Now, we are going to talk about something that you already know and suffered, probably until now, it was a financial earthquake that cost the world tens of trillions of dollars, 30 million jobs around the world, and doubled the US national debt, that is "The 2008 Financial Crisis". But why did this happened, why nobody said anything, why couldn't moody's, Finch or anyone warned us about all that crap that we had coming?. Ok let's start by reviewing what is a mortgage.
So, What is a Mortgage?
IF someone wants to buy a house, often will borrow hundreds of thousands of dollars from a bank. In return, the bank gets a piece of paper called "mortgage". This means that the homeowner has to pay every month a pre-established amount of money that consist, part of the principal, and part accrued interests. If for some reason you don't pay, it is called a default, which is when a debtor is unable to meet the legal obligation of debt repayment, in this case, to "whoever" holds the mortgage, and it is a big ass "whoever" because the original lender often sells the mortgage to some 3rd party, if you own a house, you know what I am saying, because different financial institutions have or have had your mortgage and you have noticed it, and looking back, it was traditionally very hard, or almost impossible to get a mortgage if you had bad credit or did not have a steady job, because banks were just not ready to take the risk that you might default on your loan. But at the beginning of the XXI century, that started to change.
How did Everithing Start?
In the 2000's, everyone (I mean, the banks, US government and abroad) was looking for a low-risk, high return investment, so everyone started to throw money at the US housing market. The plan was to get a better return on the interest rates that the homeowners pay on mortgages instead of investing on treasury bills that pay very low interest. But the huge investors in the US and abroad, wouldn't buy one or two mortgages and deal with us as individuals, it is just too much trouble, instead, they bought investments called "Mortgage Bank Securities (MBS)" and this is created by large financial institutions that promise to "securitize" mortgages. So, MBS's consist of buying thousands of individual mortgages, bundle them together and sell shares of those bundles to investors, and investors buy this shares because they pay a lot more interests than any other low-risk inversion, looking like very safe bets because, what could go wrong? right?. For once, the home prices in the US are constantly growing, so in the worst case scenario, the borrower defaults on the mortgage, investors are still sitting in a bunch of money (our houses) that they can sell easily and turn into cash really fast and also profiting out of it. At the same time, credit rating's agencies were telling investors that this "MBS's" were rock solid investments, giving lots of these Mortgage Backed Securities AAA ratings. Now, to be fair to this, it is necessary to say that most of this AAA ratings were awarded when mortgages were given only to borrowers with good credit.
At the beginning it was, like they say, "rock solid" investments, but investors have got hungry for more and more of these securities, so lenders did their very best to help create more of them, but to create more, they were going to have to create more mortgages, and in order to do so, they had to loosen their standards and make loans to people with low income and/or poor credit history. This is called "Subprime Mortgages" and next thing you know, most institutions started to use what is called "Predatory Lending Practices" in order to generate more and more mortgages. Soon, almost every financial institution was generating loans without verifying income and offered absurd adjustable rate mortgages with payments that people could afford at first but quickly ballooned beyond their means.
This brand new subprime lending practices, although dangerous as hell, were keep of being awarded AAA ratings by all credit rating's agencies. They didn't take the time to check how loans were really granted, so as the time went by, these subprime mortgage investments became more and more dangerous and unstable, but since investors trusted the ratings and kept on pouring their money. Traders also started to sell an even more dangerous product called "Collateralized Debt Obligations (CDO)" with some of these junk were given the highest credit ratings from the rating agencies, even though they were made of these incredible risky loans.
While investors, banks, traders and everyone else were crazy, throwing money into the housing market, the price of homes in the US was going up and up, mainly because of the lax lending requirements and low-interest rates, which made the MBS's and the CDO's look like an even better investment, because, if the borrower default, the bank will still have this super valuable house, right? Well, no, wrong from head to tail. This is just where the problem starts.
You can call this many names but the one that better explains this is "bubble", yeah, it is a bubble since it is a rapid price increase driven by irrational decisions, and the worst thing about bubbles is that they have the annoying tendency to burst, and this one did, because people could no longer pay for their incredibly expensive houses, or keep up with their ballooning mortgage payments, so borrowers started defaulting, so more houses were put back on the market for sale, but they weren't any buyers left so supply was up to the top, demmand was dirt low, and the home prices started to collapse. As prices fell, some borrowers suddenly had a mortgage way more than their house was worth, some stopped paying, which led to even more defaults, therefore, pushing houses prices even lower.
As this was happening to all of us, financial institutions stopped buying subprime mortgages and subprime lenders were getting stuck with bad loans. Finally, big lenders, really big ones had declared bankruptcy by 2007.
The problem spread to the big investors that pour tons of money into this securities and CDO's and they started to lose money on their investments, but there was more. There is another financial instrument that financial institutions had on their books, that exacerbated all these problems, those are the over-the-counter, unregulated, derivatives, including the so-called, "Credit Default Swaps" which were basically sold as insurance against the default mortgages backed securities, and that is when AIG dropped to the ground by selling tens of billions of dollars worth of these insurance policies without money to back them up if things went wrong, and they did, so they broke.
Some major financial players declared bankruptcy, like Lehman Brothers, while others were forced into mergings and needed to be bailed out, like Bear Sterns. No one knew exactly how bad the financial statements of these big financial institutions were because of the complexity of these unregulated and complicated financial instruments.
Panic set in, trading and the credit market froze, the stock market crashed, and the US economy suddenly found itself in a disaster zone.
So, after the bailout program (it was actually called TARP-Troubled Assets Relief Program) the cascade of panic seems to weakening as the time passes by and in 2010, Congress passed a financial reform called the DODD-FRANK Law which took steps to increase transparency and to prevent banks from taking on so much risk by setting a consumer protection bureau to reduce predatory lending, requiere that financial derivatives to be traded in exchanges that all market participants can access and observe, and it put mechanisms in place for large banks to carry out their operations in a controlled and predictable manner.
But we seem to have a very bad memory because, as is from today, the Senate passed a bill to ease the DODD-FRANK Law on banks and that was to be expected since today's president Donald Trump promised this when he was in campaing.
Now we are getting back where everything started, on the way of another and much bigger train-wreck, so the question is. Would the world get back on its feet again? What if we learn from our mistakes. What if my friend, what if.
Check this video out, it will explain alot, I am sure that you are going to love it.
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