I’m one of those people fascinated by the mortgage/foreclosure crisis: how it happened, how it was allowed to happen, the resulting effect on Americans and their communities …
So I’ve recommended Michael Lewis’ The Big Short to a lot of people. Lewis is one of these talented writers who can take a sprawling, complicated issue and make it easily digestable. In this case, he focuses on the six or so people who saw the bottom coming and bet against the American mortgage machine. By doing so, he encapsulates exactly what was going on and how things were slipping through the cracks.
Fresh Air’s Terry Gross also focused on the “complex foreclosure mess” last night with New York Times financial reporter Gretchen Morgenson.
One of the things that both Morgenson and Lewis talk about is how a bunch of risky loans would be pooled together — and because that seemed to equal a diverse portfolio — it would be given a better rating.
From Fresh Air:
“Thousands of them would go into one security, like say 10,000 mortgages, from a variety of places. They were trying to achieve diversification in these pools so as to diminish the risks associated with them.
And so you would have varying economic ability to repay in the loans. You would have very high-grade loans, you would have subprime loans, you would have a variety of loans from different geographic areas. And so this would, you know, it was hoped, be put into a security that would perform well over time and, you know, where people would repay the mortgages. And at the end of the line, the owner of the securities, and there were many of them because they were sliced up into varying risk degrees, okay. But in case, the idea was that everyone pretty much would get repaid at the end of the line.
Well, what was happening that many people did not recognize was that the types of loans were poisonous, toxic as you describe them, made to people who could not repay them, carried interest rates that would ratchet up dramatically after a few years, thereby making certain that they couldn’t be repaid.”
Lewis goes even further, talking about how loans were made to people who had very little credit history (thin credit files). Say, recent immigrants to the country. Because they had no previous credit history, it was easy to manipulate a high credit score. These loans would then be used to help achieve a certain average credit score in the pool of mortgages, making them appear to be less risky.
So if you’re interested, both Lewis’ book and Gross’ interview are worth a look.
