The Coder Behind the Mortgage Meltdown

axjms writes "New York Magazine has a confessional/abdication from the man who wrote the software that turns mortgages into bonds and those nasty little things called CMOs. An interesting first-person account from a coder whose work reached far beyond what he or anyone could have anticipated."

Comments

More than anyone could have predicted?

[brian0918]

This article from eight years ago sure did a great job of predicting this whole thing. Is it any surprise that when a government (whether under Clinton or Bush) promotes "affordable housing" as an end in itself, by manipulating interest rates and bank regulations, that they're bound to create a bubble, and bubbles by definition cannot last?

Re:More than anyone could have predicted?

[vertinox]

Is it any surprise that when a government (whether under Clinton or Bush) promotes "affordable housing" as an end in itself, by manipulating interest rates and bank regulations, that they're bound to create a bubble, and bubbles by definition cannot last?

I think they key problem here was the lack of regulation than too much of it.

First, subprime lenders were lending money to people who didn't even meet federal standards, then bundling this toxic debt into CDOs and then selling it off to people who didn't even look at the credit of the people in the inside and then sold it to other people.

Secondly, the subprimes were talking these people and other borderline credit score people into adjustable loans.

Then federal reserve twiddled its thumbs about raising interest rates when it needed to calm the situation but because everyone had adjustable loans, the had no choice to default en masse making the situation worse.

Oh and don't forget about the uptick rule that the SEC removed that prevented short sellers from shorting on stocks on downward movement that had originally been in place for 70 years because of the 1929 market crash! And people have to ask why the market did what it did.

So yes... More regulation would have stopped this.

1. Banks and subprimes should have been regulated into not giving loans they knew could not be paid back.
2. Uptick rule needs to be reinstated which they are doing soon under the new head of the SEC.

And don't bitch and moan about free market because it has been historically observe that free market does correct itself but always... AND it always creates boom and bust cycles through the past 500 years of free hand markets. Which is why we get depressions.

Here's one reason the financial system failed.

[Anonymous Coward]

Two words: Information asymmetry.

Re:Here's one reason the financial system failed.

[__aagmrb7289]

Variable rate mortgages aren't really all that hard to understand - it doesn't take an expert to understand that when things go bad, your rates will go up - perhaps to unaffordable levels. I've seen the friggin' paperwork - it's just not that hard to understand, if you bother reading what you are signing - AT ALL. Blaming the mortgage broker alone is silly.

CMO vs. CDO vs. CDS

[Fantom42]

The end of the article starts to get to the heart of the problem, which really happened after he was involved. It was when they started doing this with all debt that it got really bad. And even then its only half the picture without looking at the other piece of this the Credit Default Swap. Another thing he alluded to when he talked about default models. The problem was much more complicated than this one guy.

Re:This topic is too hot to handle.

[bunratty]

Frontline on PBS had a good explanation of the mortgage meltdown. The problem wasn't the securitization of mortgages itself. The problem was that financial institutions borrowed money to buy more mortgage securities than they had in available cash, creating an insatiable demand for securitized mortgages. In an effort to keep the supply of mortgages to meet the demand, mortgage companies lent money to anyone who could breathe, even if they clearly couldn't repay the loans (i.e. "subprime mortgages"). When the homeowners defaulted on their loans, the bank seized their properties, which were the collateral for the loan. Because so many homes foreclosed, it created a huge supply of houses for sale on the market. This huge supply made housing prices drop, so that other home sellers owed more money on their mortgages than they could sell their house for. This in turn led to their houses going into foreclosure. Wash. Rinse. Repeat. For each foreclosure, the supply of money to the securitized mortgages dried up, making those securities drop in price. Because financial institutions had borrowed money to buy those securities, they ended up losing more cash than they originally had, which any investor knows can happen if you buy on margin.

It's all pretty simple, really.

Re:Oh, jeez, not more CRA-blaming

[dkleinsc]

Some citations for those interested:
http://www.ccc.unc.edu/news/news.021809.php
http://www.clevelandfed.org/research/Commentary/2000/1100.htm
http://www.treas.gov/press/releases/ls564.htm

All are very clear that the CRA had little to nothing to do with the subprime mortgage foreclosures.

Re:This topic is too hot to handle.

[CFTM]

Wow.

That's all I have to say about that one.

Wow.

Hyperbole, Check!
Misogyny, Check!
Confusing Causation and Correlation, Check!

Re:This topic is too hot to handle.

[Americano]

This system is, I think, known as "owner financing" - the current owner of the property agrees to finance the purchase, and in return, the buyer pays them a monthly payment (instead of a bank); if the buyer defaults, ownership of the house would revert back to the original owner.

Problem with this is, you still need somebody in the mix who has a vast sum of money - bank or owner - to provide the financing for the new buyer, or the new buyer will end up paying exorbitant monthly fees to cover the interest & risk on the loan the owner must take out to provide financing.

I'd amend your initial sentence to read: "There's no reason everyone couldn't own a home they can afford." This is the problem - some predatory banks extended too much easy credit to people knowing they didn't have the means to repay, and some unscrupulous people took that credit knowing they didn't have the means to repay. Not everybody is a crook on either side, but both sets of people are guilty of ignoring the simple reality that they were spending (or enabling people to spend) beyond their means.

If you buy a house you can't afford based on the assumption that "home prices will always rise, so I can just refinance once I have equity!" are taking a gamble, not making an investment.

Re:This topic is too hot to handle.

[loteck]

Because they aren't allowed to charge interest (too Jewish or something)

It's called usury, and it is prohibited quite explicitly by Islamic law. Nothing to do with Jews.

Re:This topic is too hot to handle.

[Estanislao Mart�nez]

If it is obvious that the debtor will never be able to pay back, you would have trouble selling the loan, right? Unless the buyer is unaware of the risk involved, of course.

Exactly. Securitization packages up pools of loans into bonds that get given a credit rating by an agency. A lot of bond buyers just go by the bonds' ratings. These bond buyers are the ones who ultimately provide the easy money that ends up being used for the junk mortgages.

Who are these bond buyers? All sorts of banks, and, more worrisome, retirement pensions and bond mutual funds in people's 401k plans. Look, for example, at what happened to Fidelity Ultra-Short Bond Fund. This is a fund that was supposed to be extra-low risk; it lists "preservation of capital" as a goal, and it's supposed to compete with money-market funds and bank accounts. It lost 20% because of exposure to highly-rated subprime securities.

Re:Oh, jeez, not more CRA-blaming

[Rycross]

If you actually read that, the CRA did not require or force banks to make risky loans. They could deny an applicant based on income, credit rating, or any other relevant factors. What it forbid was red-lining, which was denying loans based on the current living location (used as a proxy for the applicant's race). A person's race and living location does have correlation with risk of defaulting, but a responsible financial institution would have a person's credit and income information. This information points to causitive factors behind the correlation, which means that a person's living location is useless for anything other than discrimination.

The actual CRA law does not require high-risk loans, and the evidence bears this out. CRA loans were given out for three decades with no problems, and all current evidence points to CRAs having little to do with the current financial situation. The citations in Wikipedia article you posted bear this out, in addition to the seven citations the other posters gave.

Furthermore, the criticism in the Wikipedia article you cited is mostly just "he said she said," accusations, devoid of any facts. It would be more convincing if the detractors could point to actual evidence that the CRA loans were a problem as opposed to speculating. How detractors imagine the CRA works in theory is not very interesting to me. What I am concerned with is reality, and the reality seems to be that the CRA makes a convenient scapegoat for free-market advocates, given that they can't give any objective evidence to support their point of view.

If you were hoping to change anyone's opinion, you failed.