The Giant Pool of Money

notes on Blumberg, Alex and Adam Davidson, “The Giant Pool of Money”  This American Life 355, 9 May 2008.

There is this long chain of people that starts with these Wall Street guys and ends with people who stand to lose their houses. And all along that chain there were bankers, and brokers, and investors, and homeowners. And everybody along the chain kind of deluded themselves, thinking they could throw out the old rules of banking.

– NINA loan: “no income, no asset” — a loan that does not require (does not even check to see if) you have income or assets. Often extremely confusing — to the point of being misleading — for homeowners. (“That’s a liar’s loan. We are telling you to lie to us, effectively.”)

– this “global pool of money” they’re  talking about is the total savings of the entire world, apparently about 70 trillion dollars. This number is actually the total of a subset of global savings, all the fixed-income securities. It has doubled since 2000.

– With so much more money in savings, there is more available to invest, but investment opportunities have not grown at the same rate. So investors had to get very, very creative.

– The new favorite investment became residential mortgages. Higher interest returns there than in, say, Treasury bonds. Homeowners get a mortgage from a broker, the broker sells the mortgage to a small bank, which sells it to an investment firm. The investment firm takes that and thousands of other mortgages and groups them into one interest-receiving body. Shares of the monthly income from that group of a few thousand mortgages are then sold as mortgage-backed securities.

– There was a huge demand for these securities, and mortgages needed to be found to keep up with demand. Eventually, they kind of ran out of qualified borrowers, and began to lend to people who were less and less likely to be able to pay it back. The riskiness of the loan just mattered less, because the banks would sell the loans right off to Wall Street.

– With housing prices rising and rising, it seemed like win-win — a default on a loan would leave the bank with a foreclosed house  that was worth more than it had been when the loan was made.

– And the data they were working with supported the idea that the loans were relatively low-risk, with the potential for very high returns. The data did not include loans as risky as the new no-income no-whatever ones.

– Standard & Poor’s and Moody’s (the credit rating agencies) were giving out tons of their highest rating (AAA) to these very risky mortgages — saying they were safe as a Treasury bond.

– The mortgage-backed securities were divided into tranches (slices) based on their credit rating.  The lowest-rated tranches are actually called toxic. They’re that bad.

– The next innovation (the one that would really push us into crisis) was the collateralized debt obligation, or CDO. To make a CDO, you buy up the lower-rated, toxic tranches of many different mortgage-backed securities, and then you bundle them up, set up a new hierarchy of tranches, and get them re-rated, with the top magically at AAA (“financial alchemy”)

– Back to the housing bubble: house prices go up and up and up, incomes do not. People begin having to take loans out against the raised value of their house in order to pay their mortgage — equity lines of credit.

– In 2006, 2007, Wall Street firms stop wanting to buy these awful loans. This puts the highly leveraged (often something like 20:1) small sellers of mortgages in a bad way. They default on their loans.

– Neighborhood Assistance Corporation of America (NACA) works with homeowners in trouble to try and help them avoid foreclosure. Part of their biggest problem with negotiating loans/interest rates down is actually finding the person who now owns the loan.

– They’ve been sold and re-sold and shared out — for example, one CDO office that TAL talked to owned a share on approximately 16 million loans.

– Changes going forward: the “global pool of money” doesn’t want high-return, it wants zero-risk. Treasury bonds were looking good again.

2 Responses to “The Giant Pool of Money”
  1. dem says:

    This episode of TAL is probably the best one stop shopping for an understanding of the financial crisis in 60 minutes.

    I’m also a fan of the episode (can’t remember though if it was TAL or Planet Money) where they tag along on a closing of a bank. Totally amazing.

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