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October 3rd, 2008

PART 1: How Did We Get To This Point

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It all boils down to one simple problem: low-income borrowers, and borrowers with poor credit, applied for and were issued loans they could not afford. How did this happen?

Starting in 1992, Congress demanded that Fannie Mae and Freddie Mac increase the amount of mortgages they buy which were made available to low-and moderate-income borrowers. By 2000, HUD, Fannie and Freddie’s regulator at that time, had required that the two dedicate 50% of their loan portfolio to accommodate low and moderate income borrowers. In order to reach that goal, lenders were forced to relax their lending standards. “You went from subprime loans being 2% of total loans in 2002 to 30% of total loans in 2006,” said Steven Schwarzman, the chairman of Blackstone Group. According to Wayne Barrett of the Village Voice, in 2003 alone, Fannie and Freddie spent $81 billion on subprime mortgages.

-Subprime loans were bundled into securities, given better ratings by rating agencies, and sold to investors around the world.

-Over time various types of new products with very low initial payments were introduced to borrowers. Subprime borrowers soon began to fall behind on their monthly payments, and eventually defaulted on their loans, sending their homes into foreclosure.

-As more and more mortgage loans began to default, investment banks and other holders were forced to decrease the value of their holdings, and take additional steps since a large percentage of the mortgage investments they held were failing. All of a sudden, there were vastly different values for the same type of investment throughout the worldwide marketplace. Certain banks that invested more heavily in these mortgage securities were forced to devalue not only the investment itself, but their total earnings and overall market value. Investment banks were also forced to set aside increasing amounts of cash to cover loan losses.

-In turn, investment firms found themselves in, as Schwarzman puts it, “a structurally impossible situation.” What happened was, investment banks had to raise money in order to generate fresh income. But the end result was that it cost these investment banks more to raise the money to generate the extra income than they would have gotten back from lending it. They went bust.

Coming Soon: Part 2 — “What’s Being Done To Solve It?”

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5 Responses to “PART 1: How Did We Get To This Point”

  1. david Says: October 5th, 2008 at 3:00 pm

    Where is part 2 “What’s being done to solve it”?

  2. Tim Manni Says: October 7th, 2008 at 12:08 pm

    David, Part 2 is coming soon, it should be written either today or tomorrow. Thanks for reading, check back with us soon.

  3. peter Says: October 15th, 2008 at 3:55 pm

    You seem to be saying that these investment banks were holding on to all these loans..

    “-As more and more mortgage loans began to default, investment banks and other holders were forced to decrease the value of their holdings, and take additional steps since a large percentage of the mortgage investments they held were failing. All of a sudden, there were vastly different values for the same type of investment throughout the worldwide marketplace. Certain banks that invested more heavily in these mortgage securities were forced to devalue not only the investment itself, but their total earnings and overall market value. Investment banks were also forced to set aside increasing amounts of cash to cover loan losses.”

    Yet I was under the distinct impression that the investment banks were merely the ones that took the loans and repackaged them and then ONSOLD them onto other investors, such as foreign investors, insurance companies, hedge funds etc etc.

  4. Tim Manni Says: October 15th, 2008 at 4:20 pm

    Peter,

    We appreciate your comments and thanks for reading the blog.

    Indeed what you have said is true, but, they also invested in the mortgage-backed securities and CLO/CDO obligations which contained various elements of these “bad” loans.

    After all, they are “investment banks” — investing shareholder dollars in hopes of getting a return, not to mention fees for facilitating the packaging deals in the first pace.

    Again, thanks for your thoughts, hope to hear from you soon,

    Tim

  5. mortgage brokers Says: November 21st, 2008 at 12:27 pm

    mortgage brokers…

    Before deciding to get exchange the equity tied up in your property for a lump sum, have you considered alternatives? You could of course sell up and move to a smaller home, but perhaps you have lived in your home or community all your life and have ma…

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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