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

This topic is too hot to handle.

[mosel-saar-ruwer]

There is no way in Hades that this topic could possibly be addressed honestly - not at NYMag, nor at /., nor at any other mainstream news outlet.

The underlying horror of the demographics at work here - and the galactic insanity of the CRA & the redlining initiatives & the fiduciary disaster at Fannie & Freddie - is just too much for the circuits to handle.

Not to mention - heck, even I can't mention that one.

Re:This topic is too hot to handle.

[slashdot_commentator]

Cut the crap. You're telling me that FMA and FRE caused the world financial meltdown??? That's like blaming Bernie Madoff for the world financial meltdown. FMA and FRE were improperly run, and neutralized regulators, and its going to cost taxpayers in the 11 digits. But they are only a small part of the mortgage market collapse. Residential housing is not the only construction sector being hit, and how many poor people could FMA and FRE subsidize to go bankrupt?

Look at how bank lobbyists were able to deregulate their industry. What happens when they go into financial competition with a gov't program? They scream bloody murder. Its like saying unionism caused the American economic collapse.

Re:This topic is too hot to handle.

[Hatta]

if it wasn't for the "affordable housing" and "homeownership for all" agenda pushed by both the Clinton and Bush administrations?

There's no reason everyone can't own a home. Whether you own or rent, you are paying for your living quarters either way. In fact, renting is even more expensive than owning when you consider that you don't get to keep any of the equity, and the landlord needs to make a profit. Knowing this, I would argue that any system where the vast majority of people are not home owners is fundamentally broken.

So the crime here isn't that poor people had the audacity to buy homes. The problem is the accounting tricks our fucked up system needed to get the poor people in their homes. If, instead of lending large sums of money to poor people up front, our system allowed people to pay as they go and still build equity in their homes, this wouldn't be a problem.

I imagine some kind of a rent-to-own for homes. If you stay the whole time and pay it off, you get to keep the house. If you can't pay it off for some reason, you're no worse than you would be if you had rented, and no one lost the cash they would have lent you to buy the home. Seems like the best of both worlds.

Re:This topic is too hot to handle.

[umghhh]

Oh so it is a housing and mortgage that are problematic now? I mean any credit can default and if there is enough defaulted credits there is no system in the world that can sustain damage. There is another problem of course that all the financial products similar to insurance where not following any rules that are forced upon real insurance companies making it impossible to pay in case things go wrong as they seem to do. And then there is another problem that greenback is thought to be world currency and holds to its value although it should not - not with such deficit that US has. Now it works all well as long as holders of dollar denominated reserves believe they have value but it paralyzes the system as the holders are scared shitless to move their dollars and so the gov starts to print big time. Until dollar loses some value the economy will not pick up and this does not happen until dollar falls. I suppose all other problems being big and nasty are just a side effect of the inbalance in US-world relationship where US was allowed to buy products so cheap that their production became unprofitable everywhere else except China etc. The problem became so big that even economy as big as german went down with it. One of the reasons why dollar holds value against other currencies is that countries that still produce anything have no transparent financial markets and governments that all to readily take their money, so even if dollar is not as good as it once was it is still better bet than to live your account in say China. Paradoxically excellence of US and UK financial system breaks the system by itself. It is mind boggling and yet it seems that this was unavoidable as the structures that brought down the system were the same as the ones that made it working in the first place. To see it from another angle the system if left alone will go bananas as it did. Too much freedom for one component (finance) while others have to follow constraints of physical entities is apparently bad. Who might have thought.
I only hope that the return to economical normality will not take another WW.

Re:This topic is too hot to handle.

[geoskd]

Renting is not more expensive than owning property. It's fairly borderline, depending on what you do with the money you save through renting. There are plenty of other ways to build equity.

Renting is absolutely more expensive than owning, by a *very* significant margin. When people figure the cost to own vs. cost to rent, the costs are almost always figured in the present tense, but you need to consider the cost over the lifetime of the occupant. If you are looking at a house that costs $150,000, and you can get 8.0% (not great, but not horrible for someone on the low end of the credit spectrum), then you will pay about $1000 / month in rent, plus about $290 / month in taxes. A fair observation is that the property will also cost you an additional $290 in maintenance and insurance, so your total monthly cost is $1580. Now, say you can rent the same property for $1100 / month today, saving you $480 / month.

Sounds like renting saves a bunch of money doesn't it... Now stop and figure in the rest of the equation. That mortgage will cost you that same $1000 for thirty years, so you paid $360,000 plus about $105,000 in taxes, and $105,000 in maintenance, for a total of $570,000: bottom line, you have $150,000 in equity (assuming no growth in the homes value, which is ridiculous over that kind of time scale) for a total cost of $420,000. Divide that by 360 months, and you have $1166 / month (about the same as you were paying in rent to begin with).

Now, the magic part comes when you remember that you will *not* be paying $1100 per month for the rest of your life, every year, the rent will increase by roughly 3%, so in thirty years, your rent will be $2670 / month. If you calculate the total cost of the rent over 30 years, it then comes to $678,000, which is much higher than the $420,000 you paid to own the same home above. This is the fundamental reason why investors are willing to buy a property even knowing that the rent is 30% or more below what their monthly costs are at the start. Even if the property never gains any value at all, the investment still makes money, and the increase in property value just sweetens the deal. Plus after thirty years, their monthly payments drop by 60%, but the rental income stays the same; making rental property ideal as a nest egg for retirement: It starts paying off big time right about when you're ready to retire. The trick is surviving the first years while the investment is still cash flow negative.

This basic investment strategy, and the lending practices that enabled it, caused our current woes. Most of these investors were affluent people with big paychecks, leveraged to the hilt, so when things turned a little ugly, it took them down whole. Add on top of that, the speculators buying and selling houses based purely on the expectation of rising home prices, and the whole thing looks like what it was: a big bad idea. A bunch of investors who just wanted their money to earn money and didn't feel that they had any responsibility to have to work for their earnings, coupled with a bunch of over ambitious "entrepreneurs", who saw the long term potential of investment property, and over estimated their short term ability to take a loss, and down it goes. I own rental property. I started five years ago, but I took a slightly different approach. I only bought the properties I knew I could get a positive return on investment on right from day one. It doesn't need to be much, in fact, I can live with break even for a long time to come, but i was *very* careful. I turned my nose up at plenty of deals that would have paid of big time in the long run because of the sure knowledge that a turn for the worse would bring me down just like the rest. The funny thing is that most of us in the business saw trouble coming early, and scrambled to make ourselves healthy, which had the perverse affect of adding fuel to the fire. (I myself cleared two of my riskiest buildings right at the height of it, and clearly remember my mortgage agent thi

Off by one

[diablovision]

Makes my off by one errors seem so quaint. Add 12 zeros and soon you're talking about real money.

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

[dkleinsc]

That is one of the most fantastic explanations ever offered, and by an AC no less.

A more in-depth explanation for those who want more than 2 words:
1. A mortgage broker knows more about mortgages than your typical homeowner, and uses that advantage to sell a bad deal to said homeowner. The reasons it's a bad deal are buried in the fine print that would take a real-estate attorney to sort out (which a typical sub-prime borrower couldn't afford). The mortgage broker promptly collects the commission.
2. The mortgage company that the broker works for builds a security that nobody really understands that effectively hides the bad loan that the broker gave out. They work with the security rating agencies to make sure it has a good rating even if it shouldn't. Once someone buys the security, the mortgage company has its profits and no risks.

In other words, every step of the way the mortgage brokerage has more information than any other party, and uses that to screw over borrowers and investors.

Re:Buck passing...

[macraig]

Economists actually don't know anything - anything correct - about economic systems. They've been beer-bonging the wrong Kool-Aid and preaching the wrong sermons for a very long time; the entire field of economics has been hijacked by a greedy minority and perverted to their benefit. Climatologists actually understand more about economic systems than economists do, since climate and economics have quite a bit in common in terms of systemic behavior.

40-year low interest loans

[xjerky]

That played a large part in this problem. I was eyeing a home from around 2000-2001. Proces were still reasonable. Then the rates dropped to ridiculous lows. Great, right? But then that caused a mad rush on homes, driving the prices to even more ridiculous highs. At that point, your monthly payment became even higher than when the interest rates were higher. At that point I dropped out of the market for a house. Who the hell else didn't see this coming? Who was Alan Greenspan really helping by keeping the rates so low?

Re:The real reason behind the meltdown

[david_thornley]

I was contracting at a mortgage company from Summer 2006 to Summer 2007, working on a model to predict mortgage behavior (and watching the office getting emptier and emptier). A few observations.

Why, in the name of the FSM, did my data have "stated income" as a yes-or-no field? Nobody sane would make a major loan to somebody who couldn't even verify his or her income, unless they had absolutely no concern about whether it would be paid. Nobody sane would purchase such a loan from a broker. There was no federal regulation saying "You have to make loans to indigent liars" that I know of.

We had several projections of housing prices. The number of them that showed any sort of decline? A bit less than one. It wasn't that nobody was talking about a bubble, either.

What I saw was idiotic, short-sighted, greed, laid out in 1s and 0s. This had nothing to do with any sort of pressure, other than for the quick buck right now.

If was the Li's formula

[S3D]

Wired: The Formula That Killed Wall Street
David X. Li formula used "Gaussian copula function" for risk estimation. It greatly oversimplified risk estimation and ignored any nonlinear, topological and whatever nontrivial dependencies, taking into account only single correlation parameter. Formula was applied recursively and the end result was completely divorced from reality.

Re:More than anyone could have predicted?

[thethibs]

Nassim Taleb repeatedly predicted these events and made a fortune putting his money where his mouth was.

death star contractors

[evilmousse]

oh good, my comments still there from the first time i saw the story:

i programmed in some of the same subject matter for several years recently, and much of this strikes me as a very believable tale. ...except it feels history-rewritten so as to remove any negative light from the author. he comes off entirely too saintly-while-surrounded-by-evil, and that makes me wonder what else to believe.

in particular how he made it seem like he just happened to fall into his deal to maintain/integrate/etc the software for its new owner, unpaid for a cut of its sales. that's a daring endeavor you take only when you honestly believe in long-term success, so i don't see "i'm tired and wanna take something easier", i see "all in, show your hands boys" kinda farm-betting. he knew then like he said now that his software could become the standard, shot for and achieved success. but i don't think his waxing philosophical about the potential dangers of that success started only after the trouble.

the contractors building the death star knew the risks of that association, so to speak. (I should explain, this is a meme, and honestly an unfair comparison)

Re:Requirements?

[musicalmicah]

Coders don't design faulty business logic. Coders code what they are told to code.

But the best coders have the guts to point out problems in business logic if they discover any in the design or implementation processes.

CRA

[weston]

the galactic insanity of the CRA

Whether the CRA was a good idea or not might be up for debate, but if "galactic insanity" implies that it was operating at a scale necessary to be a real driver of the crisis, there are significant indications you're wrong.

Consider, for starters, these statistics:

"Federal Reserve Board data show that:
* More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions...
* Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that's being lambasted by conservative critics."

There are a number of other relevant resources (such as those posted elsewhere in this discussion and in my comment history) which also examine the idea that the CRA was a significant cause of the current problems. The data seems to indicate that not only were CRA loans not any significant portion of problematic loans, they're actually turning out better than comparable private loans.

confession?

[superwiz]

He was part of a team that wrote some trading application. Confession? Is this a joke? Blaming wall street for this meltdown is like blaming your electrician when the power company stop providing power. All they do is repackage stuff. All the repackaging in the world wouldn't raise home ownership from 20% to 30% in 10 years. This was through policy... Brought to you by your friendly government (which I must be a right-wing nut for questioning, right?). Reminds of a the Jackie Mason joke: "This is the richest company in the history of the world and every year we lose money. That's because your congressman gets paid whether we lose money or not. I say put em on commission..." Honestly though... It's the "ownership society" that created this crisis -- not the middleman they are trying to blame now.

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

[AvitarX]

I don't think this is true.

The general terms of a mortgage are fairly simple, and don't require an attorney to understand.

Things like interest only, balloon, ARM are easy to understand to most everyone, unless they do not have it explained. The mortgage broker misrepresenting is not legal. Not that it matters, because their commission won't cover the damage done (houses losing 20% of their value when mortgaged against 100% of the purchase price).

The real problem is that nobody gave a shit, because if someone couldn't pay their mortgage, it was easy enough for them to sell the house for a profit and get out anyway. The banks didn't care, because they were getting money for nothing lending to people that couldn't afford it. Said people would just sell the house, and make money even.

A guy I work with purchased 3 houses interest only, turned them around in 8 months for a nice profit and purchased 3 more. Now the mortgages have adjusted, and are no longer interest only. He has one rented out now, with the rent being hundreds less than the mortgage payment. He knew what he was doing, and I am willing to bet that it was people like him that caused the crises much more than the un-informed masses.

I would hear a lot of "well if it is too much house, I can always sell it", even if it wasn't purely for profit, and just a nicer house than could be afforded.

I say this as someone who has nothing but benefited from the loser rules of the last 4 years.

They let me get a mortgage there was no way I could pay (using their calculations), I knew I could because I had 2 room-mates lined up for an additional $700/month they didn't consider, but I could easily have wanted to move my family of 4 into the house too. Nobody in the chain of responsibility would have cared, and this with about 1% down (plus 3% sellers assist). Mortgage + Car + Car Insurance left me $340/month to live.

I then went and purchased a house to move into about 6 months ago. My wife and I qualified for the second house, while I still owned the first. The two mortgages combined are within $1000 of our total take-home (best case). Considering the other costs we have to keep alive and employed it was a pretty bad bet to make IMO (and actually by that point people really should have known better).

Cost to fix problem = $206k per person-on-planet

[Richard0Thomas]

Apparently a lot of people do not know what they are talking about. The people most invested in the system cannot see the flaws and do not want to. The financial jargon is used to obfuscate. Some genius that actually understands it all at the byte and master accounts level, made it very simple for everyone to understand.
Derivatives = Bets
Credit Default Swaps = insurance on bets
Hedge Funds = borrowing of money to gamble with (unregulated and secret also used to manipulate markets)
Taxpayer Bailout = Taxpayers covering the gambling losses for gamblers? (it won't happen without a revolution taking place to correct it)
Reality = Insurance (e.g. AIG) cannot cover failed bets which amount to: USD 206k per person-on-planet.
The number it is based on has grown from USD 1.144 Quadrillion to USD 1.405 Quadrillion, ie, +22% worldwide. The GDP of the entire world is USD 50 trillion. The derivatives "bets" total USD 1,144 trillion which is 22 times the GDP of the whole world. The money 1,144 trillion doesn't really exist in system but only in the terms of a contract, artificial value not validated by economic system participants. It would be inappropriate for the citizens to go into debt as they already have, to cover these contracts. The people that created this catastrophe do not feel the pain of their decisions, but the common folk do. You can read all the rest of this and a bunch more insight into a system that would actually work on http://coinage.me/ Perhaps most ironic was an attempt to build a computer game based on the current economic model, eventually the game / economy always crashed.

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

[Splab]

The problem isn't education per se. Here in Denmark most people are well educated, but common sense is not on the agenda, while our housing situation isn't as bad as the US, it's still pretty rough for some home owners - the problem is people happily signed the contracts without reading them nor understanding them. If you don't get the numbers you call someone who does, people just blindly trusted the bank.