"From Bubble to Trouble: The Financial Crisis of 2008"-The Role of The Mortgage Meltdown
Thursday, November 27, 2008PAUL KANGAS: If there is a ground zero for this crisis, it would probably be located in the red- hot housing markets of a few years ago. With home prices rising in these cities at double-digit rates, home ownership seemed to be the road to riches and plenty of ordinary Americans wanted to get on the bandwagon. It was a trend the mortgage banking industry and Wall Street were happy to encourage, making sub-prime and other loans available to borrowers with poor credit. But by mid-2007, the housing bubble was turning into a housing bust and the financial repercussions began. Erika Miller looks at how players in the mortgage market helped lay the groundwork for the crisis.
ERIKA MILLER, NIGHTLY BUSINESS REPORT CORRESPONDENT: When you hear the word ninja, this may be what you think of, but the financial crisis has given the word a whole new meaning. Ninja loans went to people with no income, no job, no assets, the lowest of the sub-prime loans. Princeton economics Professor Alan Blinder says mortgage lenders should have known better than to give money to people who didn`t provide such basic information.
ALAN BLINDER, ECONOMICS PROFESSOR, PRINCETON UNIVERSITY: This is where the earthquake started and they were granting loans on terms that, in retrospect, are ludicrous and even in prospect should have been seen as ludicrous.
MILLER: Mortgage lenders were comfortable relaxing their loan standards when home values were rising. But when prices started to decline and interest rates edged up, sub-prime borrowers increasingly defaulted on their loans.
BLINDER: The system cracked on sub-prime mortgages and once it cracked, more and more fissures started to appear; more and more weak points in the system started to become apparent. The contagion then spread to other mortgages.
MILLER: It was Wall Street`s securitization of mortgages that eventually turned a nasty housing downturn into a full-blown global banking crisis. Major brokerage firms bought up risky mortgages, bundled them together and sold them off in slices to investors -- often keeping big chunks for themselves. As bond market expert Tony Crescenzi points out, credit ratings agencies then gave the securities top marks.
ANTHONY CRESCENZI, CHIEF BOND MARKET STRATEGIST, MILLER TABAK: They didn`t think through the risks in their entirety, particularly the liquidity risk, which is to say that the rating agencies didn`t think about what would happen if securities were difficult to buy and sell in the financial markets.
MILLER: Former Lehman Brothers CFO Brad Hintz, now a brokerage stock analyst, says the problem was that buyers of mortgage-backed securities didn`t know what they were getting.
BRAD HINTZ, BROKERAGE ANALYST, SANFORD C. BERNSTEIN: Securitization, fundamentally, is a good thing. The problem with securitization is when you take it too far, and that`s the idea that I can securitize something and I don`t care the quality of what I`m securitizing. You know, it`s a box of dirt. "I`m going to sell a box of dirt and that`s fine.
MILLER: The crisis also would not have escalated so quickly had it not been for esoteric financial contracts called credit default swaps - CDS for short. These complex derivatives were supposed to reduce risk by guaranteeing against losses in particular mortgage securities. Instead, they spelled disaster for companies which backed them, like AIG, the nation`s largest insurance firm.
CRESCENZI: Where CD`s went wrong was that they lacked transparency. We couldn`t know for sure how many CDS existed for an underlying security. For example, a company might have $1 billion of bonds outstanding, but there could be $4 billion, $5 billion, $10 billion of CDS outstanding.
MILLER: Last March, Bear Stearns was the first brokerage to reach the brink of collapse, which made other financial firms reluctant to lend to each other. The ensuing credit crisis led to the demise or government bailout of Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, Wachovia and many other financial institutions around the world. Fraud did play a role in getting the crisis started. In many cases, home buyers inflated their incomes and brokers got appraisers to push up home values and because they wanted to keep the number of new mortgages growing, many financial firms chose to look the other way. Erika Miller, NIGHTLY BUSINESS REPORT, New York.
