Wherever you are, stop and read this absolutely stunning article by Michael Lewis (a hero of mine) on the subprime mortgage crisis. The entire thing just leaves me speechless. Money quotes:
He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number.
In Bakersfield, California, a Mexican strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy a house for $720,000 [by a WaMu subsidiary]
The most horrifying practice documented here was the securitization of multiple securities. Normal everyday boring mortgage-backed securities were sliced into bonds based on who got first crack at the money. Somebody bought the right to the first 50% of the non-defaulting payments, and this bond was rated AAA, then the slice of x% was rated AA, and so on down to BBB. Then, in true “how the fuck does anyone get away with this” fashion, tons of BBB bonds from all over the market are themselves combined and securitized, and re-rated, with up to a AAA rating! This meant that institutions that really, really coule not afford any defaults were allowed to buy these securities.
Imagine you’re a slaughterhouse, and you slice up your cow into AAA steak, AA stewing beef, A hamburger, and BBB hot dogs. This is the equivalent of Kraft buying up all of the hot dogs, picking out the “best” parts of them, and re-selling it as steak.
For another great perspective on this, check out this video from a talk at Netroots Nation, given by the author of my of my favorite financial blogs (http://bonddad.blogspot.com/). He’s the first speaker to go in the video:
http://bonddad.blogspot.com/2008/12/youd-think-i-would-have-posted-this.html