The Crisis of Credit – visualized!
In my never ending quest to understand more about why we are currently in a recession and why my house is worth less than a brace of Latte’s from Starbucks, I seek insight from teh intertubes. I found such insight at the Church of the Apocalyptic Kiwi – (who were also inspirational during the presidential race, fyi)
Enjoy!
The Crisis of Credit Visualized from Jonathan Jarvis on Vimeo.
Category: American Culture, Communication, Current Events, Economy, snake oil
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I'm a technophile with an enduring interest in almost anything real or imagined. I suffer fools badly, and love trashy science fiction, plot-free action movies, playing guitar, and baking (especially scones. You haven't lived 'til you've eaten my scones. I've recently undertaken bread, and am now in danger of gaining in a matter of weeks the 60 pounds I've lost in the past 2 years). My wife & I are Scottish, living north of Atlanta, GA, with two children, one dog, and a growing collection of gadgets. I work for a living.Subscribe
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Pretty good video. It leaves out one important detail. many of the investors are also home owners who have investments in mutual funds and IRAs.
Niklaus
But they're not 'real' investors. Only pension fund managers and people with major equity stakes are 'real' investors.
That's why you have zero real power as an 'investor'. You have exactly the same power as an employee in a non union shop. (free to leave, but while you're here, these are the rules)
Did you ever wonder why such fund managers would rather take management fees rather than equity stakes in the funds they manage? One would think the latter would 'invest' the manager with a sense of ownership and care, No? Actually that's exactly why they don't. They can then treat the investment as a black box game – win or lose they get their fee (but obviously with additional gains if they win big!)
Tony,
They are not professional investors, however, they ante up the money for purchasing the shares of mutual funds and are represented by the brokers who act as a front for these non-pro investors.
Also, after some thought on the matter, it appears that there is something else that should be noted. A lot of the sub prime mortgages were issued as adjustable rate mortgages (ARM) to people who could qualify for a fixed rate mortgage on a less expensive property. Many of the banks, which also acted as investment bankers after the deregulation, encouraged home buyers to go with an ARM by calculating the front and back end rations based on the lower rate under the same qualifications for a fixed rate mortgage. By doing this, people that could only qualify for a prime fixed rate mortgage on a $150,000 house, were qualified for a $500,000 home on an ARM.
Additionally, many of the home owners who defaulted had speculative mortgage loans that included the property rehab expenses and were secured by the estimated value of the improved property. These were loans made to real estate "Flippers", who bought houses in need of repair, borrowed for the purchase and repair expenses with the expectation of selling the house at a considerable profit within a few months. Often the buyers for these houses were those that qualified for an ARM that they should not have qualified for.
The multinational financial corporations have subsidiaries that specialize in predatory lending. Thes predatory loans are usually made in good faith of the consumers, most commonly for home repairs such as replacement windows, gutters or new siding, then converted to revolving accounts without the informed consent of the consumer, (this is often achieved by issuing a high rate credit card and charging the principal to the card. The required opt-out period is addressed by mailing the card and terms as late as possible, then conveniently losing any correspondence requesting the opt-out.) The goal of predatory lending is to perpetuate this credit card debt and make money by charging fees.
So a lot of what lead to the credit crisis is a great deal of institutionalized fraud, perpetrated by corporations with the attitude that any laws rules which interfered with them increasing their profits should be ignored.
Niklaus: I agree with your account. I would add that the predatory lenders have not been selling the old-fashioned ARM's, the adjustable rate mortgages that truly go up when interest rates go up and down when they go down. The predatory lenders have been foisting "exploding ARMS" on the customers during the past 10 years. These are ARM's that are often rigged to shoot up even when the rates of generally available interest stay level. I've represented dozens of people who were sold loans with these exploding ARMs, and the written boilerplate plainly contradicts the slick sales talks that were given. It's so bad that many of them were buying loans that it would be impossible for them to pay after the first adjustment (3 years after signing up), regardless of what the generally available interest rates were doing. It was systematic fraud through and through (by those who sold the loans and the Wall Street firms that "rated" the loans), as clearly described here, in this interview involving Bill Moyers and bank regulator William K. Black.
I guess what disturbs me about the video is that it implies that low income home buyers caused the problem, when those really at fault were the mortgage brokers, investment bankers and the lawmakers who removed the rules and oversight. You will notice that the sub-prime borrowers are portrayed with cigarettes, presumably beer bottles in hand and with too many children, yet a large part of the sub prime loans were second mortgages by existing homeowners. In any case, the sub prime borrowers were victims along with investors in a scam of legendary magnitude.
There were rules in place to make sure that those overweight smoker homeowners weren't even given the chance to overextend their debt beyond their reasonable means of repaying it. Those rules were broken systematically by sophisticated businesses. Thus, I largely agree with you, Niklaus, though I personally know of individual homeowners who did know better and overextended, nonetheless. If those loans had been honestly rated as the shit they were, this whole process would have come to a screaming halt. Sleazy mortgage bankers are also guilty of pushing bad loans on people who were already in stable situations, and handing them loans that were guaranteed to fail, loans loaded with hidden fees and exploding ARMs. Highly educated people were in responsible positions to make sure that homeowners afflicted with innumerousy would not even have offered these terrible loans.
Niklaus
I agree – they are not professional investors. In fact they were mostly scammed by predatory lending practices!
Consumer regulations are generally there to protect people from themselves (in many cases) – so that you don't give away your entire life savings, so that 'bad guys' can't sell you substandard goods or services, so that consumers are protected from fraud.
But those regulations were largely stripped over the past few decades. Safeguards were there for the wealthy, and those who could afford to negotiate contracts – but not for the poor sucker who was required to sign the contract.
Erich's example of 'exploding' ARMs are a case in point.
Teaser rates work fine in an expanding market for those who wish to flip, since they can buy, fix, and sell long before the rate changes. This is a reasonably good thing, so long as the 'flip' is more than cosmetic! Improvement and maintenance of housing stock is always a positive!
They don't work so well in ANY market for those who were really unqualified for the loan in the first place. No-one should be getting loans at more than 5x gross income. No-one. It's stupid. Yet there are many examples of people getting qualified for loans that are 10 or 20 times their income.
At 5% interest over 30 years:
a mortgage of $150,000 will cost almost $10,000 per year
a mortgage of $250,000 will cost about $16,250 per year
and a mortgage of $500,000 will cost around
That is predatory lending.
Now that we are in a recessionary market – things are coming home to roost for everyone affected by such loans. The flippers are left sitting with unsold properties worth less than the loan. They will simply default (if they were 'smart' they flipped as a limited company, anyway) or be foreclosed – leaving an unoccupied and uncared for property on the market. All of the people who couldn't afford the loan in the first place, are now being foreclosured – which also negatively affects their current and future credit prospects.
The only people who come out of this with any positive income are the fat cat middlemen who created the mess in the first place with their collateralized debt.
oops — $500,000 mortgage costs about $32,500 per year.
a 3x multiplier is safe and sensible for most people.
a 5x is probably 'on the edge' for most people, and certainly leaves nothing spare — definitely house poor.
more than that is insane.
Erich, I don't think it was innumeracy, but misplaced trust. Most homeowners are not real estate expert and when they apply for a mortgage find themselves hit by a barrage of mortgage jargon which they lack the training to understand. They are pressured to close the deal and feel it necessary to place their trust in their real estate agent, brokers, real estate lawyers and others while expecting the law and the government to protect them from con artists. The government and the laws failed to protect them.
The deregulation, and the resulting convergence of depository institutions with investment banks and mortgage brokers resulted in an environment designed for exploitation by scam artists.
"I see con-artists. They're everywhere. most of them don't even know they're con-artists. They think they're successful businessmen" — Kid in the movie "The Sicks Cents"
Niklaus: I agree that there is a whole lot else going on in addition to failure to appreciate the meaning of the numbers. In many cases, though, there is a monthly payment that is well advertised to the mortgage customer, prominently displayed all over the paperwork, that is a budget killer. I don't quite understand how so many people jump at mortgages that could cost them most of their monthly after-tax income. Don't they need to eat, buy gas, pay medical bills, etc? I think that the trust is abused too, and that sets the groundwork for purchasers to overlook the immensity of the numbers. Once they trust the scam artist, it really doesn't matter what is on the (generally incomprehensible) paperwork.
On the issue of readability of legal forms and contract, consider the damning evidence offered by Alan M. White and Cathy Lesser Mansfield in an article titled "Literacy and Contract," (abstract here) published in the Standford Law and Policy Review. The authors took the time to consider the legal issues in light of careful testing demonstrating that many American adults, arguably most of them, haven't a clue as to what they are signing when presented with complex legal forms. Here are a couple excerpts: