The Predatory Loan Thing

For years, the world had seen a certain amount of money lie with the biggest nations in the world, with smaller nations in the process of actively borrowing and circulating that same amount.

With the maturity of new economic powers, there was suddenly a good deal more fixed income securities in the world. Now, when nation-states become wealthy the central banks search for steady investments, ideally those that feature little to no risk and perhaps a decent long term return. Countries across the world were hoping for better investments, ones that were long term and safe.

Like, for instance US mortgages? The American Dream has always featured the desire to buy a home, and home prices were on the up and up in the United States.

So, what would happen then is that a broker would sell a mortgage to an individual. Then a small bank would buy that mortgage from a broker.

Now these banks would borrow a good deal from regional banks to buy up these mortgages. Once these smaller banks had about a couple hundred of these mortgages, they would sell them to Wall Street.

On Wall Street, a pool of thousands of mortgages would become mortgage backed securities, safe 30 year investments with a decent 5%, maybe 9%, return. And so all of that new money circulating about in the world, in the banks of various newly well off nation-states, found a new and reliable investment opportunity: the US housing market.

NiNa Loans

These mortgage backed securities became very, very popular. Mortgages are traditionally very safe, since the banks would only give loans to qualified individuals. But eventually, the supply was starting to dry up. It seemed that most people banks would give mortgages to already had mortgages.

But the demand for these securities from across the world were still rising. And so came a corresponding loosening of standards. The small banks only owned the mortgages for a couple of months before they sold them at a profit to Wall Street. So who cared if the loans were a bit riskier?

So now, banks didn’t need to know your income or even your assets for you to qualify for a loan. You could just get a No Income No Asset Loan (a NiNa).

And with this came a flood of individuals applying for and receiving mortgages that they could not realistically afford. Some of these people would default on their first payment. But what did it matter, thought everyone involved. Because housing prices kept rising, if people foreclosed, the bank had technically just turned a profit by acquiring that asset.

And, if people couldn’t make a payment, they could always take out another loan against the value of their rising house. Everyone wins.

History

The historical data proved that these mortgages were safe investments. They could be trusted because foreclosure rates are generally only around 1-2%.

Credit agencies then labelled these new bundles of risky mortgages as Triple A: just as safe as a US government bond.

Well, unfortunately, the historical data couldn’t be trusted because it didn’t feature these NiNa loans. They'd never been done before.

And then, the impossible: housing prices began to decline. People just couldn’t afford the soaring prices anymore, as the average home was now four times the average American’s income (as compared to a historical relation of two or three times more).

So no longer could people take out further loans against the rising value of their house to pay their mortgages. Foreclosures were happening left and right.

And then, Wall Street stopped buying mortgages and creating mortgage backed securities. The smaller brokerage firms now had no one to sell their bought mortgages to so they could not pay back the banks they’d borrowed from. Suddenly, everything was in shambles.

An entire industry went under in a few months and that echoed out globally. Nation states lost about half of the money they’d invested in the housing market. And so they turned their backs on any risky investments. Everyone became very wary about lending any money to anyone. Banks had lost millions by lending to institutions now out of business and were crippled. Corporate institutions were suddenly unable to borrow any money to build and expand. Small businesses couldn’t find anyway to get off the ground because no one would give them a loan. And hundreds of companies depending on their line of credit to stay afloat went under. Lay offs became endemic. The unemployment rate rose across the world.

cite: The Giant Pool of Money, This American Life