Last week I recommended that you watch the movie “The Big Short”. The movie did an excellent job of explaining why the housing market collapsed in 2008. For those of you that have been slammed with closings and not had a chance to watch the movie here is a short synopsis of what the writer and a few others hold as the cause.
For decades, mortgages have been packaged into securities known as mortgage-backed securities (MBS) and collateralize debt obligations (CDO) and sold to investors on Wall Street. The MBS and CDO typically contained at least 65% of highly rated mortgages, meaning mortgages giving by people with great credit. The remaining portion of the MBS/CDO contained 35% of risky loans typically known as sub-prime mortgages. Credit rating agencies such as Moody’s and Standard & Poor rated these investments as Triple-A. Triple-A rated securities are supposed to be among the best and safest.
As the housing boom of 2005 to 2007 withered, there were not enough good mortgages to package into MBS and CDO so lenders began loosening standards to qualify for loans and investment banks started putting more and more risky or subprime loans into these securities. Some estimates hold that the 75% to 90% of the MBS and CDO contained highly risky loans and only 10% to 25% of highly rated mortgages. In short the MBS and CDO were extremely risky investments. Unfortunately, the credit rating companies continued to rate these very risky securities as Triple-A. Investors had no idea they were buying garbage. When the housing bubble exploded and the subprime mortgages started defaulting in extremely high numbers, the banks and investment companies holding these securities collapsed. Interestingly, Fannie Mae and Freddic Mac led the way in relaxing loan standards.
Peter J. Wallison of the American Enterprise Institute asserts that the lessening of credit standards was directly and proximately traced to the affordable housing policies initiated by the US Department of Housing and Urban Development. According to the Financial Crisis Inquiry Report conducted by Congress in 2010, the Big Three rating agencies were labeled as essential cogs in the wheel of financial destruction. The commission report said the “mortgage-related securities at the heart of the crisis could not have been marketed and sold without their seal of approval…The crisis could not have happened without the rating agencies.” Journalists, Bethany McLean and Joe Nocera blamed the practice on “an erosion of standards, a willful suspension of skepticism, a hunger for big fees and market share and an inability to stand up to investment banks issuing the securities.”
We are now 10 years removed from the start of the Great Recession. Could it happen again?
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