Complications
I’ve been thinking about the statements made here that much financial crime is too complicated to make a good basis for a murder mystery, or that some of it isn’t even technically crime.
Before I get to what bothers me about that, let me say that when I said that the subprime mortgage meltdown mess would make a good basis for a murder mystery, I wasn’t talking about doing something esoteric about somebody who knew too much about the way the business was operating.
I was thinking of killing off–in a literary sense–one of these guys who scammed first time homeowners. And there were a lot of them, and what they were doing was definitely scamming. Some of these “loan officers” lied about the chances of an adjustable rate mortgage requiring rising payments rather than falling ones, and about how fast that could happen. One guy would turn couples down for loan A, then help them apply for and get approved for loan B, where loan B could be as much as twice as large as loan A. The trick, of course, is that the loan officer was paid a percentage of the total amount of the loans he approved–and he couldn’t get caught by his loans defaulting, because the loans would be sold to another company before that happened.
But it bothers me that so many people seem to think this is too complicated to understand. Of course, it’s what conmen do–make you think “it’s complicated” when what you should be thinking is “it’s crazy.”
So, if you can bear with me, let’s look at the mortgage markets.
In a sane and ordinary market, here’s what happens:
1) The homeowner applies to the bank for a loan.
2) The bank decided what the risk is that this homeower will default. If the risk is relativel small–if the homeowner looks solid–the bank approves the loan.
3) The homeowner makes mortgage payments. The bank collects these payments, and pays itself the interest.
4) If something untoward happens–a catastrophic illness, a job layoff, whatever–and the owner defaults, the bank works very hard to get that homeowner to the point where he does not go into foreclosure BECAUSE
5) The bank tends to lose money in foreclosures, and it looks bad in the community if the community is a regular small one, and it looks bad in the accounting, too.
The above system has, in the US, one exception, and that is in mortgages for people with very low incomes, which are guaranteed by the federal government through two quasi-governmental entities called Fannie Mae and Freddie Mac.
Guaranteed mortgages have a higher rater of default, because they have lower standards for granting loans, but they’re not bad for the banks because they’re guaranteed and the Federal government picks up the tab if there’s a problem.
So far, so good.
Note, however–the system depends for its stability on THE FACT THAT THE BANKS HAVE TO HOLD ONTO THE LOANS.
For the system to work as described above, the bank that grants your mortgage has to hold onto your mortgage and be responsible for it.
What happened starting in the early Eighties was something new, and it went like this:
1) The homeowner applied to the bank.
2) The bank granted the loan based on whatever criteria it had (see above).
3) The bank then SOLD the loan to another bank, or to an investment bank, or to a brokerage OR
4) The bank took a whole bunch of these loans, bundled them together, gave them a name (House Proud!), and sold STOCK in that bundle to investors, other banks, etc.
5) Whether the bank did 3 or 4, the result was the same, and that was:
6) The bank DID NOT make money because homeowners were paying their mortgages BECAUSE
7) The bank DID make money by selling those mortgages to somebody else.
So, if I’m Happy Local Bank, and I give an alcoholic kleptomaniac barber a $200,000 mortgage for a house in Happy Acres, I don’t have to worry if the barber can make the payments.
I take that $200,000 loan and sell it to Megacountry Investment bank for $300,000 (the amount of the loan plus the expected interest over the course of the loan).
I’m not free and clear–I’ve made $100,000 on that mortgage, and I don’t have to give a damn if it defaults or not. It’s none of my business.
In 1980, the average mortgage guy at the average bank was a bank officer hoping to move on up to the next level in the hierarchy.
By 2005, the average mortgage guy at the average bank was a salesman working on commission.
It made sense for the guy and his bank to make as many mortgage loans as possible, the bigger the better, no matter what the chances that they would ever be repaid.
They just took those loans, bundled them into packages, sold shares in the packages until they were completely covered–and went out and made more loans.
This is really not complicated.
It’s stupid, and it’s crazy, but it’s not complicated.
It could have been avoided in a number of ways, not the least of which would have been holding on to something called the Glass-Steaggall Act, but I do think it’s straightforward enough so that issues arising from it could become the basis of a murder mystery without too much time being spent explaining things.
Although, in writing such a book, I’d concentrate on the people–some of the biggest operators here, especially the ones working for the big non-bank mortgage companies, were extraordinarily vile in the way they treated people.
But mostly I think it bothers me that the con men have managed to get so many of us to throw up our hands and declare “it’s too complicated for ME to understand!”
It isn’t, really, once you accept the obvious–that what’s happening is a scam, and it only seems complicated because if you look at it as simple it’s obvious that it’s a scam.
Ack.
Two to four days from finishing this book–the one I’m writing–and then I’m going to fall over like a tree.
2 Responses to 'Complications'
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I’ll grant you there was no doubt scamming and scoundrels around, but selling the mortgage doesn’t make it a scam, and doesn’t make the people who buy and sell mortgages con men. The mortgage on the Empire State Building used to change hands fairly frequently, because “owning” the building had prestige value. But a lot of good solid commercial properties would have to dig a little to find out who holds the mortgage this month.
The interesting bit to me is the fellow at Megacorp Investment Bank who took the old saying “safe as houses” WAY too literally, using a wildly optimistic formula for calculating default risks on bundles of mortgages because they never looked at the individual cases. I’d say “idiot” but there were a lot of him, with first-rate credentials as such things go. If the people at MIB had estimated the risk correctly, their offer for the bundled mortgages would have been a lot lower. (You can’t sell the mortgage for the value of the loan plus interest. You sell it for the value of the load plus interest minus something for the risk of default and something more for “money later” instead of “money now.” Money later is worth less, which is why we have interest.) And if the offer were lower, the bank would have less incentive to pass on the mortgages.
And MIB was reselling the bundled mortgages in “tranches” based on degree of risk within that wildly optimistic assessment of the bundle and priority of claims, and MIB was borrowing operating capital with loans whose rates would go up if property values sank–and at that point my own forehead starts to look somewhat Kingonish.
But MIB wasn’t the only cause of the mess. A lot of governments–local state and national–both put the squeeze on banks to loan to poor credit risks and–Fannie Mae and Freddie Mac again–guaranteed a lot of bad loans with what turns out to be my money. Some of the people involved are pushing for yet more loans to bad credit risks. There are terms for people who do the same thing and expect different results, but “shrewd investor” isn’t one of them.
On the other hand, they’re not playing with their own money. Like to make one of the politicians the murderee? (I choke on “victim” in this context.) I’ll even provide the last words: “But I meant it all for the best!!”
If you want a murder for revenge, go back to prospecting expeditions and handshake deals, or comrades abandoned in a wilderness. Try to avoid terms like “third tranche” and “risk assessment formula.”
robert_piepenbrink
18 Jan 10 at 6:14 pm
I do understand – now – how the mortgage scam worked, and I think I understand Ponzi schemes. I don’t think you can assume they’re well-enough understood to base a mystery on them because while, on the one hand, ‘he lied about investing my money and instead spent it on luxuries and paying off people who wanted out’ is easy enough to understand, and could motivate murder, ‘someone I didn’t even know bought some ‘financial product’ I never heard of and don’t understand, so my employer is laying people off and I’ve lost my home” is just confusing to a lot of people.
And Robert, from all I read about the mortgage mess in the US, a LOT of people were involved in out-and-out fraud. They lied about the risks, they lied about the future costs, and they manipulated people into taking out mortgages they couldn’t afford, sometimes in exchange for mortgages they could handle. This wasn’t merely a case of people not reading the small print before they signed, or not understanding it, although I suspect that happened too.
Cheryl
19 Jan 10 at 7:43 am