November 6, 2008 • 18 mins
The 2008 US financial crisis has been blamed on the excessive use of mortgage-backed securities. But what exactly is a mortgage-backed security? Learn more about these securities and how they contributed to the crisis in this HowStuffWorks podcast.
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Speaker 1 (00:00):
Brought to you by the reinvented two thousand twelve camera.
It's ready. Are you welcome to Stuff you should know
from how stuff works dot Com? Welcome to the podcast
located from deep within the bowels of how stuff Works
dot Com headquarters. It's Josh and Chuck. Chuck. That makes
it sound really fancy or creepy or something. I don't know.
(00:21):
I like it. I was going for creepy. Okay, I'll
take it. It didn't work. I'm creepy out. Yeah, okay, Chuck.
Did you look out the window today at all? I have?
Did you did you notice that everything is spinning very
quickly clockwise? I have? Yeah. Do you know what that is?
A downward spiral? It is. It's the US economy circling
(00:45):
the drain very quickly and taking the entire nation with it.
It's pretty bad. Have you heard about this economic downturn? Yeah?
I mean you can't miss it, man, It's everywhere it is.
It is popping up everywhere. Um. Huge investment banks that
did whether the depression are starting to go under. Um.
You know, there's there's all sorts of financial groups that
(01:06):
are suffering as well. A i G. The largest insurance
company in the United States who ensures all these people
is going under right, Well, now it's owned by the
government almost completely. Yeah, we well, uh, eight percent stake
seventy nine point nine percent stake is owned by the
federal government, owned by you and I we own we
own part of that. I feel it. I feel it inout.
(01:27):
I know, did you feel richer? I know if you're
wearing your top hat and monocle today very appropriately. Um,
So all of this stuff is going on. Yeah, it's
impossible to miss it. The crazy thing is that all
of it can be traced back to a single thing,
a single investment instrument that caused all of this problem.
(01:48):
And I was happy to learn this. Do you you
know what it is? Yeah, I'll go ahead, and it's
called a mortgage backed security. And you're kind of the expert.
I want to go ahead and preface this by saying
that Josh wrote these articles, and uh, I'm an economic
idiot basically. So I learned a lot by reading them,
and hopefully people will learn a lot by listening. Oh,
I learned a lot by writing them. So if people
(02:09):
if people learn a lot listening, then it will be
a trifecta. Everyone will have learned. So yeah, what we're
talking about today are subprime mortgage backed securities. There's different kinds.
Some more mortgage backed securities are are worse than others,
and the worst of the bunch or subprime mortgage backed security, Well,
go ahead, and I think the the raw definition probably
(02:30):
would get people interest right off the bat. So basically
what it is is a mortgage backed security is an
investment tool that is based on a pool of mortgages.
So you take Chuck's mortgage and our producer Jerry's mortgage,
and you know, everybody at how stuff works mortgages, you
pull them together and then you divvy them up into
(02:54):
basically shares of all this this one single pool of mortgages.
And as long as everybody like Jerry and you, Chuck
are are paying UH on your monthly your monthly mortgage payments,
everything's fine right there. Like dividends, it gets distributed across
the shareholders of this pool of mortgages and everybody's happy, right. Well,
(03:15):
who are the shareholders though, they're the people who bought
uh these mortgage backed securities which are banks larger than
the banks. It can be anybody, it can be anyvidy, Yeah,
what you're talking about is the process of how this works.
So that what I just said, that's a that's a
mortgage backed security. You could purchase a mortgage backed security,
no way you if you wanted to, you could, and actually,
(03:37):
ironically enough, um, because these mortgage backed securities are based
on mortgages, and because they've been so divided up and
repackaged and repurposed. Will get to that in a little bit. Um,
it's actually possible that if you have like a four
oh one K, or you invest in a mutual fund
or something like that, you may actually own a share
(03:57):
of your own mortgage. Right. I couldn't at that in
your article and I was blown away. Isn't they cool?
That cool? I don't know if the if the economies
in in the in the tank, then yeah, it's not good,
but yeah it could be cool if you're making money
off of your own mortgage, paying back yourself. It's positive
about luck kind of. Yeah. So what you just mentioned, Chuck,
(04:18):
is is how a mortgage becomes a mortgage backed security.
So say you go in and you you get a mortgage,
you go through all the rigamar role and they issue
you a mortgage. The bank when mortgage backed securities were hot,
would turn around, put it together with you know, several
other of their mortgages that they'd issued that day, and
(04:40):
turn around and they sell it to UM an investment bank. Right, Okay,
an investment bank takes the your bank's mortgages and some
other banks mortages and pulls them together. Even more so,
now you have several hundred different mortgages and all of
a sudden, it's a single UM mortgage back security. Right.
And then they start selling shares. The investment banks starts
(05:02):
selling shares, and then the investors, your your your mutual
fund manager or somebody at JP Morgan Chase who who's
looking for an investment, they buy these shares and they
start collecting the dividends. So that's how it works, right, Okay.
It's actually a lot simpler than I thought. It's very
very simple, Like if you look at it, just uh
(05:23):
just it's a very basic method of investing. But it
was completely totally radical when it came about. I think
it was the late nineties when they first really hit
the scene, maybe early twenty first century. And here's the thing.
It's a really safe way to invest as long as
you know the housing markets going well. Uh, the economy
(05:45):
is doing well, and people are making their monthly mortgage payment.
There were rich times there for about a decade, probably
right in the housing and it was it was based
on that that housing Uh, that housing boom was keeping
mortgage backed securities. Uh, it was making them perform well.
So because of that, because the interplay between the housing
(06:05):
market and mortgage backed securities, mortgage backed security has become
this hot commodity on Wall Street. Everybody's buying, everybody wants them.
They're just great. It's money in the bank, right. The
problem is is that demand created a situation where we
needed more mortgages. So I mean basically, say you know
(06:26):
you're a good prime borrower. Uh, you're somebody who you know,
based on your credit rating, your credit history, your employment history,
that kind of thing, you pose little risk of defaulting
on your loan. There's a finite amount of prime borrowers
in the United States. And after a couple of years
with you know, with the mortgages being pulled together and
(06:48):
put into mortgage backed securities, UM, this pool of people
dried up. And then I know what came next was
the sub prime market, which is the big reason why
the housing boom, uh, the bubble burst exactly because subprime borrowers.
A lot of people think that subprime is uh has
something to do with the rate, the interest rate. It's
(07:10):
a below prime rate, That's what I always thought as well.
But no, it refers to the barrow exactly, as people
that don't have enough income or the right credit. Basically,
they were just writing things. Uh. You know, it's kind
of like a blank check, a false market almost very much,
very much so. But when banks change their lending practices
to include subprime borrowers, all of a sudden, there's this
(07:34):
huge untapped pool of people who can create mortgage backed
securities because you can't have mortgage backed securities without mortgages.
So basically, to answer this clamoring for more mortgage backed
securities on Wall Street, UH, banks had to uh start
issuing more mortgages, and the investment banks were more than
(07:55):
willing to buy all these mortgages no matter what. Right,
So your local bank you go to say you're a
sub prime barrowerk. And subprime has this really evil connotation
here in two thousand and eight, but but really, if
you think about it's just somebody who has a credit
score maybe below. I think right now it's six thirty.
It could be six nine. When you're a subprime barrower,
(08:18):
or maybe you've even changed jobs in the last year,
they could make you a subprime bar There's there's a
lot of factors. It doesn't mean like you're this um
you know, nefarious drug dealing cat burglar. You're not taking
the bank, drawing the welfare checks and swindling houses out
of banks, exactly right. Um, necessarily, some some have, but
for the most part, it's you can't really categorize these
(08:41):
people beyond their credit score. UM, so the banks since
they're no longer hanging onto the mortgage. You know, time
was you went to a bank. You've got a mortgage
that sat in the bank's vault, that piece of paper
did and you made monthly payments to the bank and
they took it in. And then after thirty years or whatever,
you paid your last you made your last payment and
(09:02):
they sent your mortgage and they were they did a
lot of investigating into your history at that time because
they were the ones, you know, that had the most
to lose. They were carrying all the risks. If you
defaulted on your loan, that bank took the hit and
that was it ended there right. Um, with with the
subprime or with the mortgage backed securities, that all changed.
(09:22):
Banks no longer had any risk whatsoever. They would almost
literally issue you a mortgage and possibly that same day,
turn around and sell it. That really explains it right
there in a nutshell. So whoever ended up with this
mortgage in whatever form, whether it was a mortgage backed
security and it was divided among like fifty or a
(09:43):
hundred or a thousand people, um, whoever ended up with
it in the end assumed the risk. So these investment
banks didn't necessarily carry the risk either. The risk of
you not paying your loan went to the individual investors. Right,
Since all all these mortgages started to become based on
subprime mortgages, all all the mortgage backed securities became based
(10:07):
on subprime mortgages. When the foreclosure started, the market almost
immediately plummeted, right because it was directly tied. Yeah, it
wasn't a trickle down effect. That were directly linked. There
is another instrument too that we're based on mortgage backed securities. Right,
(10:27):
So think about this. You have a mortgage, it's turned
around and sold packaged with some other mortgages and then
divided into shares. Those shares can actually be divided further
and repackaged into something called collateral debt obligations. And some
of these these can be based on all sorts of
different things. You can take just mortgage mortgages from a
(10:49):
mortgage backed security and that will all mature in five years,
or that are all interest only, or that are all
fixed interests. There's all sorts of ways to package it.
But one of the hottest items on Wall Street for
collateral debt obligations were these, uh these instruments that were
made exclusively from subprime mortgage backed securities. Because you're a
(11:11):
subprime borrow where you get a higher interest rate, So
the security the investment on whether or not you're gonna
pay your loan. It's riskier, but the dividends are higher
because the interest rate is high. Sure and not unlike
a lot of just the regular Wall Street stock market stocks,
great risk equals great rewards and and that that pays off.
(11:33):
But really, if you look at it long enough, arc
it never pays off. It always it always goes under.
So what you have now is is a bunch of
people playing playing hot potato with these things. They were
they short excited, They're greedy, greedy, It's as simple as that.
Was it a live for now type of thing that
they plan on dumping knees? I guess here's that's I
(11:53):
would assume, yes, that that once people started realizing, wait
a minute, eventually, when you follow these down the line,
you're going to get to a house, and that house
is basically its value is in this situation based on
whether or not the person is making payments, and we're
we're betting on subprime borrowers making payments, and if they don't,
(12:15):
this this security tanks and we lose all of our money.
Someone somewhere down the line, around say two thousand six
figured out that these things were going to tank because
of foreclosures, and that's exactly what happened. So it started
this domino effect. Well, who's it fault here? Or is
that even important? I mean, was it? Or? I guess
(12:36):
everyone kind of shares in the plane because the homeowner
that that really doesn't have the money shouldn't go out
and try to get the house. The lender certainly they
were making the commissions correct the mortgage brokers, so they
were making money and then selling them immediately, or actually
I think the mortgage lender it immediately goes to the bank,
so they're not even really tied to the bank necessarily,
and then the bank sells them. And it's just seems
(12:58):
like the more it gets spread out and split up,
the more fractured it gets. It's really hard to even
tell who's to blame anymore. It is. And I mean, ultimately,
you know, finding the person to blame isn't gonna help
anything now exactly, but it kind of eases the pain
a little bit, or at the very least you have
someone to direct your I or two. Well, I know,
in an election here though a lot of people are
looking at point fingers. If this is not an election year,
(13:19):
probably going down a little bit differently. I think, Um,
I think there's a lot of people to blame, as
you said, And I don't think it's just the lending
industry or the investment banking industry. And I don't think
it's just the people who who yeah, or the hockey
moms don't forget them right. I don't think it's it's
the average subprime barrower who took out a loan larger
(13:41):
than they can because they were sold a bill of goods,
oftentimes because I wrote an article on subprime mortgages and
a lot of people didn't even know what they were signing.
These mortgage lenders would kind of use tricky dialogue to
get them to sign on the dotted lines so they
could make their commissions. Yeah, there's there was a lot
of predatory lending going up big time. Um so regard
list of who's to blatant. These foreclosures start happening, and
(14:03):
they start happening big time, widespread, all over the place, right,
and like I said, it starts this domino effect. The
weird thing is is new houses that were being constructed
stop stop being sold as quickly because all of a
sudden they had to compete with these four closed homes
on the market exactly that were maybe half price. Yeah,
I bought my house and foreclosure. Yeah. I mean this
(14:25):
was even before the big, big foreclosure bust where they're
all over the place, So we just got kind of lucky.
But yeah, all of a sudden, these new houses are
sitting empty because, like you said, they can't compete with
the house that's discounted. So all these four closed homes
have this effect on the market the housing market, right,
more new homes on them or more homes on the
(14:45):
market means that the new homes aren't being sold because
the foreclosures are going. It's like a fire sale out
there in real estate in the US. UM but the
presence of more homes on the market, the presence of
more anything, the more supply, the lower the price. Housing
prices dropped. So you've got people all of a sudden
who are like, wait a minute, I'm in this huge
(15:06):
terrible UM maybe hybrid arm adjustable rate mortgage, and all
of a sudden they owe more on their house than
it's worth. How long are you gonna stick around? When
are you gonna leave and start renting? So, foreclosures keep
going and going and going. And as these this wave
of foreclosures takes over in the US housing market, it
(15:26):
also directly impacts the the investment market as well, because
everybody was, you know, so heavily invested in subprime mortgage
backed security. And then you have the construction companies who
own all these houses that aren't selling, so they have
to lay people off, and then it leads unemployment. It's
it's a huge domino effect. That's exactly right. Everything, Uh,
(15:49):
pretty much in the modern economy and the global economy
and the US economy, everything is in a related precariously so,
but it all goes back to mortgage back securities in
this case. That's exactly right. Whose idea was this to
begin with? I don't know, I've I've never found that
out and I've actually looked. I think that they are
laying low. There's got to be a dude, there's one
(16:10):
guy who had this idea. Yeah. Well, there's a lot
of financial instruments that are out there, and they come
out of places like Harvard Business or Wharton School and
you know, among other places, and they're modeled. You know
that you can run them through an an economic model,
but it's really just a model and you can't really
tell what kind of effect it's going to have until
after it's introduced in the market. In the real world
(16:32):
is a little different sometimes, right, And there's no as
far as I know, there's no regulation over introducing a
financial instrument to the market, you know. I mean, we
we regulate whether or not you can introduce a non
native fish into a lake, but nobody's you know, watching
over the financial instruments that are being introduced to the
(16:54):
to the the market right right. So I'm thinking basically,
if we had regulation of that, if things were tested
out on a small scale first before being released on
mass that could be helpful. I think there's a whole
lot of regulation that that could that could you know,
take place. Well, maybe these guys should start listening to
(17:15):
Josh Clark. Yeah, I guess this is a pretty dense
subject to agree, Chuck. It's dense or I'm dense, one
of the two. I don't think. I don't think you're dense.
It is. It's a very dense subject that I would recommend, uh,
anybody listening to this podcast going on to how stuff
works dot com and typing in how can mortgage back
securities bring down the US economy? And stick around to
(17:36):
find out which four articles Chuck and I consider essential
reading right now? So, Chuck, four articles essential reading, right,
I'll say them because I know you're shy. Uh. They're
all articles that you wrote, and they're really great in
depth articles, and they are about the four uh candidates
for president and vice president for this upcoming election. So
we have how John McCain works, how Obama works, how
(17:59):
Sarah H. Palin Palin Palin works, and how Joe Biden works.
And I don't haven't read the Joe Biden one yet,
but I'm hoping there's something in there about his teeth.
Nothing about his teeth, a lot about his um foot
in mouth condition. Right, Well, if there's room in that
mouth for a foot from all those teeth, then past
does have amazing teeth. They're great beans and choppers like that.
(18:22):
You can check all four of those out by typing
in Joe Biden, Sarah Palin, Barack Obama, John McCain, any
of them in our wonderful search bar on how stuff
works dot com for more on this and thousands of
other topics. Is it how stuff works dot com. Let
us know what you think. Send an email to podcast
(18:43):
at how stuff works dot com. Brought to you by
the reinvented two thousand twelve camera. It's ready, are you
Brought to you by the reinvented two thousand twelve camera.
It's ready. Are you welcome to Stuff you should know
from how stuff works dot Com? Welcome to the podcast
located from deep within the bowels of how stuff Works
dot Com headquarters. It's Josh and Chuck. Chuck. That makes
it sound really fancy or creepy or something. I don't know.
(00:21):
I like it. I was going for creepy. Okay, I'll
take it. It didn't work. I'm creepy out. Yeah, okay, Chuck.
Did you look out the window today at all? I have?
Did you did you notice that everything is spinning very
quickly clockwise? I have? Yeah. Do you know what that is?
A downward spiral? It is. It's the US economy circling
(00:45):
the drain very quickly and taking the entire nation with it.
It's pretty bad. Have you heard about this economic downturn? Yeah?
I mean you can't miss it, man, It's everywhere it is.
It is popping up everywhere. Um. Huge investment banks that
did whether the depression are starting to go under. Um.
You know, there's there's all sorts of financial groups that
(01:06):
are suffering as well. A i G. The largest insurance
company in the United States who ensures all these people
is going under right, Well, now it's owned by the
government almost completely. Yeah, we well, uh, eight percent stake
seventy nine point nine percent stake is owned by the
federal government, owned by you and I we own we
own part of that. I feel it. I feel it inout.
(01:27):
I know, did you feel richer? I know if you're
wearing your top hat and monocle today very appropriately. Um,
So all of this stuff is going on. Yeah, it's
impossible to miss it. The crazy thing is that all
of it can be traced back to a single thing,
a single investment instrument that caused all of this problem.
(01:48):
And I was happy to learn this. Do you you
know what it is? Yeah, I'll go ahead, and it's
called a mortgage backed security. And you're kind of the expert.
I want to go ahead and preface this by saying
that Josh wrote these articles, and uh, I'm an economic
idiot basically. So I learned a lot by reading them,
and hopefully people will learn a lot by listening. Oh,
I learned a lot by writing them. So if people
(02:09):
if people learn a lot listening, then it will be
a trifecta. Everyone will have learned. So yeah, what we're
talking about today are subprime mortgage backed securities. There's different kinds.
Some more mortgage backed securities are are worse than others,
and the worst of the bunch or subprime mortgage backed security, Well,
go ahead, and I think the the raw definition probably
(02:30):
would get people interest right off the bat. So basically
what it is is a mortgage backed security is an
investment tool that is based on a pool of mortgages.
So you take Chuck's mortgage and our producer Jerry's mortgage,
and you know, everybody at how stuff works mortgages, you
pull them together and then you divvy them up into
(02:54):
basically shares of all this this one single pool of mortgages.
And as long as everybody like Jerry and you, Chuck
are are paying UH on your monthly your monthly mortgage payments,
everything's fine right there. Like dividends, it gets distributed across
the shareholders of this pool of mortgages and everybody's happy, right. Well,
(03:15):
who are the shareholders though, they're the people who bought
uh these mortgage backed securities which are banks larger than
the banks. It can be anybody, it can be anyvidy, Yeah,
what you're talking about is the process of how this works.
So that what I just said, that's a that's a
mortgage backed security. You could purchase a mortgage backed security,
no way you if you wanted to, you could, and actually,
(03:37):
ironically enough, um, because these mortgage backed securities are based
on mortgages, and because they've been so divided up and
repackaged and repurposed. Will get to that in a little bit. Um,
it's actually possible that if you have like a four
oh one K, or you invest in a mutual fund
or something like that, you may actually own a share
(03:57):
of your own mortgage. Right. I couldn't at that in
your article and I was blown away. Isn't they cool?
That cool? I don't know if the if the economies
in in the in the tank, then yeah, it's not good,
but yeah it could be cool if you're making money
off of your own mortgage, paying back yourself. It's positive
about luck kind of. Yeah. So what you just mentioned, Chuck,
(04:18):
is is how a mortgage becomes a mortgage backed security.
So say you go in and you you get a mortgage,
you go through all the rigamar role and they issue
you a mortgage. The bank when mortgage backed securities were hot,
would turn around, put it together with you know, several
other of their mortgages that they'd issued that day, and
(04:40):
turn around and they sell it to UM an investment bank. Right, Okay,
an investment bank takes the your bank's mortgages and some
other banks mortages and pulls them together. Even more so,
now you have several hundred different mortgages and all of
a sudden, it's a single UM mortgage back security. Right.
And then they start selling shares. The investment banks starts
(05:02):
selling shares, and then the investors, your your your mutual
fund manager or somebody at JP Morgan Chase who who's
looking for an investment, they buy these shares and they
start collecting the dividends. So that's how it works, right, Okay.
It's actually a lot simpler than I thought. It's very
very simple, Like if you look at it, just uh
(05:23):
just it's a very basic method of investing. But it
was completely totally radical when it came about. I think
it was the late nineties when they first really hit
the scene, maybe early twenty first century. And here's the thing.
It's a really safe way to invest as long as
you know the housing markets going well. Uh, the economy
(05:45):
is doing well, and people are making their monthly mortgage payment.
There were rich times there for about a decade, probably
right in the housing and it was it was based
on that that housing Uh, that housing boom was keeping
mortgage backed securities. Uh, it was making them perform well.
So because of that, because the interplay between the housing
(06:05):
market and mortgage backed securities, mortgage backed security has become
this hot commodity on Wall Street. Everybody's buying, everybody wants them.
They're just great. It's money in the bank, right. The
problem is is that demand created a situation where we
needed more mortgages. So I mean basically, say you know
(06:26):
you're a good prime borrower. Uh, you're somebody who you know,
based on your credit rating, your credit history, your employment history,
that kind of thing, you pose little risk of defaulting
on your loan. There's a finite amount of prime borrowers
in the United States. And after a couple of years
with you know, with the mortgages being pulled together and
(06:48):
put into mortgage backed securities, UM, this pool of people
dried up. And then I know what came next was
the sub prime market, which is the big reason why
the housing boom, uh, the bubble burst exactly because subprime borrowers.
A lot of people think that subprime is uh has
something to do with the rate, the interest rate. It's
(07:10):
a below prime rate, That's what I always thought as well.
But no, it refers to the barrow exactly, as people
that don't have enough income or the right credit. Basically,
they were just writing things. Uh. You know, it's kind
of like a blank check, a false market almost very much,
very much so. But when banks change their lending practices
to include subprime borrowers, all of a sudden, there's this
(07:34):
huge untapped pool of people who can create mortgage backed
securities because you can't have mortgage backed securities without mortgages.
So basically, to answer this clamoring for more mortgage backed
securities on Wall Street, UH, banks had to uh start
issuing more mortgages, and the investment banks were more than
(07:55):
willing to buy all these mortgages no matter what. Right,
So your local bank you go to say you're a
sub prime barrowerk. And subprime has this really evil connotation
here in two thousand and eight, but but really, if
you think about it's just somebody who has a credit
score maybe below. I think right now it's six thirty.
It could be six nine. When you're a subprime barrower,
(08:18):
or maybe you've even changed jobs in the last year,
they could make you a subprime bar There's there's a
lot of factors. It doesn't mean like you're this um
you know, nefarious drug dealing cat burglar. You're not taking
the bank, drawing the welfare checks and swindling houses out
of banks, exactly right. Um, necessarily, some some have, but
for the most part, it's you can't really categorize these
(08:41):
people beyond their credit score. UM, so the banks since
they're no longer hanging onto the mortgage. You know, time
was you went to a bank. You've got a mortgage
that sat in the bank's vault, that piece of paper
did and you made monthly payments to the bank and
they took it in. And then after thirty years or whatever,
you paid your last you made your last payment and
(09:02):
they sent your mortgage and they were they did a
lot of investigating into your history at that time because
they were the ones, you know, that had the most
to lose. They were carrying all the risks. If you
defaulted on your loan, that bank took the hit and
that was it ended there right. Um, with with the
subprime or with the mortgage backed securities, that all changed.
(09:22):
Banks no longer had any risk whatsoever. They would almost
literally issue you a mortgage and possibly that same day,
turn around and sell it. That really explains it right
there in a nutshell. So whoever ended up with this
mortgage in whatever form, whether it was a mortgage backed
security and it was divided among like fifty or a
(09:43):
hundred or a thousand people, um, whoever ended up with
it in the end assumed the risk. So these investment
banks didn't necessarily carry the risk either. The risk of
you not paying your loan went to the individual investors. Right,
Since all all these mortgages started to become based on
subprime mortgages, all all the mortgage backed securities became based
(10:07):
on subprime mortgages. When the foreclosure started, the market almost
immediately plummeted, right because it was directly tied. Yeah, it
wasn't a trickle down effect. That were directly linked. There
is another instrument too that we're based on mortgage backed securities. Right,
(10:27):
So think about this. You have a mortgage, it's turned
around and sold packaged with some other mortgages and then
divided into shares. Those shares can actually be divided further
and repackaged into something called collateral debt obligations. And some
of these these can be based on all sorts of
different things. You can take just mortgage mortgages from a
(10:49):
mortgage backed security and that will all mature in five years,
or that are all interest only, or that are all
fixed interests. There's all sorts of ways to package it.
But one of the hottest items on Wall Street for
collateral debt obligations were these, uh these instruments that were
made exclusively from subprime mortgage backed securities. Because you're a
(11:11):
subprime borrow where you get a higher interest rate, So
the security the investment on whether or not you're gonna
pay your loan. It's riskier, but the dividends are higher
because the interest rate is high. Sure and not unlike
a lot of just the regular Wall Street stock market stocks,
great risk equals great rewards and and that that pays off.
(11:33):
But really, if you look at it long enough, arc
it never pays off. It always it always goes under.
So what you have now is is a bunch of
people playing playing hot potato with these things. They were
they short excited, They're greedy, greedy, It's as simple as that.
Was it a live for now type of thing that
they plan on dumping knees? I guess here's that's I
(11:53):
would assume, yes, that that once people started realizing, wait
a minute, eventually, when you follow these down the line,
you're going to get to a house, and that house
is basically its value is in this situation based on
whether or not the person is making payments, and we're
we're betting on subprime borrowers making payments, and if they don't,
(12:15):
this this security tanks and we lose all of our money.
Someone somewhere down the line, around say two thousand six
figured out that these things were going to tank because
of foreclosures, and that's exactly what happened. So it started
this domino effect. Well, who's it fault here? Or is
that even important? I mean, was it? Or? I guess
(12:36):
everyone kind of shares in the plane because the homeowner
that that really doesn't have the money shouldn't go out
and try to get the house. The lender certainly they
were making the commissions correct the mortgage brokers, so they
were making money and then selling them immediately, or actually
I think the mortgage lender it immediately goes to the bank,
so they're not even really tied to the bank necessarily,
and then the bank sells them. And it's just seems
(12:58):
like the more it gets spread out and split up,
the more fractured it gets. It's really hard to even
tell who's to blame anymore. It is. And I mean, ultimately,
you know, finding the person to blame isn't gonna help
anything now exactly, but it kind of eases the pain
a little bit, or at the very least you have
someone to direct your I or two. Well, I know,
in an election here though a lot of people are
looking at point fingers. If this is not an election year,
(13:19):
probably going down a little bit differently. I think, Um,
I think there's a lot of people to blame, as
you said, And I don't think it's just the lending
industry or the investment banking industry. And I don't think
it's just the people who who yeah, or the hockey
moms don't forget them right. I don't think it's it's
the average subprime barrower who took out a loan larger
(13:41):
than they can because they were sold a bill of goods,
oftentimes because I wrote an article on subprime mortgages and
a lot of people didn't even know what they were signing.
These mortgage lenders would kind of use tricky dialogue to
get them to sign on the dotted lines so they
could make their commissions. Yeah, there's there was a lot
of predatory lending going up big time. Um so regard
list of who's to blatant. These foreclosures start happening, and
(14:03):
they start happening big time, widespread, all over the place, right,
and like I said, it starts this domino effect. The
weird thing is is new houses that were being constructed
stop stop being sold as quickly because all of a
sudden they had to compete with these four closed homes
on the market exactly that were maybe half price. Yeah,
I bought my house and foreclosure. Yeah. I mean this
(14:25):
was even before the big, big foreclosure bust where they're
all over the place, So we just got kind of lucky.
But yeah, all of a sudden, these new houses are
sitting empty because, like you said, they can't compete with
the house that's discounted. So all these four closed homes
have this effect on the market the housing market, right,
more new homes on them or more homes on the
(14:45):
market means that the new homes aren't being sold because
the foreclosures are going. It's like a fire sale out
there in real estate in the US. UM but the
presence of more homes on the market, the presence of
more anything, the more supply, the lower the price. Housing
prices dropped. So you've got people all of a sudden
who are like, wait a minute, I'm in this huge
(15:06):
terrible UM maybe hybrid arm adjustable rate mortgage, and all
of a sudden they owe more on their house than
it's worth. How long are you gonna stick around? When
are you gonna leave and start renting? So, foreclosures keep
going and going and going. And as these this wave
of foreclosures takes over in the US housing market, it
(15:26):
also directly impacts the the investment market as well, because
everybody was, you know, so heavily invested in subprime mortgage
backed security. And then you have the construction companies who
own all these houses that aren't selling, so they have
to lay people off, and then it leads unemployment. It's
it's a huge domino effect. That's exactly right. Everything, Uh,
(15:49):
pretty much in the modern economy and the global economy
and the US economy, everything is in a related precariously so,
but it all goes back to mortgage back securities in
this case. That's exactly right. Whose idea was this to
begin with? I don't know, I've I've never found that
out and I've actually looked. I think that they are
laying low. There's got to be a dude, there's one
(16:10):
guy who had this idea. Yeah. Well, there's a lot
of financial instruments that are out there, and they come
out of places like Harvard Business or Wharton School and
you know, among other places, and they're modeled. You know
that you can run them through an an economic model,
but it's really just a model and you can't really
tell what kind of effect it's going to have until
after it's introduced in the market. In the real world
(16:32):
is a little different sometimes, right, And there's no as
far as I know, there's no regulation over introducing a
financial instrument to the market, you know. I mean, we
we regulate whether or not you can introduce a non
native fish into a lake, but nobody's you know, watching
over the financial instruments that are being introduced to the
(16:54):
to the the market right right. So I'm thinking basically,
if we had regulation of that, if things were tested
out on a small scale first before being released on
mass that could be helpful. I think there's a whole
lot of regulation that that could that could you know,
take place. Well, maybe these guys should start listening to
(17:15):
Josh Clark. Yeah, I guess this is a pretty dense
subject to agree, Chuck. It's dense or I'm dense, one
of the two. I don't think. I don't think you're dense.
It is. It's a very dense subject that I would recommend, uh,
anybody listening to this podcast going on to how stuff
works dot com and typing in how can mortgage back
securities bring down the US economy? And stick around to
(17:36):
find out which four articles Chuck and I consider essential
reading right now? So, Chuck, four articles essential reading, right,
I'll say them because I know you're shy. Uh. They're
all articles that you wrote, and they're really great in
depth articles, and they are about the four uh candidates
for president and vice president for this upcoming election. So
we have how John McCain works, how Obama works, how
(17:59):
Sarah H. Palin Palin Palin works, and how Joe Biden works.
And I don't haven't read the Joe Biden one yet,
but I'm hoping there's something in there about his teeth.
Nothing about his teeth, a lot about his um foot
in mouth condition. Right, Well, if there's room in that
mouth for a foot from all those teeth, then past
does have amazing teeth. They're great beans and choppers like that.
(18:22):
You can check all four of those out by typing
in Joe Biden, Sarah Palin, Barack Obama, John McCain, any
of them in our wonderful search bar on how stuff
works dot com for more on this and thousands of
other topics. Is it how stuff works dot com. Let
us know what you think. Send an email to podcast
(18:43):
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