One of my goals is to practice writing on themes that I think I might be interested in writing professionally. Obviously my blog is very much personal exploration.
Article one is Mortgage Market Securitization. While completing my MBA, we spent considerable time discussing the Global Economic Crisis – the causes and the effects. Mortgage Market Securitization is considered to be part of the cause and is definitely one of the reasons the crisis spread throughout the market so thoroughly.
As we studied, I realized my first home purchase was tied to the cause of the crisis.
In 2001, I moved to a new job, a new city. I had always been told that a house was a cornerstone of wealth. This was 2001, so my new employer provided a great moving package that included a real estate agent to help me choose an apartment or a house. The agent gave me the number of a mortgage broker and told me to call them and ask how much house I could afford. I called, gave them a small amount of data and they told me I could buy a house worth 4 times my annual income with no down payment. It seemed like a deal to me. My parents were surprised that a young twenty something could get such terms but it seemed like a deal to them too. They were proud that my credit was so great.
Of course, little did we know that I was just part of a larger developing phenomenon. The mortgage broker I called was in the business of securing as many mortgages as he could. Regardless of the risk, the mortgage broker knew they could sell my mortgage for some cash value to a securitizing firm. The mortgage broker’s pay was tied to getting my signature on the mortgage paperwork. There was little to no penalty to that broker if I later defaulted on the loan. The broker made his cash as soon as the mortgage was sold to the securitizing firm.
My worry started immediately after I signed the papers. The broker looked at me and said: “This is fantastic for you. You know we could never have agreed to this if you had a car loan. You are at your limit.” Uh-oh. Youthful mistake: I had assumed the experienced professionals were looking out for me and wouldn’t let me get in over my head. Thank goodness for roommates to help cover bills and for part time work!
For those that do not know, “sub prime” is a term used for mortgages qualified for securitization during late 90s, early 00s after the federal government loosened mortgage standards in an attempt to increase home ownership. The loosened standards involved the percent of income to house purchase and amount of down payment. So, based on the statement from the broker – yep, I was “sub-prime”.
No worries felt at the mortgage broker who quickly sold my mortgage to the securitizing firm. No worries felt at the securitizing firm either. They looked at the numbers on my mortgage and categorized my mortgage and bundled it with other similar mortgages into tranches. Tranch is French for slice so my little mortgage was a small part of a big slice of mortgage debt that the securitizing firm then sold to investors looking for a percentage return (the percent increased as risk increased). Investors received a portion of my payment based on whatever security package they purchased.
My story ended well, I moved again and sold that house by the end of 2003. Of course, I spent 2 years on a tight budget with revolving roommates and working odd extra jobs to make ends meet but I was able to get out of the loan before everything crashed. For many people, both home owners and investors, the story did not end well. Defaulted loans caused loss of homes and for some investors loss of retirement savings. Even now, culturally, we collectively still feel the anger at the banks, the brokers and securitizing firms, that made money while the individuals on both sides of the mortgage meltdown suffered.
Personally, I learned two valuable lessons: “question and double check the professionals” and “yes, something too good to be true is often not true”.