Quote:Credit default swaps (uncovered insurance instruments) collateralized debt obligations mortgage backed securities and a whole long list of products the average person never heard of.


The adjustable rate mortgage was invented for qualified buyers in the inordinate rate environment of the 80s that had no choice but to have rates come down over time. It was never intended for no doc no incone loans in a rate environment that had no choice but to go up over time.


The government decided that housing shouldnt be subject to market forces. Math will out.


In order to increase leverage and fund the more COMPASSIONATE view of housing wall st invented all the cool economic wmd listed above.

 

This is definitely part of the story.  This is part of the Wall Street greed.  However, this also created several other layers that added to the problem (predatory lending, bad loans, etc.).

 

 

Quote:There's plenty of blame to go around to the government, wall street, and general population.

 

Absolutely.  I was just curious to see where the blame is placed from ordinary people.

 

Here is my TL/DR view of what happened.  There are actually more details, but this is the biggest reason for the whole mess (in my opinion).  People and companies were taking on more debt than they could afford.  Much of that debt wasn't backed by any tangible collateral.  No one party can take the sole blame for the mess... both had their hands in it.

 

Part of the story begins in the 1990's with the run up and boom of the "dot com bubble".  People were making money on "virtual product" that had no tangible value.  It was also the time when the so-called payday lenders, check cashers and auto title loan business started popping up.  Government stepped in and tried to regulate the industry as well as convince banks to make loans to people with "less than ideal" credit, and was the birth of the sub-prime loan.

 

Also during that time frame, Bill Clinton signed into law the Financial Services Modernization Act.  In essence, this bill allowed investment banks, traditional banks and insurance companies to merge (this was originally prohibited by the Glass-Steagall Act which was repealed).

 

2000 - 2008

A lot happened during this time frame.  The first thing to note is the Commodity Futures Modernization Act signed into law by Bill Clinton.  In a nutshell, what this law does is enable the creation of certain "securities" by the investment banks, notably Credit Default Swaps (CDS) and Collateralized Debt Obligation (CDO's).  Essentially what these are.  A CDO  could be a bundle of mortgage loans put together to form a sort-of "bond" on the stock market backed by the property of these loans.  Property values at the time were increasing, so these were determined to be "safe" investments by the rating agencies (Standard & Poor, Moody's, etc.).  Credit Default Swaps on the other hand are basically "insurance" against a loan, or group of loans.  As a simple example, say a loan is made to purchase a $100,000 home.  A CDS would basically be "insurance" on the loan, and would cost a premium of say 10% per year for 5 years.  So if you bought a CDS on the loan it would cost $10,000 per year for 5 years.  If during that time frame the loan defaults, you get $100,000.  If it doesn't default, then you lose $50,000 after 5 years.  This comes into play later on.

 

After the attacks on 9/11/2001 Alan Greenspan started lowering interest rates to the point where it was down to 1% in 2004.  What this meant was saving cash in the bank yielded very little interest, and it also meant that loans were dirt cheap.  That meant anything from financing a car, home or anything else was very easy.  It also meant that people started getting loans worth far more than their ability to repay those loans.  Home prices started to sky rocket and some people decided to get into real estate, thus the birth of the "home flipper".  Buy a home with an adjustable interest rate, often a "teaser" rate of 1 or 2% or maybe no interest for the first 3-5 years on a mortgage, then turn around and sell the house after 2 years after it (artificially) appreciated and make a profit.  Rinse and repeat.

 

What also happened was that Wall Street was eager to buy mortgages in order to package them up into CDO's because it was a hot commodity.  That encouraged many mortgage brokers that had sprung up that would "loan" money to anyone with a pulse.  The ink wouldn't even by dry on the contract when they sold the mortgage to a Wall Street brokerage that would turn around, package a group of mortgages into a CDO then sell them to investment banks worldwide.

 

With that kind of action, it drove real estate prices higher at a much faster rate that wasn't sustainable.   However, people were making money "flipping" homes and investment banks were making money selling CDO's.  At that point a few people saw what was happening and asked for a CDS against some of these CDO's that were selling on Wall Street world-wide.  Many investment banks were oh-so-willing to create and sell these CDS's thinking that it was a "fool's bet".  One investment bank in particular, Lehman Brothers (along with many others) were dealing in both and would eventually collapse.

 

Once real estate sales slowed down and people stuck in adjustable rate mortgages had to pay the higher rate couldn't afford the payments, the defaults on loans started rolling in.

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