Mortgage Melt Down of 2008
I wrote an article dealing with the Money People years before the mortgage collapse of 2008 titled, Mortgage Fraud 101. It discusses the consequences of committing mortgage fraud on the perpetrator, his family and somewhat on the immediate victims.
I recently watched the movie, The Big Short and realized I hadn’t written about some of the obstacles the loan officers, the men and women on the front line, faced. Most of the movie deals with what happens after mortgage loans are made. A few minutes of this movie portray the loan officers, the ones who deal with the consumers who are purchasing a home, as wheeler-dealer; slick fellows who are playing fast and loose with the guidelines.
I believe there is a misperception that most of the loan officers in the 2000s were operating fraudulently. They weren’t. They were originating loans pursuant to some loose guidelines from real loan programs.
This is not to say that there weren’t loan officers who were crossing the line and committing fraud. There were. But that happens now and in every decade. It was not confined to the first decade of this 21st Century.
The Money People Mortgage Loan Guideline Basics
In order to understand how things got so messed up you need to understand some of the basics.
Mortgage loans have guidelines. This example will demonstrate one:
Ben asks if he can borrow some money to buy a house that costs $100,000. You think, “Hmm. Not a bad idea, but will he pay it back?” You tell Ben that you will lend him the money. But just to be safe, you’ll only give him $80,000. If he doesn’t pay it back he has to give you the house, which is currently worth $100,000.
Ben asks you, “What’s your angle here?” You tell been, “Since you’re putting $20,000 into the deal, you are much more likely to pay me back. Because if you don’t, you loose your house and your $20,000.”
This is an example of a down payment or, equity guideline. For this particular guideline, 20% down payment requirement, is considered to be pretty safe risk.
The Value of Mortgage Loans
Money in your pocket right now is more valuable than money in the future. It’s basic supply and demand. If I need food today but don’t have any money, I have a need for money right now. If you have more money than you need for food today you might lend me some of your money. You’ll need that money for food tomorrow, but you’ll let me have some today as long as you are confident that I’ll get it back to you before tomorrow.
Since there is risk on your part you want a couple more bucks in exchange for lending me the money.
The Money Comes from the Money People
Think of a pool of money. Literally, a swimming pool full of cash (it’s fun). The bills total exactly ten million dollars, and you are in charge of it.
The Value of a Pool of Money
Once you loan out all the money, it’s gone. Now you can’t make any more loans until you receive enough of the monthly payments so that there is at least enough money to make another loan. This can take a while. So, since people know that you are the guy to go to when they want a mortgage loan, you have a need for large chunks of money right now.
What if you could sell your loans to people who don’t need to get their money back right away. They are fine just getting the monthly payments over 30 years. Since they are eventually going to get much more in interest than the amount of money they spent on buying the loan from you, there is more value. In this case, they would be willing to pay a bit more money than you loaned out. For example, they might be willing to pay you $104,000 for a loan than the loan you made for $100,000.
This is a benefit to you since you now get to put the $100,000 back into your pool. Additionally, you made a profit of $4,000.
For the person who bought that loan, they will get their $104,000 back, plus interest in 15 or 30 years (or whatever the term was of the loan).