In the summer and fall of 2007, I wrote here about the intentional targeting of minorities and women for subprime mortgages. I thought this was discrimination, pure and simple. I knew subprime loans were being sold to people who would qualify for conforming loans (and bigger commissions were being collected on the sale.) I knew that people who didn’t vaguely qualify for a mortgage were getting mortgages. I knew that once we got to peak, the house of cards would fall.
I didn’t know that in 2006 there was another agenda on Wall Street.
Like most people, I was not aware that people with great credit scores were being sought-out for their borrower credentials. Why? Because high credit scores were being used as a marker of a better mortgage bond. (Income and credit scores of a particular borrower were not being measured together.)
On July 1, 2006, Standard & Poor’s changed their rating model. Coincidentally, that was also the same time that real estate peaked. The assumption on Wall Street was that the new Standard and Poor’s ratings were stricter. Therefore, the creation of subprime mortgage bonds shot up.
Michael Lewis writes:
Either piece of news – rising rating standards or falling house prices—should have disrupted the mortgage bond market and caused the price of insuring the bonds to rise. Instead, the price of insuring the bonds fell. Insurance on the crappiest, triple-B tranche of a subprime mortgage bond now cost less than 2 percent a year.
Get it? The mortgage bonds were getting worse, but being reclassified as better, and being insured for less. It is legal to insure bonds, and therefore bet against their success. This insurance is not like normal, regulated insurance – regulated insurance must be able to pay off.
Michael Lewis tells the story of the handful of people who were reading the fine print and buying insurance by the tens and hundreds of millions on mortgage bonds that were sure to fail.
Meanwhile, in 2006 in homes across America, home equity stopped dead and started to recede. Therefore, Joe Homeowner couldn’t refinance his way out of his financial woes.
The trains were on the track, full throttle, no brakes, headed for the train wreck in July 2008.
Where were you in July 2006? Where were you in July 2008?
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