Sub-prime
Wednesday 15th October
I learnt about sub-prime lending this morning.
So let me get this straight… you need 1 rich banker (RB) and 1 poor gullible soul (PGS).
The RB knows that the PGS can’t afford to pay back a loan, and therefore encourages the PGS to borrow lots of money and buy a house that’s too large for their means (or to borrow a large sum of money guaranteed against the nice house they already own). The RB is betting on the fact that the PGS’s house will be worth more when he repossesses it than it was when he lent the money.
Additionally, the PGS will pay a number of repayments before defaulting on the mortgage. And an ‘acceptance fee’.
So the RB ends up with 1) a nice big house AND 2) a bunch of repayments AND 3) an acceptance fee. The PGS ends up with nothing but a bankruptcy judgement which means they will only be eligible for sub-prime loans in future (see a pattern?)
Now the rich bankers are moaning, and their banks collapsing because the houses they’ve placed these bets on are worth less than when they extortedhelpfully loaned money to their PGS.
Greedy monkeys.
It’s a bit more complicated than that: in the USA, I gather, it went something like this:
Banks check people out and want to lend to good risks. They can sell the mortgage obligation on to another bank, since it represents a bunch of future repayments and whoever holds the asset collects the payments.
When a bank checks someone out and finds they are not a good risk, they are sub-prime and the bank doesn’t like to lend them money.
The US gummint says “hey, it’s no good that we have all these homeless people blocked from the American Dream. You must lend them money!” So the banks start lending mortgages to people who are not a great risk.
The banks find that they can’t sell on the sub-prime mortgage assets because they are, well, sub-prime. You’re only getting a /probability/ of future repayments. So the original lender is saddled with all the risk of the non-payment. (Bank does not want a house because it’s a hassle to sell it.)
So some bright spark invents the “Collateralized Loan Agreement” (CLO) whereby you take a big bundle of prime-cut beef (mortgage assets) and you chop in some gristle and bone marrow (sub-prime) and make a sausage, which lets you shift portions of the sub-prime risk off to the bank that’s buying your new “innovative financial product”.
The buyer of this sausage doesn’t know what’s in it and frankly doesn’t have time or resources to work out what’s in it, so trusts the Financial Services Agency (in the UK, dunno the US equivalent) who looks at the sausage and says, “hmm, bit hard to figure out what that’s made of, let’s just say it’s tasty and good for you!”
So now a market in “innovative” CLOs springs up, and lenders can see a way to profit: lend on sub-prime like the gummint says, and dice it up into CLOs, which the investment market will snap up. Their sales guys are told “yay! we’re not scared of sub-prime any more, go get ‘em!”
So the sales guys start really badly over-selling mortgages.
Then a bunch of Americans default. In the US, if you walk away from your home, then the bank can’t chase you for the outstanding balance, so these people trash the places and move out. The investment community perks up and says “ooh look, some mortgage assets are looking really bad! which ones are they, then?” then it turns out that nonbody knows where the bad assets are, because they’ve been eating sausage for the last decade. Not only that, but nobody now believes the regulator who was formerly rating CLOs as super low risk.
So all these cash injections are all very well, but a much more helpful thing would be to publicly audit all our banking institutions and work out ACTUALLY how much they are worth. What’s missing /really is/ confidence — a small amount of knowledge would go a long way to easing that!
sweavo
15 Oct 08 at 10:12 am
s/Agreement/Obligation/
sweavo
15 Oct 08 at 10:13 am
It’s the American way my friend. This gazillion dollar bailout was not about keeping people from being homeless, it was about making sure they could still buy a $3 cup of Starbucks before collecting their unemployment check in the morning….
andygoose
15 Oct 08 at 10:33 am
The Road to Hell is strewn with good intentions (along with greedy fatcats). It seems to have been a conscience-free exercise, anyway
lordhutton
15 Oct 08 at 2:18 pm
I think that’s why we rent where we live. My husband and I couldn’t figure out how all these people were getting loans to buy houses.
How were they going to make payments, we asked ourselves??? Especially people with no money! Duh!
We may be “poor” (don’t own a house), but we’re at least not stupid, too.
Debster
16 Oct 08 at 4:26 am
Debster, watch for when the shit hits the fan in your town, then you’ll be able to get a fixer-upper for peanuts!
sweavo
16 Oct 08 at 9:17 am