Let me tell you a story about how the subprime mortgage market collapsed and millions of baby boomers had to accept less money in retirement. If you liked the Da Vinci Code, you’re gonna love this one. It’s not wrapped up in sex, or murder, or corruption, just good-old fashioned “pass the buck” and “what the little guy doesn’t know won’t hurt him” attitudes.
WARNING: If you are prone to believe conspiracy theories, you are going to curse, kick the cat, and be extremely pissed off after you finish reading this.
Here is the dirty little secret of the mortgage securitization boom of the last 5-10 years: The little guy gets stung with the losses.
First, a little history lesson. It’s kind of boring but stick with me here. Mortgage backed securities (MBS) were originally the old Ginnie Mae pass-through certificates. The VA or FHA packaged up their loans and sold them through Wall Street to little old ladies who wanted to “juice up the yield” on their portfolio. They were safe because they were backed by a government agency. They yielded more than treasuries because they were a conglomeration of various mortgages. The money was loaned at, oh… 14% (remember the early 80′s ?) and the investors received, say…12%. It was a good deal because the little old lady could only get 9% on Certificates of Deposit. The difference was spread among loan servicers, Wall Street, and even the gub-a-mint agency by employing this securitization tactic.
The problem was that loan principal was returned, along with the interest, on the old Ginnie Mae pass-throughs. Little old ladies didn’t care because they weren’t going to live long enough to spend all of their money (these were 30 year issues). However, Wall Street had problems selling these deals in bulk to institutions because of the prepayment features.
An ambitious mail-room clerk named Lew Ranieri worked at Salomon Brothers and saw an opportunity in the mid 80s. Salomon Brothers was hiring rocket scientists to create a new breed of mortgage-backed security, a collateralized mortgage obligation (CMO), designed to more accurately predict the prepayment speed of the mortgages backing the bonds they sold. Lucky Lew ran around the country preaching God, motherhood, baseball, and a CMO in every portfolio. Lew convinced the WORLD investment community that the American homeowner was a damn good bet.
It worked ! The American homeowner was a damn good bet. The MBS market boomed and the rocket scientists found a way to make more money selling derivative products that only they understood. All was well until some punk MBS salesman at Merrill Lynch (relax, I was one of them) convinced the Orange County, CA Treasurer to roll the dice with the county’s money on derivatives. The market moved against him and one of America’s wealthiest counties declared bankruptcy.
ARE YOU STILL AWAKE ? Good! Here’s where it gets juicy.
Fast forward to 2001. A little mortgage broker from New York grew into one of the largest lenders; Countrywide. He, among others, understood the power of the MBS market and started designing new mortgage products. He, among others, understood that if you loosened the guidelines a LITTLE BIT, you could add one quarter to one half percent to the rate and whet the appetite Wall Street had for yield. Something was about to happen that would have the Wall Street Titans begging the little mortgage broker for more mortgages with the guidelines loosened just a LITTLE BIT.
Two planes crashed into some big buildings in Lower Manhattan and the world as we knew it ended.
Fearing a global liquidity crisis, Alan Greenspan started the process of easing interest rates down to their lowest level in over 40 years. Mortgage rates, and their subsequent MBS yields, dropped like a ball off a table. The Titans of Wall Street were now beyond begging the little mortgage broker for loans with guidelines loosened just a LITTLE BIT; they told him to lend money to anyone who could fog a mirror. The Wall Street rocket scientists (remember them?) felt that housing prices were about to take off. If they were wrong, no big deal…because….(now here’s the part where you get pissed off and start throwing stuff at the computer…)
Wall Street was selling these MBS to pension funds and mutual funds. The little old ladies didn’t own these mortgages anymore, it was you and your company’s retirement money. Basically, the Titans of Wall Street never had to answer for the performance of these loans because the money managers wanted that last little bit of yield the risky or exotic mortgages produced. The rising housing market would disguise the loose guidelines (defaults would just be refinanced) and everyone would make their little golden crumbs as the vanishing loaf was buried deep in the breadbox. If that wasn’t enough, the lenders would buy securities firms and the securities firms would buy lenders, all of them buying time before the cat got out of the bag.
Then Alan Greenspan raised interest rates and all hell broke out. Rapid growth in housing arrested and the refinance boom stopped. Alas, the lenders and Wall Street Titans kept the easy money machine flowing. Think about it, it wasn’t their money, it is yours…so why close the bar tab if you never intend to pay it ?
Now…here is the part where you should be infuriated but don’t have to be… This crap has been buried in so many funds that it won’t have too much of a lasting effect. The debacle that we read about will be paid for by you, Mr. and Mrs. America with the $57,254 balance in your IRA account. And it is going to hurt you, probably to the tune of two or three grand. That means these HUGE default rates we read about MAY lower your IRA balance to $54,819 next year. If you’re 50 years old, it means that the monthly check you draw from that IRA when you are 70 years old WILL be some 38 bucks lighter because of this mess.
DO YOU REALLY WANT TO GET ALL WORKED UP FOR A LOUSY THIRTY-EIGHT BUCKS A MONTH WHEN YOU’RE SEVENTY?
Oh, shit ! I’m starting to sound like one of them !
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