercial mortgage backed securities) since if we can't rely on Moody's/Fitch's/S&P's ratings on residential MBS, why should I rely on them for commercial mortgages or anything else for that matter.
5) CDO's suffered the worst - Most CDO's (not mine - mine are backed by whole loans, not that it matters today) are backed by bonds with ratings. If you don't believe the ratings on the collateral backing the CDO bonds, why would you EVER believe the ratings on the CDO bonds????
6) For the most part, the underlying issue as SCSL says is liquidity. Subprime borrowers can't refinance because noone can get their hands on the cash to provide them a loan. If they can't refinance, and they can't afford the new rate on the mortgage when it resets, they either have to do a forced sale or default and let the bank sell it.
Summary: More than enough blame to go around. MarkP and I differ as to the Fed's responsibility here, but I think he and I both agree that there are a lot of players with some explaining to do. Wall street firms that pushed on the ratings agencies, the ratings agencies that allowed themselves to be pushed, lenders that originated loans without regard for a borrower's ability to pay at the higher adjustable rate, or lenders that just forgot good underwriting (i.e. why would you do a no doc loan for a guy that actually HAS a job and is actually able but does not want to document his income???)
And let's not forget those poor borrowers. The biggest investment of your entire life and you fail to read the section of the note or the disclosures explaining how your payment works? Or, you lie about your income so you can get the mortgage, like the extra income is going to magically appear to pay the bill?
That said, here's a few more myths.
1) The vast majority of defaults are caused by divorce and unforeseen medical expenses with job loss a distant third place. In subprime world, a fourth cause would be poor money management skills. Oddly enough, if you really wanted to fix the mortgage problem, you need to do something about healthcare. We're too rich a country to have mothers and kids without insurance.
2) Subprime lending isn't a bad thing. When I was buying these loans 10 years ago, we always expected 30% of them would default and we'd lose 40% of the loan balance on average. Having 30% of the loans default and 30% of the families on the street is a bad thing. Still that's 70% that remain in their homes that wouldn't have had the chance.
3) ARM loans and interest only loans are not necessarily a bad thing. I've had one of each. My current mortgage is interest only. I have a small salary with a larger bonus (not this year!) , so the low payment for 11 months of the year matches my income pattern and helps me manage cash better.
Happy to chat about the whole issue with anyone impacted. Also, my apologies to anyone who's in financial trouble and takes offense at my broad sweeping generalizations. As has been said, "There but for the grace of God, go I."
Regards,
BT
