Monday, June 16, 2008; 12:30 PM
Washington Post staff writers Alec Klein and Zach Goldfarb were online Monday, June 16 at 12:30 p.m. ET with guest John Taylor, Stanford economics professor, to discuss their three-part narrative series about the U.S. housing bust.
A transcipt follows.
Read the series online.
Alec Klein: Thank you all for joining us today to discuss our three-part series in The Washington Post about the housing boom and bust. We're glad to be joined by Stanford economics professor John Taylor. We have a lot of questions, so let's get to them.
San Francisco, Calif.: I live in a city where the median income cannot afford to enter the bottom of the real estate market without ARM's or other exotic loans. A crash seems like the only solution.
Do you foresee government "fixes" or new exotic loans preventing a crash and somehow sustaining real estate at these ridiculous prices?
Thanks! And I loved your articles!!!
John Taylor: You make an excellent point. The bubble led to prices that are simply too high in many parts of the country. A correction will make houses more affordable. This will make it easier to attract people to live in the Bay Area, for example. It is kind of a silver lining to the black cloud of the crisis.
Alexandria, Va.: As a renter & amp; single person, I was locked out of the housing market by the ridiculous prices for entry-level condos. At $70k I couldn't afford even a one-bedroom. And now I'm supposed to feel sorry for people who got in over their heads buying million-dollar McMansions using their first home as down payment, while I've been making my landlord rich? The popping of the bubble isn't bad news... It's GOOD news for people like me who knew what they could afford and knew the inflation couldn't continue forever. Why should my tax money be spent bailing out the people who made it impossible for me to afford a place of my own?
Alec Klein: Your comment raises an interesting debate being played out in policy circles: What should be done about the bursting of the housing bubble? To what extent should the government bail out homeowners? Some look to the rescue of Bear Stearns as an example of how the government intervened, potentially putting taxpayer money at risk. As reporters, we leave it to the experts to work this out.
Utica, N.Y.: My personal definition of a bubble is when a normal market upswing based on good business practices is artificially extended through bad business practices.
The dot-com upswing started with Silicon Valley venture capitalists sorting through the nerds' ideas and then teaching them business and marketing. It became a bubble when Wall Street venture capitalists threw money at any idea without sorting out the bad or hand holding the inexperienced nerds.
The housing bubble started with increasing home ownership to qualified buyers and became a bubble when credit was given based on home price increases and second mortgages/home equity loans were given for short term items like boats, cars and vacations.
I think that future bubbles may be controlled by watching for this transition. Do you think this can be done?
Alec Klein: You would think that history serves as a good lesson--and yet the dot-com boom and bust didn't happen long ago, and I think it's fair to say that the euphoria that gripped the Internet at the beginning of the decade took hold in a similar fashion now near the end of the decade. It makes me wonder: To what extent can greed be controlled?
Floris, Va.: Gentlemen: After George W. Bush won the 2004 election he began touting "the ownership society." This approach was three-pronged: One: privatize Social Security which was rejected by the public. Two: pay for your own illnesses through Health Savings Accounts which was passed into law but has become just another kind of tax deductible retirement plan since you don't have to tap the money if you get sick and you earn interest on the funds. The average income of someone with an HSA is $166,000 by the way, so one could look at this as yet another tax break for the rich.
Part three was the home loans. This administration wanted as many of us as possible to become mortgage owners based on the belief that after buying a home, one becomes more conservative. So how much did the White House encourage lenders to open up and offer money to people who--as it turns out--had no business buying a home based on their credit in the first place?
Zach Goldfarb: The notion of an "ownership society" certainly helped raise the profile of subprime and other unconventional loans in the first part of this decade. While the Bush administration certainly promoted the idea, it wasn't alone. The Clinton administration, Republicans, Democrats and others also embraced the idea that the financial markets had found ways to get loans to low income people, minorities, immigrants and others who had not in the past had access to loans at fair rates. The Bush administration in particular pushed this along by encouraging the government chartered mortgage companies to supply money for subprime loans by buying more pools of them. The original notion seemed to support a noble social goal--expanding homeownership--but of course there quickly were considerable excesses that we talk about in the story.
San Jose, Calif.: Now that the real-estate bubble has burst, what sort of financial help is there for those investors that invested in the CDO, and other fancy bonds that the mortgages and banks sold? Does the bank have to buy back those bonds?
John Taylor: The people who bought the CDOs took a risk. I don't think the government should bail them out in such situations, unless there is clear spillover to the rest of the economy. When you take on risk you can benefit or you can lose.
Paramus, N.J.: Do you think any criminal suits will be filed against participants in this bubble? Perhaps against the credit rating agencies or the actual mortgage brokers themselves?
Alec Klein: I wouldn't want to speculate, but we know this much: The credit raters have been under attack from members of Congress and other federal officials for blessing many of the exotic mortgage-backed securities that later faltered; the raters have been criticized for being paid by the banks whose securities they rate. The raters say they have procedures in place to mitigate conflicts of interest, and they recently changed some of their practices in response to the New York attorney general. More possibly to come.
Pittsburgh, Penn.: The Fed has been jawboning for a week about inflation. Mortage rates have soared. The Fed futures contract has priced in multiple rate hikes by the end of the year. Do you think they are serious about hiking their forecast for 2007? It was terrible.
John Taylor: I think the Fed lowered interest rates too much already this year, and that is one reason there is now a threat of inflation. So yes, the Fed should be thinking about raising interest rates again.
Utica, N.Y.: I believe the root cause of the current and some past bubbles is that the original Fed charter gave too much power to the Fed chairman. Murphy's Law of Economic Power (my idea) is that if you give one person the power to screw up the entire global economy then eventually someone will do it. Alan Greenspan did de facto deregulation and ignored the housing bubble until way too late. Other government agencies don't have the power to execute such policy changes without Congressional approval, i.e. FCC, FAA, FDA. I believe that the Fed needs to widen its authority to cover the increasing variety of financial institutions, but needs to have the top level policy decisions made by Congress. It's hard to make the big mistakes if you have to pass them through 600+ politicians. What is your opinion on the Fed chairman's power?
Alan Greenspan should have been aware of the subprime industry problems long before he apparently did know. He needed to spend more time keeping his eyes and ears open and less time pontificating. Cutting down the Fed chairman's power to that of comparable agency chairpeople will make a pontificator less likely to take the job.
All of the problems I read about in this bubble are things I learned in high school economics. Why didn't all of these MBA's see them coming? Why didn't the Fed chairman?
Zach Goldfarb: As we wrote in Part 1, Greenspan did in fact note privately there was a housing boom, financed by large amounts of mortgage debt, but he didn't feel it was appropriate for the Fed to pop the housing bubble or any other bubble. He is also a committed laissez faire economist -- thinking that generally less regulation, rather than more, is the best government policy. But people were warning him throughout the years that borrowers--in particular subprime borrowers--were vulnerable to excesses.
As it happens now, much of the government's response to the crisis may involve increasing--not decreasing--the power of the Fed. Right now, the Fed has expanded its monitoring to more closely scrutinize what's happening inside the nation's investment banks -- the Bear Stearns of the world that deal in the arcane world of securities and complicated financial instruments. The Treasury Department has also released a blueprint to put more power in the Fed's hands. It's probable that the debate over whether that's a good idea or not will last a while.
I'm wearying of the alarmist nature of these stories...: Unless something really drastic happens, I'm not losing my house. My parents are still in their homes. So are my grandparents. None of my friends are behind on their mortgages or are in foreclosure. My neighbors who have been in their homes since the early 60s don't seem to be struggling.
I understand that some people have been hit hard by this housing problem, but they are not the majority. Please put it into perspective when you write these stories.
Zach Goldfarb: That's a good point. Many people who got loans during the bubble are safely paying off their mortgages. That's easy to forget. But the problem is that a million or more people have lost their homes--what would seem to be the most secure asset possible. And as they lost their homes, it caused a crisis throughout the financial markets and spilled over into the overall economy.
Seattle, Wash.: I am interested in Prof. Taylor's views on how long it will take for the non-GSE mortgage securtitization market to rebound and what are the first steps that you would look for?
John Taylor: This will take a very long while for the more exotic securitues and rightly so. For the time being, there should be more focus on less complex non-GSE securitization. I think these will come back as soon as the residentail housing market stabilizes.
Germantown, Md.: First, to Mr. Klein and Mr. Goldfarb, I wanted to say thank you for publishing this series. For a while now I've been trying to find someone to explain to me just what this whole credit crisis is about, and your articles and graphics have done an excellent job in doing so.
While reading these first two installments of the series, there is one thing that has struck me. Now, this could either be hindsight or oversimplification, but what I don't understand is how people, especially those at the top, couldn't foresee the increase in subprime lending as a problem. Where is someone who makes $35,000 a year going to get the money to pay off a half-a-million dollar loan? My question(s) to you is this - Did those at the top, meaning investment bank executives and officials at the Fed and the Treasury Department, think that the number of regular (non-subprime) loans would offset any possible defaults from the subprime loans? Is this why they weren't concerned until it was too late? Did the lack of transparency in hedge funds mean that these officials didn't realize that subprime loans held a much higher percentage of the market than they thought?
Alec Klein: Thanks--and thanks for the question. It's a good one. We can't disclose all of the people we interviewed, but we did interview several key players at the Fed, and it's clear that the central bank did not anticipate the subprime mess cascading throughout the entire economy--at least not until late in the game. Part of the Fed's thinking, according to those we spoke to, was that any damage in the subprime market would be relatively small when compared to the whole economy, and officials simply didn't realize that the losses in the subprime sector would be heavily concentrated in financial institutions.
Upper Marlboro, Md.: As a government employee, I think it is fascinating that the same folks who are touted as so perfect and worth emulating always seem to get caught by surprise and drop the ball. By this I mean the perfect private sector. I notice there is no more talk of private investment of Social Security taxes when the banks are tanking. How is the average person to anticipate these issues when borrowing or investing when the trained professionals who are supposed to spend all of their time studying these things fall short?
Zach Goldfarb: That's a great question. If the PhDs and policy leaders didn't know what was happening--how are you supposed to? The best advice is probably to always be cautious about your personal finances when making major investments, talk to (perhaps multiple) professional financial advisers and avoid doing things that seem "too good to be true" -- like extracting thousands of dollars from your home equity to buy a big flat screen or pay for a vacation -- something people did in large measure during the bubble.
Arlington, Va.: In the neighborhood I rent in, a house is for sale, sold in mid 06' for $340,000 and was quickly flipped for $550,000, the current owner is asking $575,000. To me, this price history seems amazingly unrealistic. No matter how much the original buyer put into the property there is no way the real value of the property increased 200+ K in 3 months. To me this is almost criminal.
What about the banks? They approved loans on this. Even if the buyer is capable of making that purchase, a responsible bank should shy away from making that loan.
And now everyone wants bailouts? I'm having a hard time feeling bad for people who are getting burned in a market designed for profiteering.
I would love to buy a house, but I don't want to pay for peoples foolishness for the rest of my life.
Zach Goldfarb: Just publishing for an interesting point of view.
Rockville, Md.: The subprime bubble is history. What can we do to protect our pension funds form the oil bubble?
Zach Goldfarb: You may inquire with the money management firm behind your pension fund about their exposure to commodities. But beware of two things--large swaths of the economy was exposed to the oil markets, and it's notoriously difficult to guess when a bubble will end.
Washington, D.C.: What are the solutions to the subprime crisis? Here are some: S.2636 by Senator Coleman recommends using court-mandated loan modifications instead of voluntary actions by lenders. The Center for Responsible Lending backs this action. Sheila Bair, Chairman of the FDIC, suggests freezing ARM rates at the starter rate. In areas with high unemployment, like Detroit and Chicago, a Katrina-like forbearance period is suggested. Also, developing an objective database and analysis to separate speculators from home-owners may help to identify those who are speculators vs. those who want to stay in their homes long-term. Any other solutions?
John Taylor: You have to be careful that solutions like these do not make the problem worse. Court mandated modifications, rather than work outs between borrower and lender would certainly raise interest rates in the future. Shelia Bair's good idea has effectively been adopted, first in California and then by the Treasury, but it is largely a voluntary actions by the investors. It is working pretty well so far.
Kathy, Penn.: I find it extremely hard to believe that the so-called top minds in banking couldn't see the end result of subprime loans, etc. Seriously, how difficult was this to predict? I saw it coming and I don't work in banking and don't have an economics degree.
Zach Goldfarb: It's hard to know what the top bankers were "really" thinking. But what's striking about this boom and bust cycle is that in many cases many players thought they would never ultimately be responsible for many of the loans. So the mortgage broker got a fee and passed the loan to a lender, which passed it to Wall Street for a fee, which bundled it for a fee and sold it to investors all around the world. The process could be continued over-and-over. So no one felt they really were liable for the risky loans if they went bad. Now we know that wasn't exactly true....
Maryland: What fascinates me is that the boom and bust and aftermath (great series, btw) could not have occured without willing consumers. We bought our home in the late 90s. We were two college grads with entry-level jobs and enough money to -barely- swing a -small- mortgage payment. They offered us loans for $250,000! I ran the numbers and realized we literally did not make enough to handle that kind of mortgage payment. They tried to get us in an ARM, instead of the 30-year-fixed we knew we wanted. So of course we turned them down, found a company that worked for us, and paid a little over $100k for our older townhome in a working-class neighborhood. Even so, we had to budget carefully to pay the bills. It does not take intelligence to realize the loans originally offered weren't going to work for us, nor does it take an inside view of the real estate business. It just takes a calculator and a basic understanding of arithmetic.
No matter what the mortgage industry was doing, I do not understand how consumers allowed themselves to be fooled in such large numbers. It's not rocket science.
Alec Klein: Thanks. Greenspan did raise concerns about the expansion of housing as early as 2002, according to a transcript of his private remarks to his colleagues then at the central bank. But when he was preparing to leave office in late 2005-early 2006, a Fed staffer gave him a trade publication that showed how the subprime market had essentially tripled in a short period. He found it hard to believe. He told us he couldn't recall whether he told his successor, Bernanke, about that growth. Bernanke did not express concerns about the subprime market until a good deal later, when the crisis was pretty far along. I just wonder, if it took economic authorities some time to figure this out, how unreasonable was it that many consumers also failed to understand the ramifications?
Bethesda, Md.: While your series mentions the subprime mortgages, what about interest only mortgages? Weren't these interest only mortgages part of the problem? What percentage of the interest only mortgages were subprime mortgages?
Also, you mentioned in Sunday's story that Ned Gramlich was concerned about the mortgages while he was a Governor but doesn't talk about what he did afterwards (that is, while he was at the Fed). From other sources, I recall reading that he had expressed his concern at the Fed but that Greenspan and others ignored him. Is that the case?
Zach Goldfarb: Great questions. Some subprime mortgages were interest only. In other words: no money down. By referring to subprime and other unconventional mortgages, we were talking about a whole range of loans made to people with financial limitations. So that includes loans made without any money down and without employment verification and even some loans made for MORE than the price of the property.
Re: Gramlich. My understanding is that Gramlich first mentioned his concern about excesses in lending to Greenspan in 2000, in an informal kind of way, and when Greenspan expressed some hesitation to expand the Fed's role in monitoring that kind of lending, he dropped the issue as an internal affair. But Gramlich from his time in the Fed to after he retired in 2005 to write a book on subprime, continually warned that subprime borrowers were vulnerable to unfair practices.
San Francisco, Calif.: Hi,
A follow-up to the first question: There has been a lot of talk about bailing out borrowers. I don't see how this would help the economy. A crash would reset prices to an affordable level and allow the responsible borrowers to begin borrowing money again.
So my question is: wouldn't a bailout just extend the problem by keeping housing prices out of reach for new home buyers, or am I missing something here?
John Taylor: Yes, it would be best if housing prices were left to reach a new, more affordable "equilibrium." The concern however is spillover: Banks who have to write off mortgage losses will be more reluctant to make loans to businesses for example. So far the spillover problem has been much less than people had forecast.
Great Falls, Va.: How much longer do you think this subprime mess will last? Some people say two more years of foreclosures as adjustable rate mortgages continue to expire. Do you think that's true?
Zach Goldfarb: Hard to know how long the housing bust will last. The consensus seems to be a few more million foreclosures over the next two or so years as prices recalibrate. The chief of Fannie Mae, a big mortgage company, recently said we're about halfway through the decline in housing prices.
Tampa, Fla.: I find it interesting that none of the "bailouts" of homeowners seem to be limited to the principal residence of the homeowner. If we want to keep people in their homes, why not require that any government assistance be limited to those actually living in the house as their principal residence, not as a vacation or investment property?
Zach Goldfarb: That's an interesting point. One issue in the bubble was the number of people who say they'd live in their home when getting a loan -- qualifying for a lower interest rate, because people are unlikely to default on a mortgage for their place of residence. But it turned out many of these were speculators looking to flip property or rent the place out to people who may or may not be reliable sources of monthly income.
McLean, Va.: Why are you guys so late to the party? The housing bubble bloggers were predicting much of what has come to pass as early as mid-2005.
Zach Goldfarb: Some bloggers were pretty prescient on this topic. But we're in the here and now, and many homeowners are suffering as are many who have lost their homes or suffered the callateral effects of the economic downturn. We wanted to present a comprehensive narrative about how we got here.
D.C.: It's such a cheap, cheap shot to blame the buyers/borrowers. Perhaps it might be useful to consider it this way: Imagine a doctor who has a patient in need. The doctor decides to prescribe unneeded medication, say pain pills, and the doctor profits from the unnecessary pills. That's what a lot of brokers did to many buyers/borrowers.
So, when are we going to see some of these rich mortgage brokers in handcuffs? It'd be nice to see some lawsuits for damages from either the buyers, or the bankers who depended on their misinformation.
John Taylor: I agree that many lenders and investors were a big part of the problem. Even people with big names at the top of Wall Street firms now admit that they were unaware of the securities they were investing in. As a result many people have lost trust in the system, and restoring trust should be an important policy goal in the future.
Washington, D.C.: Congress has been kicking around various proposals to respond to the Subprime collapse, including changing mortgage lending laws, changing bankruptcy laws, and even imposing some type of a temporary foreclosure moratorium. Would any of these help, or is sorting out this issue best left to the Fed and other regulators?
Zach Goldfarb: Some of these proposals would certainly help struggling homeowners who want to renegotiate the terms of their mortgage with their lender. But the debate is how far do you go? How do you protect honest home buyers without bailing out speculators?
Fredericksburg, Va.: The housing bust has been good for me. After five years of renting I was finally able to purchase a foreclosure in my hometown that originally sold in 2005 for $516,000 - I paid $310,000. I never thought this would happen as I saw home prices rising for years.
I feel sorry for the people who have been caught in this, but bailing them out is not the solution. There's no shortage of housing in this country - the issue should always have been matching income and debt level to an appropriate house or neighborhood.
John Taylor: Your side of the story is told too rarely. Thanks for sharing it. There are an increasing number of good home buys out there even without looking at the foreclosure listings.
Arlington, Va.: Great great write-up so far about how and why it happened. I was in the Post back in 2006-2007 warning about this (the condo market specifically) and was talking about it with friends well before that time (well into 2003 and warning about it since I saw people buying houses that were not possibly financially capable or responsible). It was pretty obvious to a lot of people what was going on and the areas it would hit outside of housing. Everyone wanted to ignore it due to $$$.
My main question is about the D.C./Arlington area and the repercussions from this "greed" and uncontrolled lending and the over valued real estate in this area. The D.C./Arlington area went through a ridiculous boom of real estate, with prices skyrocketing. Condos in Arlington in 2001-02 were going for $150,000 for a 1BR and $170,000 for a 2BR. Cut to 2005 or so and they were almost $400,000 for a 1BR and $600,000 for a 2BR. Now that is just absurd and unrealistic. Now we all know that prices were mainly inflated by "false" demand. You give everyone free money and everything will "inflate" but we have to do something about getting "realistic and true value" pricing for these things like housing, condos, etc. or you will never have people getting back into the "ownership" category. Proof of this is the # of condo projects that have gone rental and the # of foreclosures. I talked to a few condos and they said that if they can't sell at the $300K + to start they will lose money. PLEASE. There were a few condos that went up in the early 2000's that started in the $150K range. It again is a sign of greed from the condo builders. We HAVE to get pricing back into ranges that are possible for the MIDDLE CLASS to purchase, especially in this area. I make good money (high 5 figures). I have the money to buy but I'm sure not going to spend that much money for a 1BR condo. That's just throwing my money away. Nothing in my life in the last seven years has drastically changed in terms of salary, etc. and yet real estate climbed at a ridiculous rate. I feel like Arlington is a time bomb waiting to happen in over-valued real estate, especially some of these older houses, town homes and condos.
Alec Klein: Thanks. It's interesting how, especially in retrospect, people nod their heads in amazement at some of the lending practices that prevailed at the height of the boom: no documentation of income; no money down. It wasn't so long ago, for instance, that here in the Washington, D.C., market, people were engaging in bidding wars, instantly escalating the price of homes by the tens of thousands of dollars--sometimes without having the property formally inspected. And yet, it's also fair to note that to many people then, it was understood to be the norm.
Gaithersburg, Md.: Hi, I'm not sure I understand my own question because the financial issues behind it are highly complex, like hedge funds, but...
To what extent is the subprime problem multiplied by derivatives? I mean, if someone like Mr. Bernake was looking at data showing that, say $2 billion of mortgage loans might be at risk, that's a blip in the economy. But if various financial investors have leveraged that amount 50 times, then the whole financial system becomes at risk.
I've heard the analogy that mortgages were supposed to be the foundation of a building, and that the building got too large and foundation too soft. Are the total losses much bigger than the "primary" losses?
Zach Goldfarb: Great question. Simple answer: To a huge extent. In the good old days, a local bank would lend the money to a homeowner and hold that loan on the books for years and years. But now the loans get pooled into exotic securities, which are pooled into even more exotic securities, etc. etc. Then Wall Street types trade other complex products -- with fancy names like credit default swaps -- to bet on the mortgage backed securities. Hedge funds borrow many times against their assets to buy and sell these derivatives and so the impact of one home loan is multipled many times throughout the financial system. Companies like Bear Stearns were major facilitators on a daily basis for these types of transactions--which is why the Fed worried that if Bear Stearns collapsed, much of the financial market could as well.
Gaithersburg, Md.: Greenspan kept interest rates artifically high in the 90's to bail out the N.Y. banks and their loses in South America. Will Bernanke do the same?
John Taylor: In the period from 2003-2005 interest rates were held too low according to my calculations based on the state of the economy and inflation at the time. That is one of the reasons why the housing boom took on such force, and why the bust has been so sharp. It now looks like the Fed's interest rate target is too low this year, but many Fed officials have suggested that they will not hold it so low for so long this time.
Washington, D.C.: Earthquakes are often followed by after-quakes for a while. How long before this has rippled through all the affected parts of our economy, that is housing, financial markets, consumer spending, etc.?
What changes do you expect as a result of lessons learned (if they will be learned) from this debacle?
Zach Goldfarb: We're probably going to see the aftermath for a while. For starters, people are going to continue to lose their homes and feel "less wealthy" because their homes will decline in value. Secondly, the credit crunch that, while having eased from the worst moments, has not ended. So that means banks are less willing to lend to companies. As people spend less money and and companies pull back, the economy is going to continue through a rough patch. We see huge jumps in unemployment. Throw in rising oil prices and food costs, and the pain appears here to stay for a while.
As for lessons learned, I think it's fair to say that people will be much more cautious when they get home loans than in the past. (They don't really have much choice in that regard). Just as people aren't as willing to bet on risky dot-com stocks anymore. But who knows what the next bubble will bring--or where it will be. Many people, obviously, think it's oil.
It'll also be interesting to see what the long-term implications of the Fed's response to this crisis is. Has cutting rates so much spurred inflationary pressures, weakened the dollar and contributed to higher oil prices? Has the saving of Bear Stearns emboldened Wall Street types to take other big risks? Or was a major financial meltdown averted, and now do we begin a long and slow return to normalcy?
Princeton, N.J.: How uniformly are housing prices declining? I would guess that cheaper houses are going down faster percentage-wise than expensive ones simply because the wealthy are doing so much better than everybody else.
John Taylor: Generally, the parts of the country that had the sharpest increase in housing prices during the boom are having the largest declines now. But there are exceptions such as Michigan where the economy has been very weak. And in some parts of the country where there is not much land left to build and where people find it attractive to live, home prices have always been high and will remain high. This is where the wealthy people usually live. The more coastal parts of California are an example.
Arlington, Va.: What are your thoughts on banks that have failed to lower interest rates despite the rate cuts the Fed made?
John Taylor: The interest rates that banks charge to each other have not come down as much as the Fed rate cuts because of the increased risk of the loans that banks hold.
Washington, D.C.: Hi,
I'm still in Chapter III but wonder whether a conclusion can be drawn that subprime mortgages overwhelmingly benefited immigrants, or just a simple majority?
Zach Goldfarb: I would say a big number of subprime mortgages benefited people who traditionally did not have access to loans--immigrants, minorities, low income people. But some higher income people also used subprime loans for real estate investment.
Washington, D.C.: The biggest absurdity surely had to be "no doc" mortgages, the so-called "liar loans" that allowed people to claim whatever income they needed to get the mortgage. Also, the door was left open to criminal schemes of various sorts. So, how much of the problem we are now saddled with can be traced to such fraud? I suspect relatively little, but that it was all so easy must say something about how crazy things got.
Alec Klein: Good question. A related answer: In a low interest rate environment, Wall Street had an insatiable appetite for mortgage-backed securities with higher yields, and when investors demanded more, Wall Street found ways to extend the offerings from government-backed securities to private-label securities, moving into such areas as subprime mortgage-backed securities. The credit raters blessed many of those securities, investors bought them, and lenders moved more aggressively to loosen lending standards so that more mortgages could be bundled into pools, sliced into trenches and then sold to investors. That cycle begins to answer the question about why such unconventional loans became more common.
Woodbridge, Va.: Please comment on the tax aspects of the "losses" by the big bankers. I understand that a CDO may still be collecting monthly payments from 96% of the borrowers but is "worthless" because there are no buyers for it above 86% of face values. Yet it is still a cash cow, but cannot be sold. Sounds like my rental property is "worthless" too but I collect $2,500 per month from it.
Please explain how the quants value a CDO?
Zach Goldfarb: Some of the math behind this question is beyond me--but I think it illustrates a good point. It's true that the housing underlying many mortgage backed securities and other financial products is still in good shape. But the securities have no value if there's no buyers for them. And if the securities lose value, financial institutions are required to mark them down to market prices--leading to the huge "write-downs" that we've been reading about.
Phoenix, Ariz.: Do you believe government regulation is the solution to preventing this sort of mess?
John Taylor: More regulation could make the problem worse if we are not careful. In fact, some of financial institutions that were most heavily regulated (banks especially) have been more of the problem than unregulated institutions (even hedge funds). We should focus now on more transparency, for example of the pricing methods at the credit rating agencies and more accountability at the mortgate lenders.
Washington, D.C.: There are two culprits in the subprime mess: lying lenders and lying borrowers. The difference is in the effect it's having on each. Lying borrowers couldn't make their payments, lost their home, may have ruined credit, have had to endure financial turmoil. In other words, they were punished appropriately for lying.
Lying lenders ... take write-downs. Maybe lay some people off (to find work in other industries). Stick it to their investors. Take a 1-week vacation instead of a 2-week vacation. Maybe get the Acura instead of the Porsche. In other words, they committed crimes but are not being fully held accountable, especially since their crimes had vastly farther reaching consequences.
Meanwhile, those of us who bought houses in the past 4 years are just stuck, waiting to see whether we'll ever be able to sell for what we paid for our houses again. (Which is fine, I didn't buy to flip, but it makes me furious that I'm paying for the crimes of others.)
Zach Goldfarb: Just an interesting comment...
Pennington, N.J.: Could you comment on what effect the repeal of Glass-Steagall had on this crisis?
John Taylor: I do not think it was a factor. Bear Stearns was not merged with a depository institution before it got into financial difficulties. But some of the instititutions have grown too big and complex to manage effectively and bettter rationalization of their different lines of business will make sense.
Alexandria, Va.: From what you say the bedrock has shifted in the lending market. A loan that used to be on the books for years could be counted on in a model to produce a certain risk. But as these loans are pooled into exotic securities, the models must go whacko because there is no reference point anymore.
Alec Klein: Thanks for the question. I'm not sure the models "go whacko," but it's interesting to note that the models have increasingly depended on the "quants," the specialized folks who work on Wall Street devising the complex mathematical formulas that help to shape the securities. Even federal economic policy makers have strained to understand the nuances of such securities.
Boulder, Colo.: What are your thoughts about mandating that mortgage lending companies use age-old lending practices that required no more than 3 times salary with a 20% down payment and a fixed rate?
It seems to me that this type of lending would, in the long run, provide the country with sustainable and affordable housing and would ultimately strengthen the economy and our country.
John Taylor: Let's hope this crisis will lead finanial firms to use more sensible lending policy in the future. The firms who have followed such approaches have faired quite well recently, especially in comparison to those that did not.
Alec Klein: Our time is up. I want to thank all who attended today's Web chat and I'm sorry we couldn't get to so many of the questions. Thanks also to Professor John Taylor for participating. Please feel free to contact me or Zach Goldfarb at The Washington Post. I can be reached at email@example.com.
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