333 – Street Level

Yesterday I was talking to Lena about the country’s recent financial woes, and I realized that there were some holes in my knowledge. So I decided to go out and get smartified on the subject… and now I am passing that smartification along to you!

Step One: Show Me the Money

Back in 2000, when the Dot-Com bubble burst, Alan Greenspan, the then-Fed Chairman, set the nation’s banking interest rates to historic lows to keep our economy out of recession. This was generally considered a Good Thing.

Low interest rates increases access to money, and results in individuals and businesses borrowing, and spending more money. The economy expands, and happy balloons go up. This too was considered a Good Thing.

Flush with cashola, banks were looking for new ways to loan it out. (That being the way banks make money.) In order to create new clientele, the banks began taking a second look at subprime borrowers, meaning folks with low credit scores. (Technically someone with a FICO score below 620.) These were people the banks typically ignored as being too risky to loan money to. (Yeah, there was no way this idea was going to blow up in their faces.)

So the banks adjusted their borrower’s interest rates to reflect the greater risk they were taking, and made a few loans. (They charged more for loans to folks they thought were likely not to pay them back.) Interestingly, there were much fewer defaults (deadbeats) than expected, and the whole enterprise went surprisingly well.

Step Two: Entering the Minefield

At this point the lid kinda blew off. Suddenly everyone wanted a piece of this great, untapped new market… People Who Couldn’t Pay! There was huge competition to sell mortgages to People Who Couldn’t Pay, with aggressive and very creative strategies for attracting them. Many, many new mortgage “products,” or as I like to refer to them, “rape loans.” The basic idea behind almost all of these products is to sell the customer a loan that is going to cost him ten dollars today, and a hundred dollars tomorrow. (After the lender has gotten safely the hell out of Dodge.) Also, these new strategies of lower front costs allowed the lenders to keep lowering the bar on who they were willing to give a loan to, expanding the customer base further into the “People Who ReallyCouldn’t Pay.”

Now a few years ago banks started what they call “securitizing” mortgage loans, the practical upshot of which is that when you obtain a loan from a bank, they can now sell your debt to another bank, freeing up all that money again to give a new loan to the next guy in line. (Basically, they’re forgoing all that interest, and just cashing in on all those fees you pay as closing costs.) As a result of this, all those subprime loans were spread throughout the financial institutions of the country, and even the world. These loans had to be disguised or held as “off book” assets in many cases in order to be purchased by companies who were otherwise restricted from purchasing subprime debt. (Restricted because it’s stupid, in case you didn’t make that connection.)

Step Three: Boom

Now subprime borrowers are mostly subprime because they can’t handle money. When the loan payments for all of these folks started increasing, (for most a few years into the loan and kicked off when Alan Greenspan…remember him?… started readjusting the nation’s interest rates back from 1% to the 4 and 5% range) the payments that they could just barely afford to begin with suddenly flew out of reach. (It’s a valid point to observe that these people should not have taken these sucker-punching loans, but we’ve already established that they weren’t good with their money.) There were suddenly defaulting loans popping up everywhere. This was generally considered a Bad Thing.

Hundreds of billions of dollars worth of losses started materializing all over the world, and with mortgages having been sold as part of umpteen types of crazy investment vehicles in order to camouflage what it actually was, banks stopped lending money to each other because they had no way of knowing how much bad debt the other banks were carrying, and whether or not they’d get paid back. This was potentially catastrophic because many of these gigantic banking institutions use short-term loans from each other as their operating capital. (Day to day money.) When that stopped… no more operating. Plus, banks were using the short term loans to pay for the all the mortgage debt they were buying. Suddenly they couldn’t pay for them any more. This too was considered a Bad Thing.

Part Two will appear Thursday the 25th. See you then!

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