Wall Street Law Blog

Bottle Of Wine Key To Understanding Subprime Debacle

Mortgage securitization for Dummies?  Not exactly.  

However, the diagram featured in this post - a tipped wine bottle floating above an inverted pyramid of wine glasses - really simplifies the migraine-inducing terminology and key concepts of mortgage securitization.  

Note- This brilliant diagram was not conceived by Wall Street Law Blog.

My goal in writing this post was to use this great visual aid to create a series of storyboards to describe the subprime debacle in a format that (a) is easy to understand, and (b) does not require readers to take any Advil, Tylenol, or Excedrin.   

I know, I know - my chicken scratch handwriting is far from easy on the eyes. And you aren't sure you can go with the whole subprime wine thing.  But hang in there. The post is pretty short.

THE SENIOR TRANCHE (lowest risk, lowest return)

THE MEZZANINE TRANCHE (Middle Tranche / Riskier than senior tranche, but still low risk/low return)

EQUITY TRANCHE (High Risk, High Return)

THE SUBPRIME DEBACLE

As long as favorable economic conditions keep default rates on subprime mortgages low, there is plenty of wine and all glasses are filled.

HOWEVER...

 

 

 

 

 Actually, the truth is that the bankers coud -- and did -- sell investors trillions in fraudulent subprime bonds.  And now, we hope, it is a little bit easier to understand how they did it.

 

By Brett Sherman

Bear Stearns, Merrill Lynch Expected Housing Disaster (our all-time most viewed post; first published Oct. 2010)

"These aren't simply the comments of some junior level analysts" Lee Sherman, securities litigation consultant

the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them.

the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial.

UPDATE: Because Bear Stearns Execs' FCIC testimony largely focused on allegedly unforeseeable, "unprecedented" market forces to defend their lack of competent management, Wall Street Law Blog decided to re-post one of our favorites. 

Long before their respective employers ceased to exist as independent companies, former Merrill Lynch Top North American Economist David A. Rosenberg and former Bear Stearns Chief Equities Investment Strategist Francois Trahan published research reports with explicit warnings about asset and credit bubbles in the U.S. housing and mortgage markets.

As early as August 2004, Mr. Rosenberg, Chief Economist at Merrill Lynch for North America, published a detailed analysis regarding the precarious state of the American housing market. Rosenberg warned that there could serious problems ahead in an Economic Commentary entitled: "Housing: If not a Bubble Then an Oversized Sud."

Former Bear Stearns Chief Equities Investment Strategist Francois Trahan first published a report that raised serious questions about housing and real estate investments in a May 2005 report called "REIT all About it." Trahan and his team at Bear Stearns followed their 2005 report with publications in 2006 that explicitly warned about the difficult future facing the U.S. housing market and even raised the possibility of a global credit crisis. The 2006 Bear Stearns reports definitively described the housing market as an unsustainable "bubble" and further cautioned that the term bubble was not one the Bear team used lightly.

It was not until 2008 that overcommitments to mortgage-backed securities (a byproduct of the housing boom), CDO's and related products tied to residential and commercial mortgages caused Merrill Lynch and Bear Stearns to suffer backbreaking losses so severe that Merrill sold itself to Bank of America and Bear Stearns narrowly avoided bankruptcy with a Fed-assisted fire sale to JP Morgan.

--Background

Along with a number of other Wall Street firms, Merrill Lynch and Bear Stearns lost tens of billions of dollars because of their firms' respective commitments to securities backed by mortgages in the "subprime" and "Alt-A" categories. Subprime and Alt-A residential mortgages are considered risky loans because they carry higher default rates than "conforming" mortgages (also called prime mortgages, or agency-quality mortgages). Typical subprime or Alt-A borrowers cannot qualify for a conforming mortgage due to factors that include, but are not limited to, bad credit histories, personal bankruptcies, insufficient income, and the inability to make sufficiently large down-payments.

--Significance of the Merrill Lynch and Bear Stearns reports

While the ultimate import of the reports remains to be seen, The Sherman Law Firm says there is no doubt that the documents are crucial to the touchstone litigation element of foreseeability. "In a litigation sense," said Managing Attorney Brett Sherman, "the question of foreseeability asks at what point in time senior management at these investment banks should have foreseen the possibility of the disasters that eventually befell them."

According to The Sherman Law Firm, the reports at issue may show that senior management at Merrill Lynch and Bear Stearns should have foreseen the liklihood of a looming financial crisis with ample time to permit business model shifts that may have prevented crippling losses and, ultimately, the end of these former pillars of Wall Street as independent companies.

--Likely Defenses and Response

When confronted with documents like the reports at issue, senior managers may respond that they cannot be expected to read the huge volumes of research produced by their companies. The view of Brett Sherman, securities fraud lawyer and Managing Attorney of The Sherman Law Firm is that "the significance of these reports is that they conclusively establish the views of top economic analysts at Merrill Lynch and Bear Stearns. Whether plaintiffs' attorneys prove that senior management at the two investment banks actually read the reports ought to be immaterial."

Litigation strategist and recently retired attorney Lee Sherman - a frequent consultant to The Sherman Law Firm, former municipal court judge, and founding partner of a top Philadelphia area firm - concurred. "These aren't simply the comments of some junior level analysts," Sherman said. "I mean, we're talking about the Senior North American Economist of Merrill Lynch and the Chief Equities Strategist at Bear Stearns. Any claims by their CEOs and the other senior decision makers at these banks to the effect that they should not have been well-aware of the opinions and outlooks of the top economic and market experts at their companies are simply not credible." 

Lee Sherman continued: "Remember, from mid-2004 until the subprime crisis had clearly arrived, the Fed steadily raised interest rates. For lesser quality borrowers, most of whom had adjustable rate mortgages, higher interest rates meant higher default rates. To say the least, there was great uncertainty as rates were rising about where we were headed. Then, the housing market slowed. I'm talking about 2005 now, before home values really fell off the table. It strikes me as incredible that the kinds of warnings in these reports were out there for years, yet seem to have gone unheeded."

The Sherman Law Firm represents investors in securities fraud / investment loss claims of all types, including claims against investment banks for losses related to mismanagement and other misconduct during the housing and credit bubbles.

Brett Sherman, The Sherman Law Firm

Wall Street's Favorite Disclaimer: "Past Performance is No Guarantee of Future Results"

Home prices can fall! Shocker, right? This post is an updated examination of one of the chief rationales behind the nonprime mortgage lending model... (hint - even moderate scrutiny reveals that this rationale is really a rationalization)

DON'T WORRY MR. AND MRS. INSOLVENT AMERICAN - WE CAN ALWAY REFINANCE YOUR MORTGAGE BEFORE THE TEASER PERIOD EXPIRES.

Nationally, home prices have not fallen since the Great Depression. Therefore, home prices will not fall.  

Thus, the argument went, subprime borrowers with 2/28 ARMs (or 3/27 ARMs) would have sufficient home equity just from price appreciation to refinance their home mortgages before teaser rates expired and rates went through the, errr, roof (sorry about that one...).  

Teaser rates, of course, are those ridiculously low interest rates that lenders and securitizers of mortgages dreamed up so they could manufacture an artificial monthly payment that most borrowers could afford for a short fixed period (2 years in the case of a 2/28 ARM, 3 years in the case of a 3/27 ARM).   

Artificially low teaser rates made it possible for cash poor Americans to afford their mortgages long enough for them to be stuffed into opaque and complex mortgage bonds and sold to investors who had no clue what kind of junk investments they were actually buying.   After 2004, the housing, mortgage, and mortgage securities bubbles were fueled by the supposed logic that home prices would rise forever, so loans that would be unaffordable to borrowers after the teaser expired could be refinanced before the that happened.  

When a mortgage is refinanced, the clock on the teaser period resets to zero.  Refinancing a 2/28 subprime ARM into a new 2/28 ARM gives the borrower a new two year period of guaranteed low monthly payments.  The system was specifically engineered to keep subprime borrowers from defaulting.   

Thus, as long as low-credit borrowers used the appreciation of the value of their homes to refinance their mortgages, default rates would stay low enough that mortgage-backed securities would have enough cash to pay investors.  

The subprime lending industry - on which investment banks like Bear Stearns, Lehman Brothers, and Merrill Lynch made very big and insufficiently hedged bets - rested on one assumption above all others: 

Housing prices would not decline (or even stall).  Ever-rising home prices - and thus increases in home equity -  would always make refinancing possible before teaser rates expired.  

The "prices always rise" premise - which (as far as we can tell) has no logical predicate -was framed by mortgage lenders and securitizers as an axiom of the U.S. housing market.

****

Well, Wall Street Law Blog has a few questions (and, as always, an opinion or two)-

Q)  The basis for the axiom that home prices always appreciate was... what? 

(Please, tell us.) 

Q)  And, what would happen if the home price axiom failed (as it obviously did)?  

****

Any company that relied on "home prices don't fall" propaganda and failed to ask and answer these questions (by answering we mean making damn sure they were adequately hedged) failed to engage in any real risk management.  

The lenders and securitizers used bad logic (we've written the word axiom too much in this post already) to justify massive risk-taking.  

Period.

****

Any financial institution that uses bad logic to make very risky bets is a classic example of 'risk management by rationalization'  

****      

By the way, there has been no world war since the 1940's. Clearly, we need not worry about the possibility of another World Warin the future. Right?

By Brett Sherman, The Sherman Law Firm

Bear Stearns Old Subsidiary Loses Mortgage Securitization Case Brought by Bond Insurer

A brand new title - same post from this morning.

Insurer Sued EMC Mortgage Over Bad Loans In Mortgage Securitization

 

In an opinion dated March 25, 2008 The Hon. Paul A. Crotty, Federal District Court Judge for the Southern District of New York, issued an opinion granting bond insurer Syncora Guarantee partial summary judgment against former Bear Stearns (and current JPMorgan Chase) subsidiary EMC Mortgage.  Wall Street Law Blog will address the case in a subsequent post.  You can read the opinion now, however, via the link below.

 

http://westlawnews.thomson.com/uploadedFiles/Securities_Litigation/Legal_Materials/Opinions_Orders_and_Jury_Verdicts/2011/03_-_March/Syncora%20EMC%20JPMorgan%20Opinion.pdf

Black Swans*, Fraud by hindsight, and Mortgage-Backed Securities. (greatest hits collection)

Events are not unforeseeable merely because they are unprecedented... 

One of the primary arguments upon which Wall Street firms rely to defend themselves from securities fraud allegations is something like this -

We could not foresee the collapse of the housing market, and therefore any allegations of fraud are merely impermissible claims of "fraud by hindsight." 

The fraud by hindsight defense is pretty much automatic in securities fraud cases.  The meaning of the defense is, as it sounds, that there is no fraud if the alleged deceit can only be discerned after the fact. Hindsight is, after all, 20/20.  The legal issue is foreseeability.  

In financial crisis litigation, Wall Streeters insist that their actions (like marketing CDOs stuffed with subprime mortgages as ultra-safe investments) are not fraudulent because banks that sold toxic waste allegedly could not reasonably foresee the housing and credit bubbles or the consequences that would rain down when the bubble inevitably ruptured.

Further, Wall Street execs insist that mass defaults of subprime mortgages were not foreseeable simply because (they contend) the U.S. has never experienced a nationwide housing slump.  Presumably, these same Wall Street executives would argue that they cannot foresee the possibility that they will one day die because they haven't yet been dead.*     

OK, Wall Street:  From 1895 through 1996 home price appreciation very closely corresponded to the rate of inflation (roughly 3% per year).  From 1995 through 2006 alone - even after adjusting for inflation - housing prices rose by more than 70%.  That type of housing growth certainly is unprecedented.  Why shouldn't such an unprecedented "up-cycle" in the housing market end in an unprecedented way?  The answer is that there is no reason.  

In fact, the housing boom was so far out of line with any previous housing cycle that one could easily argue that a reasonable economist, real estate professional, or CEO of an investment bank should have anticipated that a the story of housing's record-smashing growth would eventually come to a very ugly ending.   

The fact is that a huge number of respected experts from private industry and academia publicly warned of a huge housing bubble that could only end badly.  Certainly, many others kept quiet, wary of rocking the boat while the profits poured in, even though they too foresaw the end of the housing bubble and predicted its devastating impact on mortgage-backed securities.  

The fact is that, once the MBS industry became dependent on subprime mortgages, an eventual disaster was unavoidable.  Until the bubble popped, however, Wall Street was raking in far too much money to worry about the ramifications of the immense risks banks were taking.  

Fraud by hindsight is inapplicable in most financial crisis litigation.  Why?  Because choosing to ignore the apocalypse is far different from failing to foresee it.

      

*Inspired in part by the writings of Nassim Nicholas Taleb.

By Brett Sherman, The Sherman Law Firm

Bear Stearns, Countrywide, and the Subprime Crisis - Failure by Incompetence and Fraud

 

 

 

By Brett Sherman;  THE SHERMAN LAW FIRM

Prologue:  The Subprime Crisis in 30 Seconds or Less (really)

LOW INTEREST RATES, A HOUSING MARKET FLOODED WITH MONEY, SUBPRIME LOANS BEGET BUNDLED SUBPRIME DERIVATIVES, PROFITS AND MORE PROFITS, A CREDIT / HOUSING BUBBLE, GREED, LIES, UNACCEPTABLE RISK MANAGEMENT, RATES RISE, MORTGAGES ADJUST, BUBBLE POPS, SUBPRIME DEFAULTS, FORECLOSURES, CONTAGION, WORTHLESS SECURITIES 

  

I. Introduction:  Countrywide and Bear are Responsible for Their Respective Fates.

Sometimes you can see a storm coming simply by looking at the sky.  Unfortunately - even well after the looming subprime mortgage crisis had darkened the economic horizon – the people that mattered at Countrywide and Bear Stearns refused to acknowledge (publicly at least) the very obvious approaching disaster in the credit markets.  Despite protests to the contrary from Countrywide and Bear Stearns, it is quite clear that only two things are possible: Either these companies intentionally ignored incredibly obvious signs that the subprime gravy train was about to crash, or management at both companies consisted of people who had no business operating a cash register at McDonald’s let alone billion-dollar financial institutions.

To the delight of the men and women at the top of these companies – led by CEO Angelo Mozillo at Countrywide and CEO Jimmy Cayne at Bear Stearns - it had been raining tons of subprime and near-subprime money for a long time.  Countrywide made the loans. Bear Stearns bundled those loans into securities (CDOs being the best known), issued the securities, traded the securities, and managed in giant hedge funds.  No matter what disaster might be looming in the mortgage industry, Mozillo, Cayne and their respective minions were determined keep their vision trained only on the very-near term. By putting on blinders, Countrywide and Bear Stearns could rake in mortgage-driven profits for as long as possible.  It was classic high finance behavior - Take bucket after bucket of cash out of the well for as long as it lasts. Figure out what to do next only after the well is bone dry.  

Unfortunately for pretty much the world, and for the futures of Countrywide and Bear Stearns, by 2005-06, the approaching storm was directly overhead. Interest rates were rising and home prices were falling.  This combination, as had been widely predicted, was an atomic bomb to the subprime mortgage industry. Nevertheless, Countrywide kept lending and Bear Stearns kept bundling mortgages into what Bear represented would be safe, stable bonds that carried a very attractive yield. 

Sporting a happy face for the public, Bear Stearns chose to outwardly ignore what a smart ten year old can figure out in math class:

If a hundred defaulted mortgages have a total value of zero, then a bond created with those one hundred defaulted mortgages is worthless.

The result, of course, was disaster.

The men and women in charge of Countrywide and Bear Stearns, and those executives responsible for managing risk at the respective companies wore blinders because they were corrupted by greed.  That kind of inexcusable greed ultimately destroyed Countrywide (at least Angelo Mozilo's Countrywide) and Bear Stearns, and seriously damaged the financial lives of investors, employees, borrowers and others.    

II.  A Thumbnail Sketch of The Short Reign of Subprime Mania, using Countrywide and Bear Stearns as Case-studies.

Following the "tech-wreck" (the bursting of the dot.com and technology-driven stock market bubble) at the beginning of this decade, the Fed lowered interest rates to historic lows.  Money was cheap to borrow for banks, and that meant that there was more money available for lending and lower interest rates at which all of that money could be loaned.  

Lenders like Countrywide realized early on in this process that rates were so low that they could now make home loans to people with bad credit, or with little or no income, or with no money to use as a down payment.  In short, Countrywide and other lenders practically threw cash at Americans who had no business having access to large sums of money.  The interest only loan, or skip a payment loan, and other similar products became the focal point of a large segment of the residential mortgage business. 

Because the borrowers had bad credit, they felt lucky to be approved and were more than happy when Countrywide and other mortgage lenders asked them to pay higher closing fees and a slightly higher interest rate than the rate offered to borrowers with excellent credit.  Almost all subprime mortgages had an adjustable interest rate feature, which means that the rate can move up or down with a stated index like LIBOR. 

It stretches credibility beyond the breaking point for Countrywide, once the largest home lender in America, to deny a full and thorough understanding of the basic principle that a rise in interest rates would have an almost immediate negative impact on the ability of many subprime borrowers to meet their loan payment obligations (history proves that interest rates do not stay very low for very long).   Of course, Bear Stearns - then an investment bank that analyzed the real estate markets as part of its everyday business - also understood this principle.  Similarly, Countrywide and Bear Stearns each knew (and really must have known from the start of the subprime boom) that they would eventually face a doomsday scenario if the housing market became stagnant or fell at a time when interest rates were going up. 

But, even as the winds of disaster began to blow, Countrywide's focus remained fixed on the huge profits that could be made in subprime mortgages and other mortgages that could not qualify as "A" Paper". Bear Stearns swimming in cash due to its mortgage-backed securities business.  Bear (and other banks like Lehman and Merrill Lynch) took these same subprime mortgages and other low quality credit products, bundled them into bonds (the aforementioned CDO's and other credit derivative investment products), attached an attractive yield, and very successfully offered the mortgage-backed bonds to investors. 

When the whole mortgage-backed securities mania was starting, the thinking on Wall Street was that bundling low credit mortgages would allow for bonds with good yields in what was a time when more traditional bonds were paying poor yields due to low interest-rates. The subprime business, both for home mortgage lenders and for Wall Street, became a runaway blockbuster. Countrywide and Bear Stearns quickly became two of the most significant (if not the most significant) players on the two sides of the subprime world (lender and investment bank).

  

Lenders and investment banks built billion dollar businesses on a less than solid foundation cobbled from loans to individuals with poor credit, no credit, and/or no income.  There also were the liar loans in which an individual might get an Alt-A loan (near subprime) just by stating his or her income, no verification required.  Isn’t a business built on such poor underpinnings by definition a house of cards?  And don’t houses of cards always collapse?

So what happened next?  Profits - lots and lots of profits.  Home prices soared because there was more money to be borrowed and, therefore, more people competing for homes.  On Main Street, John Doe toasted his good fortune.  He had bad credit, sure, but he also had his dream home.  These were the new good old days, right?  John conveniently forgot that he lost most of his life savings at the end of the previous economic boom, when all of that money he had in can't miss dot-coms went up in smoke.

 

John Doe on Main Street can be forgiven for failing to understand market cycles and the concept of bubbles.  Financial risk managers cannot be forgiven for this egregious sin.  Low interest rates plus easy available money for people without credit put a whole lot of buyers in the housing market, many of whom simply should not be there.  Understanding that housing prices must go up when so many more buyers enter the market is probably covered by the third lecture in college Economics 101 (the lesson about supply and demand).  By lecture five, most Econ Professors have gotten to the concept of 'bubbles.'  This is elementary stuff.  The country was in a housing bubble.  But, as Countrywide and Bear Stearns again know all too well, bubbles never last.

Under normal economic conditions (i.e., when money isn't flowing like water and credit applications aren't written in crayon), basic math dictated that millions of subprime borrowers simply would not be able to afford their mortgages.  When interest rates did jump, all of those low interest adjustable subprime loans adjusted upward.  Thus began the inevitable end game for the subprime loan market, and for the securities those mortgages backed.  Next was the predicted flood of mortgage defaults and foreclosures.  Home prices fell in 2006, reportedly for the first time since the Great Depression.  The Housing Bubble had popped.  The subprime house of cards was collapsing.

A prime function of Risk Management groups on Wall Street is to engage in analysis and dialog with colleagues and senior management on an ongoing basis to make sure that an investment bank's overall portfolio, and the individual parts of that portfolio, are not engaged in strategies that carry an imprudent level of risk. To do their jobs, risk managers rely on their own knowledge and monitoring (the human factor), as well as sophisticated computer programs. 

The Risk Management teams (and many other senior managers) for both Countrywide and Bear Stearns certainly had to have seen the writing on the wall long before the subprime market blew up. After all, low interest rates can't last forever.  And, it takes far less than a mediocre risk manager to "get it" regarding the concept that rising interest rates plus homeowners facing rising mortgage payments, with bad credit and often little cash, is a Molotov cocktail.

Bear Stearns Risk Managers were complicit in allowing Bear to rely far too heavily on credit derivatives on a firm-wide basis, and to do so for far too long.  Maybe Bear's Risk Managers were pressured by senior management to look the other way.  Maybe they were paid “special bonuses” or had some other motivation to ignore their responsibilities.  Whatever the case, Risk Management at Bear Stearns was an abject and unacceptable failure.

Countrywide's Risk Team fared little better than the Risk Managers at Bear Stearns.  At Countrywide, the immense commitment to subprime mortgages, held for far too long, proved to be the chief factor in the lender's undoing.  At Bear Stearns, the immense commitment to subprime mortgage-backed securities had a similar impact on the investment bank.  

Lenders like Countrywide and investment banks like Bear Stearns needed each other to make the subprime loan and securitization businesses work.  Countywide and Bear Stearns both fell far from their high pedestals because each company was so blinded by greed that the decision was made, most likely at the highest levels, to essentially play out a good hand for as long as it lasted without serious regard for the future.  

Countrywide is not, to my knowledge, claiming to be the victim of a conspiracy.  Bear Stearns and JP Morgan, on the other hand, have blamed everyone from short-sellers to CNBC to Goldman Sachs to a vast right wind conspiracy (well, maybe not that).  No conspiracy killed Bear Stearns.  Bad management and fraud took care of that.  Bear Stearns is culpable for its own demise.

 

The Sherman Law Firm

 

Financial Disaster, Foreseeability, and Frankenstein (greatest hits)

Mortgage securities rise and fall, a Story Mary Shelley would love...

Confluence is a great word.  It means, in essence, a "coming together."  Most often, the term confluence is used in connection with rivers.  Probably the most famous confluence of rivers is in Pittsburgh, where three major American rivers eventually merge somewhere around the Steel City's semi-famous (at least to geography buffs) golden triangle.  

One gold star goes to the first person who can name the big three rivers.  Comments are open below.  But we digress.

The confluence discussed in this post has to do with financial disaster, not rivers. This piece is about a very rare confluence of economic conditions, electrified by almost unbelievable opportunism and greed by investment banks and others, that pushed the world into the most serious financial crisis since the Great Depression.

Wall Street executives frequently blame the financial crisis on events that were impossible to foresee during the years they pocketed multi-million dollar paychecks and, at the same time, laid a foundation for disaster.  Former CEOs invoke terms like hundred year storm, or perfect storm, or act of god when they deny responsibility for jeopardizing the entire world economy.

Wall Street money is behind the low documentation, low quality subprime loans that defaulted en masse when interest rates rose and home prices stopped their race to the moon.  Wall Street leveraged itself to the hilt to enhance return on equity and, by extension, executive compensation.  The subprime crisis, RMBS crisis, and - ultimately - the credit crisis were foreseeable events.   They were, in fact, actually predicted by more than a few folks.  

If there was a hundred year storm, it was the confluence of unique economic conditions that Wall Street investment banks exploited to fuel the housing bubble.   

    *** 

Consider what happened to open the door that, in the end, was kicked in by Wall Street Greed (and where have you gone Gordon Gecko?) -

• First, the end of the internet stock bubble followed by the humongous shock to U.S. economy from the September 11 terror attacks resulted in the Fed taking interest rates to historic lows, and holding rates there longer than ever before;  

• Second, low interest rates meant Treasury yields were so low that pension funds and other major institutional funds needed investment grade instruments with significantly higher returns than United States bonds in order to avoid invading their funds’ corpus (principal) to make required payouts (expansion on this topic requires its own blog post).  For purposes of this post, it is only necessary to understand that fixed-income fund managers restricted by law or charter to investment grade securities were desperate for yield.  This situation, if not unprecedented (I am a lawyer, not an economist) is extremely unusual.  

 

• Third, Again thanks to low rates, money was so easy and cheap to borrow - especially for banks - that it was practically free.

 

• Fourth, Cheap money (low interest rates) almost always is manna for the housing industry. Easy credit and low interest rates (and a host of similar factors too long to spell out here) allowed people to afford monthly mortgage payments on homes they never thought they would be able to afford. Housing went through the roof, and people accumulated amazing amounts of home equity (sometimes called found money) due to the increasing value of their homes. In short, most individuals could tap into the wealth produced by their homes to avoid possible mortgage delinquencies (and to put in pools, surround sound, etc.).

• Fifth (and you thought the confluence of three rivers in Pittsburgh was impressive), broker-dealers like Bear Stearns and Lehman Brothers were very experienced with a set of financial products that they believed they could market and sell to “greater fools” – especially all of those fund managers desperate for yield.  These products – perhaps you’ve heard of them - have names like mortgage-backed securities (MBS) and collateralized debt obligations (CDOs).

• Sixth, If Wall Street excels at anything, it is spotting an opportunity to exploit others for profit. In this case, subprime borrowers, many of whom would eventually face disaster, and institutional fund managers two classes of "fools."  As long as Wall Street banks could get investment grade ratings with securities made from pools of less than investment grade quality mortgages. Enter the quants (actually, they had been working on this stuff for a while already). With complex mathematical computer programs, and a lot of money in "fees," investment banks were able to bribe, err, "collaborate with" the credit ratings agencies to obtain the much needed "investment grade" stamp of approval.  

Now, all the pieces were in place and the money train pulled onto Wall Street.  It arrived regularly for about five years.  And then Frankenstein's Monster came along.  Read about that in part II.

By The Sherman Law Firm, Contact us