Starting in 2002, the U.S. Congress started putting pressure on lenders to provide mortgage loans to people who would normally not qualify for a mortgage. The Congress strongly suggested that the lenders were redlining specific neighborhoods and discriminating against certain groups of people. It was suggested that lenders might need to be investigated and/or new laws created to stop this discriminatory practice.
The lenders then invented a way they thought would accomplish the task and be "safe" by pooling subprime mortgages with prime mortgages and then dividing them into liquid securities (CDO's).
At about the same time there was a growing ton of money slushing around the world that was driving interest rates down. The money investors (your 401K, pensions, etc.) wanted higher rates on their investments but the supply couldn't meet the demand so rates kept falling. Then the CDO was born which could offer 1-2% higher interest than everything else. Looking back the subprimes should have made the CDOs offer 6-7% higher rates, but the abundance of money kept them low. Also, the rating agencies pronounced them safer in the CDO's therefore a higher premium wasn't needed.
The subprime mortgage borrowers saw their chance to get a house, an unbelievable opportunity. Many took the mortgage and didn't pay much attention to the details. The additional new buyers in the market then drove house prices up which made the subprimes look ever safer both for the borrower and the investors.
The banks loved it because they could sell the mortgages off to investment houses who then packaged and sold them as CDO's to world investors. The banks didn't have to keep risky mortages on their books and they got to collect the fees for receiving the mortgage payments. They serviced the mortgages but did not own them. The investment houses made money on the sale of CDO's. The world investors (your 401k, pension, city government, etc.) got 1% better interest for "no extra risk". The subprime borrowers got a house, the American dream. Congress accomplished it's goal of more people in homes. It was a win for everyone. Why would anyone not want to do it.
Unfortunately, the ridiculous initial low rates on the subprime mortgages started resetting and subprime borrowers found they could not handle the large increases. The foreclosures started increasing and the banks were soon discovering they didn't have enough cash to cover the losses. The banks started worring about loaning money to other banks so they stopped. This froze up the credit markets for everything (houses, cars, business loans, etc.). Businesses discovered that they couldn't fund their normal operations. Fear gripped everyone. Businesses started cutting employees. Employees became fearful. Everyone is cutting back. Home values fell, job losses started prime mortgages to start failing. So here we are.
Who is guilty for this mess? The answer is everyone either directly or indirectly.
Subprime borrowers for not understanding their mortgages.
Lenders for not making sure the borrowers understood their mortgages and for underestimating the risk to investors.
Government for pressuring for subprime mortgages and not thinking about what lenders and markets had known better for over 70 years. You don't give mortgages to people who can't afford them.
Investors like you for wanting a better than 3% return on your investments so you could have that nice retirement.
So there we are. We're all implicity or explicitly guilty and we all need to realize that we're going to have losses. That's just the way it is.
I think everything will resolve itself faster if we just face the losses whatever they will be and then move forward. All these goverment actions to try to prevent the losses as much as possible will just drag the pain and fear out for years.
p.s. My 401K is now a 101K. ;-)
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