For the past two days, I’ve read more economic news than I’ve ever read in my life. Mostly I’m trying to get a better handle on what is going on with our financial system, so I can decide whether I’m for or against the big government bailout. Of course, in the end it really doesn’t matter what I think; Congress is going to do whatever it does, and I’m guessing the rescue bill is going to pass, because the consensus is that although only a handful of reckless folks caused this mess, everyone will be hurt by it.
Anyway, I came across this New York Times article that references an episode of a Chicago Public Radio show called This American Life that aired back in May. The episode, entitled “A Giant Pool of Money,” is still on the Web, and yesterday I listened to the entire thing. The hosts — Ira Glass, Alex Blumberg and Adam Davidson — present the most comprehensible explanation of the evolution of the housing bubble that I have heard. If, like me, charts and graphs make your eyes water and you really aren’t sure what a mortgage-backed security is, spend an hour and listen to this show. It’s fascinating, forthright, and entertaining, and you’ll come away reasonably learned about how we got into this mess. Here’s my takeaway:
- There is a “giant pool of money” out in the world at any given time — from pension funds, insurance companies, 401(k)s, etc. — that money managers must a) safeguard and b) make grow (i.e., invest).
- In the early 2000s, interest rates were so low that it was impossible for money managers to make any real money on “safe” investments like bonds or CDs.
- Around that time, someone got the bright idea to create “mortgage-backed securities,” created by buying home loans in bulk from lenders and selling them as investment vehicles. The reasoning was that the mortgage-holders, who were paying around 6% interest, would provide a dependable rate of return that was considerably higher than that of bonds or CDs.
- This idea really caught on; the demand for mortgage-backed securities went through the roof. The problem was, by 2003 everyone who could get a mortgage pretty much already had one. How would the demand be met? You guessed it: by lowering lending standards.
- Lending standards kept devolving as demand for mortgage-backed securities continued unabated. As one lender lowered standards, others followed suit to compete. The bottom was the advent of the so-called “NINA” loan — no income, no assets.
- Things started to tank when people stopped making their mortgage payments — in some instances, new homeowners would go immediately into default, not making a single payment. As delinquencies snowballed, lenders finally started to get spooked, and things started to tighten up.
And here we are.
At the end of the episode, which aired nearly five months ago, Blumberg and Davidson conclude that the fallout from this bubble will be “more like the 1970s than the 1930s,” with the economy simply shifting into neutral for awhile. So even though these two men were in front of the curve in seeing that the housing boom was a house of cards, they still underestimated its impact, just like practically everyone else — including our leaders.
When you listen to this report, it seems so patently obvious that the the situation was a disaster in waiting. Yet none of our leaders and money managers saw it coming — or, if they did, they decided to ignore it. I don’t know which is worse.
But if Congress and the Fed didn’t foresee this, how do we know they’re capable of doing the right thing going forward?