Please tell me if I have this right so far:

You have mortgage backed bonds.  These are bonds that are full of mortgages.  If the homeowner's pay their mortgage, the holder of the bond makes money.  These are *relatively* safe (at least in terms of collapsing the whole system), even when people do stupid shit like buy 4000 square foot houses when they have half-assed jobs.

Then there are "CDOs", which are basically the same thing, except they have some riskier components, like auto loans, credit cards, etc.

Then there are "synthetic CDOs", or "CDO squared's".

What are these?

In order to multiply the original mortgage bond investment 20-fold, don't you need people betting against the mortgage holders at some point?  And, if they are right, where does the money come from?

I need this explained like I'm 5 years old.

Thanks.

Wasn't the whole thing with shaky loans because the government started pressuring lenders to lend to people with shoddy credit with some promise of being recouped?

FIFY

Banks were “racist” by not writing loans to subprime clients. Politicians compelled them to write loans to people who couldn’t realistically afford them, and subsequently defaulted on them. Once that stopped the economy got better again but current democratic candidates are arguing for the same practices to begin anew because “muh housing equality” or some shit

And mortgage backed securities that were so obtuse, most investors and bankers had no idea what they were doing.

Oh... and the recently changed bankruptcy laws had a hand too.

Honestly, the movie explains it fairly well.

The naked lady in the bath tub explains it, OP.

CRA can take some of the blame but you need to keep one salient fact in mind.  Nobody makes any money in the real estate business until the loan is closed.  There is always pressure to get the loan closed and get everyone their cut.  For decades the mortgage industry was based on the premise no matter what the borrower always paid the mortgage.  It was the last thing they would let go.  To some extent there was a grain of truth to that but that only went so far.  The pressure for earnings kept increasing, banks discovered low doc and no doc liar loans that Wall Street was perfectly willing to securitize, the economy takes a hiccup and the whole house of cards came tumbling down.  It was a perfect storm.  You can point fingers in any direction you want and find a guilty party.

Yep, Obama and cohorts made banks issue loans to people with no credit who didn’t have a chance in hell of fulfilling their loans, saying it was racist to deny people based on their ability to pay the loan back.  On top of that, you had banks issue loans with no money down, which had variable rates, low at the onset, and would spike higher as interest rates moved, ensuring they would not be able to pay the newer higher rates and would likewise default.

On a basic level, these loans were packaged together and sold as an investment.  Different packages had different amounts of risk, based on the credit ratings of the borrowers.

They kept selling and leveraging these as assets, when they knew they were worthless.

Eventually, one company saw that they were sitting in a house of cards, and their “assets” were about to implode since they were worthless.  They dumped, and dumped hard, causing a stampede for the doors to get out as everyone else saw their balance sheet wasnt worth shit and the value of the packages tanked.  More sellers than buyers...

Government decided everyone should own a home.

The banks refused to give shoddy loans.

The government said that they will back the loans for the banks.

Banks said this is bad, in court.

Twice.

Third time the banks said they are tired of getting used and will do what the government wants but the results are due to the .gov.

Banks started giving loans as per government: to everyone. Shitty loans. No credit. Bad credit. Defaults. 120% value loans. Bus drivers making $30k buying 500,000 homes. Prices kept climbing higher and higher.

Eventually people can't keep paying these loans and started defaulting on the mortgages. A lot.

The whole house of cards crashed down and that was 2008.

That movie is great.

People invested in the financial choices of poors and got bit in the ass for doing so. Then they made us pay for it.

Pretty much this.  It even has vignettes where they break it down for mouthbreathers like us.

Yeah, if you have a couple hours, watch it.  Good flick and pretty close to how it went down.

And it even honestly showed how no one responsible was held accountable.

Add "Margin Call" to your watch list.

I don’t remember the evil bankers forcing folks to sign mortgages  at gunpoint.

Money was easy to get and people who had no business borrowing money borrowed way to much.

The government more or less forced the banks to issue the loans. The people investing in those loans on the other hand were morons that didn't do their homework on who the loans were to.

It's part of it. The really dumbed-down version is that when somebody with a lot of cash can lend that cash to somebody else and quickly get paid in full while still making decent money, they don't care if the borrower has no real chance of ever repaying. Somebody down the road will get stuck with the loss. Mortgage lenders figured out how to do this, with some help from the government. Like most really big disasters, the end result is the cumulative effect of several mistakes. One of the mistakes was too many government incentives to make mortgage loans, but that was only one of several. Investment bankers and fund managers did plenty of dumb things too, most of which involved selling (or buying) the appearance of being able to make money with no risk. Only a handful of people saw the crash coming.

Companies such as AIG sold basically insurance policies against losses in MBS.

MBS were marketed as investment oopty.  Entire cities were invested. Until Lehman bros

Credit default swaps were implemented when the losses started.  there wasnt enough money

That is my understanding.  Then the financial institutions created financial products to lay off the risk, which were traded around with as much value as a poker game.

Local banks didn't give a shit because those bad loans were resold 2 and 3 times into packages within days.  Banks got paid because they closed the loan.

The house of cards stayed up until one finance house (Goldman Sachs?) realized they were holding worthless paper and dumped, causing a cascade in the mortgage back securities market, which then transferred over into the other securities markets.

Yep, they were stamping CDOs AAA that were really D for dogshit.  Then big players sold them to private investors and government funds alike.   I believe both the governments of Italy and Iceland took a prison like ass pounding.  Maybe Greece and France as well, but it's been a while.

Subprime had a part to play in the disaster (pushed by dims), but so did old fashion fraud that was rampant all the way thru the system.

In '04 we were shopping for our first home.  At the time, our household income was $125k.  We were approved by multiple brokerages for $500k.  $500 f'n k.  We opted for a $140k home instead.

The kicker is this, they NEVER verified my income or employment.

Mortgage backed bonds are simply instruments that pay out cashflows that come from the underlying mortgages. There are several different types.

A CDO is a broader category. A MBS can be thought of as a type of CDO. A CDO can exist without actually being backed by the underlying asset, instead using derivative products bundled together. They end up essentially being a side bet on the underlying asset, in a sense. So, the money simply comes from a counter party that is willing to bet against you.

These positions may not be "naked" in the sense that the people using the CDOs or derivative products may have certain exposures (like they've sold insurance against a product, and are trying to offset some of the risk associated with that) that they are trying to hedge. Or, they could simply be speculating.

It gets complicated in a hurry.

The market meltdown can boil down to this. The government had been subsidizing the housing market for a long, long time through federal lending programs. This helped people buy houses even though they couldn't normally have gotten loans via normal processes at banks. These mortgages had insurance on them, the government promised to pay the banks if the borrower's defaulted. These mortgages were fairly uniform debts, they shared a lot of common features, and they were all backed by insurance (VA/FHA). GNMA and the other agencies would buy these mortgages from the issuing banks. This put cash back in the banks, so they could make more loans. Then, GNMA and the others actually collected on the mortgages. To fund this process, GNMA and the others issued bonds, which were backed by the payments coming from the mortgages, and these mortgages were all insured by the government, so it was pretty safe. These bonds were the first real mortgage backed securities. The issuing banks thus made their money issuing new loans and flipping them over to GNMA. And it's all funded by investors who are buying the MBS's because they want real estate exposure with a lot of safety.

Fast forward 40 years. Banks don't have a lot of incentive to really verify all the info on a loan, because they don't really sit on it and bear the default risk. The borrower's don't have any incentive not to lie on the loan application, because they want to buy as much house as possible. Lots of other MBS's and credit default swaps, and CDOs are now floating around, as everyone figured out how to make money in every direction as often as they could. The credit risk ratings on MBSs are different than bonds, even though they kind of look the same, so a lot of people were fooled into thinking they were safer than they actually were. Sometimes companies just lied about the risk level.

All of the major banks have multiple insurance contracts, CDS's, and interlocking arrangements built up upon this system. This basically isn't really a problem, as long as everyone has enough cash to pay out and keep the financial faucets flowing.

Until... people who've borrowed too much on their mortgages start having trouble paying for them. Some of them got floating rate loans, and the rates go up. Their payments go up. They can't pay them. They start to default.

A lot of the MBS's that have been issued aren't backed by government insured mortgages. Or even if they are, the thing is, the MBS payments aren't insured. Or you were in the wrong tranche, so the payments you're supposed to get on your MBS get axed. Maybe it defaults.

No problem, you think, we bought an insurance product (CDS) on the MBS, so when it defaults, our counter party has to pay out. And that's important because you are on the other side of some other insurance like products, and you need to start paying your counterparties on those contracts. As long as the payments all happen, like they are promised to, it works.

But, as it turns out, your insurer is also having cash flow problems, because a lot of their contracts are starting to pay out. They are having trouble meeting their obligations, due to everyone trying to collect at the same time. So they can't pay you, even though they definitely owe you payments. And now you can't pay out on your obligations. So you're gonna screw over the people you owe money.

Welcome to contagion. Liquidity problems start to propagate across the market. People can't pay because people aren't paying them, and this causes a real shit show of defaults.

That's why it's called a "credit crisis". When liquidity dried up, it didn't matter what you were supposed to have on paper. Your insurance products were crap, not because you were stupid, but because the person on the other side just couldn't live up to their end of the bargain, because someone on the other side of them didn't hold up their end, and round and round it went.

A fifth grader can debunk your theory.
The housing market crashed in December of 2008.
Obama was inaugurated on January 20th 2009.

The government forced banks to approve more mortgages. Thank Clinton, “everyone will have a white picket fence.”

Loan sharks sold Arm loans and adjustable apr loans to stupid people. The loan sharks also sold NINJA (no income, no job or assets) loans when they ran out of stupid people. Then when they ran out of people for NINJA loans the sold multiple loans (multiple homes) as investments to people.

While this was going on Wall Street had been packaging groups of these loans together and sold them as good investments. They weren’t!!!

Adjustable APR’s went up, Arms came due...  the stupid people couldn’t pay them. They started getting foreclosed on. This lowered home prices. That in turn meant the people who bought multiple homes as investments couldn’t sell at a profit. They started getting foreclosed on when they stopped paying.

Then some other people saw this and realized their home could only be sold for 60% of what they owed in it. So they quit paying! More foreclosures!

No, the scam was much bigger than that.  The banks used the income from the mortgages to borrow vast sums of money to engage in riskier loans and investments.   Using the mortgages as collateral.
They assumed that the value of the original mortgages,  and income,  would continue to grow at 20% or greater.
They repackaged the whole scam as "insurance" and reaped vast profits before the house of cards collapsed.
The government bailed out the "insurance" companies., essentially buying all these bad investments, inflated value and over extended debt.

i had a side biz building houses up thru 2008. got out by the skin of my teeth. knew larger builders that went under. some never made it back up.

i was right in the middle. lots of things contributed. number one, i'd build a house and sell it for 220,000. bank makes zero down loan for 240,000 because prices are going up so fast. two income family 'buys' home. the extra money they get as part of the loan they buy a brand new escalade and a new big screen tv, maybe a motor cycle too. if one earner looses their job its curtains.

loans are bundled up into opaque securities. folks by parts of these bundles. no one knows whats in the bundles. but the real estate biz is ON FIRE!

loan makers made loans to get a transaction fee, then the loan was sold off to someone else. there were (i kid you not) in my area, nigerians closing these loans. nigerians that had come to this country to get a job and ended up, first job, making loans. and banks were using software to appraise homes. loan makers often didnt even come out to look at the home they were making loans on.

i'd sit in a closing with the real estate agent and my BIL because thats how i got into the biz, with my BIL who had been building homes for 20 years give or take, and after the closing, i kid you not, basically between us builders, the real estate agent and the lending agent, we would say 'you aint seen bad yet, but its comin'.

it got to the point that we could not find lots at decent prices and it got very hard to make any money, even in a hot market. last subdivision i was in, i bought one lot and i had a plan done that had a shit-ton of rooms in a split foyer because that was one thing that sold to our clientele, lots of rooms. i made even on my last sale and got out. BIL was left with one he couldn't sell, as was his brother, so they rented them out. one builder in the same subdivision and bought 12 lots and built on several and not started on the others. down he went, from a multi-millionaire to a guy living in an apartment and his wife bringing home the bacon working as a pharmacist.

simple answer, greed and greed creates bubbles. im in IT and i saw the greed in the dotcom buildup prior to 2000 meltdown. i'd have friends and family ask me what new dotcom stock to buy, and i'd tell em, none that i can see as there is a reckoning coming and you dont wanna be left holding the bag. i saw white collar folks put all their money into company stock, get laid off, borrow against their 401k that was corporate stock, the stock goes to zero, white collar guy has no hard skills, lost his 401k, lost his job and is basically no longer employable.

bottom line bubbles. bubbles ALWAYS happen sooner or later, i've seen it with gold in the 70s, real estate in the 70s, mortgage and loan failings of the 80s, dotcom meltdowns in the 2000s, and the real estate and mortgage bubble of 2008. what im saying is, if you pay attention, and use common since and dont get caught up in the mania, you can hedge your bets or get out before it caves in. you wanna be under exposed, have more than one way of earning a living and cash out and walk away, even if its a small loss. most folks are unable to do this though. human nature it is.

and finally, the real winners are the folks in cash when the bubble burst. you make your money when you buy, not when you sell

and

buy when there's blood in the streets, even if its your own.

Same here, in 2003.   My realtor tried to push me to do business with a broker she had a business relationship with, who tried to convince me I was crazy to lock in to a VA fixed at 5.5% (low at the time, refinanced a few years later at 3.75%) instead of a LIBOR ARM.  Just stupid, but one wonders how many folks fell into that financial tiger trap.

It would take awhile but a CDO has the actual mortgages (can be other assets but mortgages for OP)

Synthetic CDO contains derivatives and not actual financial assets. A derivative is just a contract that derives value from the underlying entity such as an index, interest rate, credit default swaps, etc.

CDO squared will be vary tranches of bonds, mortgages, asset backed securities, etc.  this can be ill defined as the bank bonds pooled with the mortgage tranche are also in and of themselves a mortgage backed bond.

Credit default swaps are basically an insurance against default if you’re a Golden retriever

NINJA Loans

Yep, all 3 brokers that approved us for the 1/2 million were all pitching "the house will be worth a million in 3-4 years before your ARM is up."  "You can cash that equity out and then blah blah."

Wasn't hard to see thru their bullshit.

The oil backed real estate bust in the '80s (tons of fraud) here in TX spawned laws that were actually tougher than places like CA.

Colleg buddy lives in SoCal, he said all his neighbors were refinancing yearly to buy toys like boats and motorhomes.

It did... and NOBODY has gone to jail yet.

Accountant

The comminty reinvest act had been around for a bit in the 80s and worked ok, it was basically banks being told to look more closely at minority applicants and give them a loan if possible. Under Clinton it was changed so that banks had to lend to a quota of minorities, but it-or another bill passed at the same time, allowed the sub prime mortgages to be transferred into securities. Over time this eventually caused a frenzy of practically giving away housing loans since they could just sell them off and didnt care about whether or not they were defaulted on, basically a bunch of hot potatoes on a grand scale, and eventually a bunch of companies got caught with the hot potatoes.

A couple other things that were related to the financial crisis of the time was that certain finical institutions had their restrictions on leverage removed, so they could play around with some absurd amts of leverage, like 50:1, iirc, and Glass_Stegal getting revoked. Bush's admin did that stuff. I think Goldman Sachs and Freddie Mac were the ones in particular this had an effect on, some idiots at freddie mac managed to use all that leverage to really fuck up the company, and Sachs had merged all their instutions so their speculators were drawing money from the banking side.

All this is iirc from a while back, so some things might not be 100%

I’ve shared my little piece of the story before but will again.  Prior to the collapse I ran a fairly large mortgage department and our holding company as a whole across multiple banks was sizeable.

We had a meeting with our rep from Freddie Mac, we will call him George because that was his name.

He said “ we are going to start paying you less for your loans because they do not help us meet our federal mandate”

I said George, what do you mean?

“ your loans are too good and we need you to originate more low and moderate income loans”

I asked him to define that and after doing so I was able to pull up some stats.

George what you are asking is impossible, based on your criteria and the number of loans fitting that description we would have had to originate 100% of those loans made last year in our trade area and the other 20 or 30 institutions would have originate zero of them.

“ I can only tell you what we need to to do or we are going to start paying you less for you loans”

Well we kept making good loans and missed most of the bullshit.  Before I moved to commercial we had only bought back 2 loans.  One due to an income calculation error ( and I still think we were ok because it was below the DTI limit) and one because they challenged the appraisal.  House had a sunken living room and they said that was atypical.

I also once wrote a letter to Angelo Mozilo at countrywide, can’t remember the issue that they were jerking us around on, Something on a jumbo loan but it got around their office.  For a few months when I’d contact them they would say “ oh your the one that wrote that letter”


I wasn’t near smart enough to know what was going on and we’d get a lot of heat from our realtors partners that we couldn’t (wouldn’t) do a lot of the stated income and asset loans.

Thanks Obunghole.

It's an amalgamation of corrupt bankers and government IMO.

So the security portion comes from the fact that the loan is based on an asset. Houses typically hold their value after the first owner (often times the first owner of a new house takes a hit, but that's a different topic).

It was assumed that houses would continue to increase, and can never decrease in value. Mistake 1.

The gov pushed for more subprime loans in the name of racial equality. Mistake 2.

Everyone in the banking industry knew that Freddie Mac would buy distressed housing asset backed securities (i.e. mortgages). Mistake 3.

Bankers would hide the risk of subprime mortgages by packaging them together. The idea is if I buy an individual mortgage I take on risk if that person fails to repay (there are still costs to foreclosure).  But if I package lots of loans together in a portfolio, I can make the subprime mortgages look safer. This is largely based on the assumption that people could reasonably afford the house. Mistake 4.

The banks started retarded loans designed to help people buy things they can't afford. Things like interest only and NINJA loans. Some of those were illegal or stretched the legality of the process, but no one cared cuz houses never go down in value.

Home builders saturated the market with houses, largely on cheaper credit. This started a domino effect, where the houses couldn't sell for what the current person paid. If you have 20 percent down on a house and take a 10 percent hit, that's a very bad day. If you have 0 down and only covered the interest, you're probably screwed.

I am an engineer, and not a financial expert at all. So take that with a grain of salt.

Inside Job goes into more detail. Although it is less "entertaining" it flays the hide off of many of the culprits that screwed the pooch. It's a series of interviews with some of the rascals involved with information on the fiasco interspersed.

And guess what?
They're baaaaaaaaaaack!

Only now they call them Bespoke Tranch Opportunities (Bespoke CDOs)

"History doesn't repeat, it rhymes."

No, it repeats.

One of my customers sits on the board of a local bank.  He told me the .gov banking types would walk in and "tell" the bank it had to make X % of loans to less than worthy borrowers or else.

He's not the type to BS.

When we applied for loan pre-approval back in 2000 the lender tried pushing us to borrow about 350K, we had a limit of 150.  She said, "But look what you can buy for 300K!!!"

Me: "Yeah, twice the mortgage.  No thanks"

We had friends who both worked two good full time jobs.  He got laid off for a few months and they were on the edge of losing their house.  Several years later they divorced, ton of CC debt and very little equity in their VERY nice house.  I was always amazed and jealous that they could afford it and two new cars and four kids.

Now I realize they couldn't

Heck, my SIL, a hair dresser, was approved for a 350'ish loan on her own.  That was back in 2006'ish.  She cosigned on a loan so that her sister could buy a house.  That ended in disaster when the sister decided she couldn't afford the payment.  Bank foreclosed on my SIL

Margin Call is an excellent movie.

The Big Short is also a great one.

It was Bubbas doing

Eta

I did some home automation work for a young stud at Bear-Sterns. Somehow he saw the iceberg coming, and got all his clients out of it.

Quote:” I counted my clients profits as I watched bodies hit the street .”

As much as I hate Obama, the seeds for this mess were sewn well before he had any power.

Point of order: When this blew up, Barry Hussein Soetoro was a nobody with a big mouth who nobody outside of Chicago had ever heard of. This was a GWB/FBJC production.

The govt had very little to do with it.  Mortgage brokers were chasing fees, the banks were chasing fees, the people buying the CDO's were chasing yield.  Nonconforming and Subprime loans offered higher yields and fees.  It was a shit show. The bankers got greedy and it blew up in their face.  They did not learn a damn thing because the govt. bailed their ass out.

FBHO

Agreed, but didn’t this whole thing pre-date the Obama Llama?

Don’t forget the follow-up lesson at the blackjack table.

This is pretty fascinating.  I missed being affected by it (was in germany at the time).

Any guesses on what the next bubble will be?

Yes.

The government had a lot to do with it. Fannie and Freddie, creations of congress, were buying the loans and securitizing them with the implicit guarantee of the treasury. CMBS, which had a lot less government involvement compared to RMBS, had its traunches worked exactly as intended without investment grade bonds taking a loss.

Not to mention how much of this was influenced by the Fed's influence on credit and interest rates...