I don't fully understand the mortgage lending problem going on. Can someone explain it to me or send me a link explaining it?
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read the news.
I do read the news but I didn't really understand the magnitude right away so I didn't pay that much attention. I'm still not clear on what precipitated the whole thing...why did Bear's funds blow up when they did and was the rest just like dominoes?
rising interest rates and poorly underwritten mortgages = greater consumer defaults than expected by models...increased mark-to-market losses causing collateral calls...flight to quality seizes up all extension of credit and levered funds lack liquidity to meet collateral demands
I'll try to somewhat map out the process for you, and the reason for the current crisis.
Mom and Pop walk into their local bank and take out a $250k mortgage to buy a home. That mortgage, along with thousands of others, are packaged together and securitized. Then this pool of cash is divided up into "tranches" based on the creditworthiness of the borrower and the likelihood that it will be repaid. Interest payment rates are assigned based on thie credit risk (and a variety of other factors we won't get into) This is a "mortgage backed security". These securities are then sold to investors, hedge funds, etcetera.
The models used to calculate repayment percentages and default percentages are very complicated proprietary models that vary from bank to bank and fund to fund.
The problem now is that none of these models took into account the fact that alot of these alternative and subprime mortgages would get defaulted on. People don't pay the mortgages, there is no money to make interest payments to investors, and the bonds go belly up.
People are now freaking out about how exactly to value these bonds, because they are "illiquid" and dont trade much. It is hard to tell which bonds comprise which mortages, etc. etc.
Because of these fears, banks that loaned money to hedge funds that "levered up" to increase their returns are making margin calls, forcing the hedge funds to sell at a loss, because other investors dont know just how bad things are going to get. The market is very tight now, nobody is buying debt for fear of a blowup, so even creditworthy companies are having to pull debt offerings.
I tried to make this a general summary, let me know if anyone has questions, or if i made a mess of things in my hurry to type this.
Sometimes, it's amazing to think there are folks that literally were working in the realm of finance around catastrophic global events like the 2008 financial crisis and had the visibility to see and foresight to understand how bad things had gotten.
These digital artifacts in themselves may need to be preserved in some form in the future for the aftermath of the current catastrophes and economic repercussions (Russia vs. Ukraine war, COVID-19 post-affects).
prepayment and default models are not complicated...they are simple step functions that have linear trends between important mortgage duration cutoffs (i.e. 24, 36, 60 months...time periods that ARMs reset)...the models used by BBs and ratings agencies were not pessimistic enough...downgrades will sweep MBS bonds and make the overall credit market more difficult, which effects all parts of the economy
@matty200
Nope i think you got it about right. Good summary.
thanks matty200. so is the problem with the model or the lenders or the borrowers or what?
I think there's a few points being missed here, specifically what happened before these loans were securitized..
The main problem was that Wall Street's thirst for structured products, coupled with low interest rates, gave these mortgage companies ridiculous incentive to originate a loan for whoever they possibly could - by any means necessary. We're talking major fraud here - overly aggressive lending tactics (everything from no-doc loans to forging information on loan applications to misinforming borrowers about the nature of the mortgage to selling people on HEL loans or refinancing they didn't really need). Needless to say, the many of these companies are now out of business.
Of course, as long as home prices were appreciating and interest rates were low, none of this was a problem - if someone was being stressed, they could just sell their home at a profit or refinance at a low rate. However, with the Fed raising rates over the last few years and oversupply and overspeculation in the housing market, the two safety nets dissapeared. Now, the other side is taking over. Resets on ARMs, job loss, depreciation, over-leverage - many things are forcing borrowers - and NOT just subprime - to miss payments. This is SLOWLY starting to flow through the securizations and CDOs, but I think there's a lot to go. Many of the 2006 mortgages (the most fraudulent batch) have yet to reset, and there actually haven't been many actual foreclorues yet - just delinquencies. I have a feeling things are poised to get a lot worse.
the problem lies with everyone. you had borrowers inflating their incomes (i think i read about 50% of borrowers in california inflated their incomes by 50% or more....). lenders were being really aggressive and underwriting wasn't done properly at all; credit was flowing and if you didn't sign the deal, plenty of other shops would. the models definitely weren't pessimistic enough in a lot of cases and people weren't being realistic about the amount of risk they were taking on for such low premiums (that's the spreads you hear about widening now, people are wisening up and now demanding a higher premium to finance what could potentially be uber-risky debt)
most of the delinquencies and defaults have been confined to residential mortgages and associated products but the ripples of the whole situation are spreading through the general credit market and affecting various products. and as matty200 said, the market for these securities is pretty illiquid and that compounded with jitters and panic is a bad situation
http://www.bloomberg.com/news/marketsmag/subprime.html
Its not just the models of the banks here, but also ratings agencies that are at fault. Even though everything S&P or Moody's rates includes a disclaimer to the effect that ratings shouldn't be used as the basis for investment decisions, those companies know good and well how relied upon their ratings are.
Underlying securitization is a Milken-esque theory (a diversified portfolio of high-yield bonds will outperform a diversified portfolio of high-grade bonds), but the bottom line is that even in these AAA rated tranches, you still have poorly underwritten mortgages against consumers with poor credit history.
I think something really interesting/useful to understand why these investment grade securities are in trouble and why all of a sudden ratings are being called suspect and changed is the principle behind mortgage backed securities. Most people don't realize that even the top rated tranches are backed by the same shitty assets as the subordinated tranches. The reason they're rated higher is in the cash flow "water fall" they get paid first...but if the underwriting on the debt was too aggressive and the ratings/models too optimistic, even the senior tranches will see losses with a small amount of delinquencies/defaults. Wikipedia's got some decent articles explaining MBS/ABS and their securitization and you can easily see all the points at which things could be bungled that are now coming out of the woodwork
Well there's the credit crunch in the markets and then there's the cold reality when it hits you personally. I need to sell my property and it's been listed on the MLS for 3 weeks and in that time I've scarcely had any interest. I feel completely entangled in this subprime mortgage credit fiasco. Let me just say. THIS FUCKING SUCKS!!!!!
Sigh. That helped.
where's your place?
i'm hoping for the real estate market in nyc to tumble.
aadpepsi, I feel for you but unfortunately my family comes first.
Chicago... the RE market in Chicago has held up against other areas (e.g. California) but it's an extremely soft market and there is so much freakin' volume. I'm a landlord now and I've been losing money every month which is why I'm motivated to sell. Also, it's just been an utter nightmare to be a long distance landlord.
I had almost an hour long discussion with my realtor this morning just to discuss strategy. The realtor is doing our first open house this weekend which will be a "test" to gauge interest for the property. I'm looking at possibly having my hand forced to reduce the listing price asap by another 5-10%. I already listed it at what we think was a fairly "cheap" price!! Just totally sucks 'cuz I'm making no money off the investment at all. I totally fit the profile of the distressed Seller :-(
Jimbo... if you're waiting for NYC real estate to tumble, I think you might find yourself with pretty attractive opportunities in a few months!!! Be patient. Get cash ready.
You really think so? What makes you think it's going to tumble? NYC real estate seems pretty stable to me. I work at a company that sees a lot of real estate transactions and typically New York deals pass through with the least resistance and are allowed to be a little more aggressive than most markets. All our in-house research is suggesting a very strong market outlook so I'm curious as to what your thoughts are. (Also, we typically see commercial real estate only so I'm not too familiar with the state of anything else...but looking for a new apartment has me thinking the residential market is pretty freaking strong too)
as long as there are no significant layoffs in the financial industry...NYC will be just fine..
if there are...look out below!
I'm speaking purely from a residential real estate perspective... I admit I don't have a finger on the pulse of NYC's residential RE market, I don't live there and I'm not looking to buy there. However, I'm sure it has its own vibe due to its strong correlation with the financial industry. But I'm sure that residential real estate prices have been inflated for quite some and if the volume phenomena going on in other large cities such as Chicago, Washington, Boston etc. are any indication, an "adjustment" wouldn't be unheard of.
Yeah, I feel for me too :-(
I can't wait until this condo is sold and it's back to leisurely living... I hate being a landlord. Wasn't for me.
Next time I buy a property it'll be because I got knocked up, got married in Vegas and started a family. Ok, well maybe not so scandalous :-)
wait that was you at the Bellagio last wknd?
HA! Funny :-)
That's me, a traditional gal.
I seriously hope there's no recession, I just graduated, I deserve to get paid $150K/year at the very least let alone be jobless.
the gravy train ends here, son.
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