Deregs

Wikipedia had this really interesting diagram that succinctly explained the above ground cause and response of the housing bubble of 2006-7-8. The section right below is also from Wikipedia.

Text Explanation of the Diagram

The ripple or domino effect was summarized in plain language by President Bush in his address to the Nation on September 24, 2008.^[1]

• Housing Market: As the housing bubble burst in late 2006 and prices declined, mortgage holders counting on home price appreciation found themselves unable to pay their mortgages. Rates on adjustable-rate mortgages increased. Mortgage payment delinquency rates and foreclosures increased. With an oversupply of homes, housing construction declined. Housing value declines meant consumers had less money available for consumption. This placed downward pressure on economic growth, increasing the risk of recession.
• Financial Market: Mortgage-backed securities (MBS) derive their value from housing prices and mortgage cash flows. As these cash flows declined or became uncertain, financial institutions and investors holding MBS faced large losses. In certain cases, they had to sell these assets to pay off margin calls. Bank capital available for lending declined due to these losses. Several major banks and dozens of mortgage companies went out of business. Loans became more expensive (higher interest rates) or unavailable to those without stronger credit. Compared to the boom period, credit became considerably less available, placing downward pressure on both consumption and business investment.
• Government responses: Central banks have lowered interest rates to stimulate economies and make it more profitable for banks to loan. Tax rebates (stimulus package) were provided to U.S. taxpayers. Homeowners received assistance with re-financing their mortgages. Individual firms received bailouts and in September-October 2008 a comprehensive, global solution to "recapitalize" banks (e.g., to provide taxpayer funds in exchange for periodic dividend payments) was implemented. It is important to note that government actions took place throughout the 2007-2008 period, not just after the financial market impacts indicated. For example, the Federal Reserve lowered interest rates several times during various stages of the crisis.

This is not news anymore.  But what we have to remember are all the decisions that were made in previous Administrations that made it easier to qualify people outside of the 34% optimal ratio for buying a house. It took off like wildfire. A whole new financial class of people whose dreams of home ownership were out of reach were now being wooed. And there is a basic truism about money: you have to have it, to learn how it works.

Struggling families like Robert and Martha came to the banks now, with the confidence of buying a home of their own. Their numbers were a little risky, but the mortgage lenders/banks had the ability to lend to them now, and take a chance and tell them they deserved a piece of the American Dream. The family has a poor relationship with banks up until now, but now the bank is their friend.

The bank reviews the app and realizes Robert and Martha owe way too much debt for the ratios they need to buy a place of their own. No problem. They just tweak the earnings portion when they prepare the paperwork so the numbers fall into line. Too much earnings to debt ratio? Just knock off some of that by falsifying the documents further. If the house doesn't appraise right? Just don't include that doc in the loan package.

Robo signers were processing the loan start to finish, without second checks from a bonafide loan officer, and their directive from the ivory tower on the 30th floor was to crank out those loans as fast as they can. During the years preceding the fall of 2008 the loan workers had monthly quotas to meet.

So Robert and Martha get to signing day. They bring their mother and kids along. They don't know any of this. They've never seen the paperwork before, sixty sheets or more of technical math and details that are impossible to read and understand at this juncture. The keys to the house are on the table.

Can we afford this, they ask their lender one last time? You wouldn't have qualified if you couldn't, is the reply. And anyway, it's fixed for three years so you can refinance before then for an even better rate. Think of all the equity in the house by then. You are making a sound investment. You will lose your deposit if you walk away and the seller could sue. Sign everywhere there is an X.

The buyers sign and sign and sign, and no one really looks too hard at it. They skip over the financial documents that led up to qualifying for the loan. The mortgage lender points out the interest rate, the terms of the loan, double checks that the address is correct, tells they they don't even have to pay the first month because it's paid at closing, and hands them the keys.

But altruism has its price.

Banks have been selling mortgage-backed securities for years, and used to have a solid reputation in that market. But as these liabilities grew with risky mortgages, the banks realized they needed to maintain a healthy balance to ensure their profits would continue. What to do, what to do. The ratio of Class C loans were becoming too heavy a load and to make profit on bundling, there must be a balanced ratio. The more class A securities, the higher the profit. There were laws governing how things are classified and sold.

And then someone clever realized that there was a way to cleanse risky loans and give them an A+ rating for resale. It was a hugely technical process that was 'legal' but fraudulent in purpose. Why else would a bank want to make a loan appear to be something it is not?

The Investment Industry took these loans that were robo signed and knew were faulty, plus the risky ones legally done as a result of the relaxed federal statutes, and gave them a bath, dressed them up and sold them as Class A. And then they sat back and collected their profit at the point of sale, right away, and transferred all the liability to the investors who bought the deed.

It was perfect, really. The condition of the market didn't matter as long as things were going up, and there wasn't much chance of a downturn. And anyway, banks had already made their profit up front and minimized their risk to boot.

But the market did turn. And it was the lynchpin issue holding everything up. As investors worldwide realized the bundled securites were leveraged with worthless and risky mortgages, sales dried up. It's an interesting thing about a reputation taking years to shine and moments to tarnish. Homeowners defaulted in record numbers on many properties the banks could not unload, and they were squeezed in the middle of their own game.

In 2011, Bank of America just settled the first of many lawsuits with investors for a whopping $8.5 Billion with a B, and more lawsuits are stacked up chest high waiting in the wings for their day in court. It's a very good thing they have all that stimulus money to pay the fines. And anyway, the Stimulus is just a drop in the bucket compared to their profits. No jail time, not even a slap on the wrist. Chase and Wells Fargo, and the others are not far behind.

This is what comes from uninspired politicians passing legislation they do not take the time to understand. What we should be discussing here is severe, politically imposed penalties so harsh the banking industry won't soon forget. Standards of integrity and ethics aside, what they deserve is a short leash and choke collar.