The subprime mortgage crisis is an important reason for the turmoil in the United States in the 21st century. In this article, I describe the whole story of the subprime mortgage crisis through a perfect timeline.
Chapter I Fannie and Freddie and Mortgage Bonds
In p>1938, before the shadow of the Great Depression disappeared, Roosevelt led the establishment of the Federal National Mortgage Association, which was later named Fannie Mae. When Americans wanted to buy a house, they needed to prepare a 5% down payment, and then they went to the savings and loan associations composed of local banks and deposit institutions to apply for loans. The loan interest rate was around 8% and the service life was only 5-1 years. As we all know, banks make money through the interest difference between loans and deposits, and so do savings and loan associations. Under the background of the Great Depression, the speed of absorbing funds by deposits is very slow, and they can only lend after the recovered mortgage principal and interest are enough for the next loan. People who want to buy a house can only wait in line for the quota. Fannie Mae solved this problem. When the savings and loan association issued a loan, it immediately sold it to Fannie Mae. When the savings and loan association got the same amount of money, it immediately put down a loan, and the speed of people buying houses increased greatly. The savings and loan association changed from making money from mortgage interest to charging a handling fee for mortgage, and the interest income from mortgage belongs to Fannie Mae. Fannie Mae was a nationalized enterprise, and the loans it bought would be reflected in the federal balance sheet. It can be considered that the federal government kept brushing its own credit and stood behind the savings and loan association to provide housing funds for the people. With the promotion of the New Deal, the 5-1-year mortgage has gradually withdrawn, and the 3-year fixed-rate mortgage has entered the historical stage, reducing the monthly repayment pressure of the people and making more and more Americans realize their housing dreams. But Roosevelt didn't have a chance to see that Fannie Mae, established under his New Deal, became the storm center of another global economic crisis 7 years later.
In p>1977, Lewis Ranieri came up with a brilliant idea-packaging the mortgage and selling it as bonds. The traditional mortgage business chain is that buyers apply for a mortgage, and the bank finally pays the mortgage to the developer, and the buyers begin to repay the principal and interest of the mortgage for 3 years. In such a long period of time, banks are always faced with the risk that property buyers will default and the principal cannot be recovered. This risk is ultimately borne by Fannie Mae in the United States. Lewis solved this problem. Banks pooled thousands of mortgages into a pool of funds and sold them in different grades according to the repayment risk of buyers. The higher the risk, the higher the bond income. For example, banks package a total of 5 million mortgages into five bonds with different risk levels, low-risk mortgages into bonds with a yield of 5%, and mortgages that are likely to be out of supply are packaged into bonds with a yield of 1%. After these bonds were sold to investors, the bank immediately recovered the principal of 5 million yuan, and the creditor of the mortgage changed from a bank to an investor, so the risk of default of the buyers was transferred from the bank to the investors, and the bank would also charge a handling fee during the sales process to make a profit. For banks, this is a profitable business.
from p>197 to 1983, the average growth rate of GDP in the United States was only 2.9%, but the average inflation rate was as high as 1.46%. This phenomenon is called stagflation in the field of economics. Nowadays, the American people are also suffering from inflation, but the highest is 9.1% in June 222. At that time, the means to fight inflation was the same as now: raising interest rates. In 1979, a two-meter-tall giant took the position of chairman of the Federal Reserve. After raising interest rates continuously, he raised the interest rate to a high of 22.36%, about 1 times as high as it is now. At the cost of a 21-month recession, the American economy finally controlled inflation from the peak of 13.6% to 2.9% in June 1983. The chairman of the Federal Reserve, who is two meters tall, is named Paul Volcker. The violent interest rate hike and the 21-month economic recession are called "Volcker shock". But this shock is precisely the first gift that the goddess of fortune gave Lewis.
On September 3, 1981, Congress passed a tax exemption bill, which stipulated that if the savings and loan bank sold the mortgage, the Ministry of Finance would return the taxes paid in the previous 1 years as a loss subsidy, and the more it sold, the more subsidies it would get. This gave the savings and loan banks sufficient incentive to sell their mortgages. At this time, Fannie Mae, which had already been privatized, was on the verge of bankruptcy because of high financing pressure and could not afford to buy mortgages. There is only one Wall Street investment bank in the United States that has the ability and demand to buy mortgage loans, and that is Lewis's salomon brothers Company.
in p>1968, in order to make the federal government debt during the Vietnam War less ugly, Fannie Mae was privatized. Since then, the mortgage for American people to buy a house is only Fannie Mae's private debt, which will not be reflected in the federal government's balance sheet. At the same time, the business of providing mortgage for civil servants and veterans was split up and established "Geely Beauty". After the split, Fannie Mae completely lost its government functions, but it also lost its shackles and could buy all eligible mortgages in the United States. In order to avoid Fannie Mae's monopoly in the United States, Congress established the third institution-Freddie Mac in 197. Since then, Fannie and Freddie have entered the stage of history, and through competition, the American people can own mortgages with lower interest rates. But under the impact of Volcker, Fannie and Freddie are also on the verge of bankruptcy. Lewis extended an olive branch to them. Under Lewis's lobbying, Fannie and Freddie provided mortgage loans for salomon brothers Company, and salomon brothers Company packaged them into bonds, and then Fannie and Freddie provided guarantees for them. Although Fannie and Freddie are private organizations at this time, they are still regarded as government-funded enterprises with government backing and impossible to close down in the market. So with the cooperation of Fannie and Freddie and investment banks, mortgage-backed securities (MBS) were born.
chapter ii madness
from p>2 to 21, the bursting of the internet bubble, the financial fraud of September 11th and Enron hit the American economy again and again. In order to stimulate the economy, Greenspan led the Federal Reserve to cut interest rates for 13 consecutive times from January 3, 21 to June 26, 23. The federal funds rate was reduced from 6.5% to 1%, and the 1% interest rate was maintained for one year. George W. Bush introduced the tax relief bill at the same time, and American enterprises ushered in the most relaxed business environment, with cheaper financing costs and tax-free savings of huge profits. Under the influence of interest rate cuts, the 3-year fixed mortgage interest rate dropped from 8.1% at the end of 2 to 5.8% in 23, and the bosses who made money took the opportunity to buy houses and change houses, and American house prices began to rise. Even worse, Greenspan also lifted the restrictions on refinancing.
For example, at the end of 2, Jack bought a house with a total price of 1 million with a mortgage interest rate of 8.1%, with a total loan of 7,. In July 23, the mortgage interest rate was already 5.8%, and the total price of his house doubled to 2 million. Jack wants to change his mortgage into a cheap loan, and the intermediary will pay the remaining mortgage for him, and then mortgage the settled house to get a mortgage loan of 7% of the total house price, that is, 1.4 million. After Jack got 1.4 million yuan, he paid back the principal and interest of the amount advanced by the intermediary, leaving more than 7, mortgage loans with 1% interest rate. The operation of converting high-interest loans into low-interest loans is completed. Jack can use this 7,-odd to spend money, or he can pay a down payment for a suite and then take out a mortgage. This process is refinancing.
The Banking Act of 1933, as an important part of Roosevelt's New Deal, strictly divided the business of investment banks and commercial banks. Investment banks can only invest in securities and funds, but can't absorb deposits, which is equivalent to domestic securities companies. Commercial banks can absorb deposits, but they can only do savings and loans. The Volcker shock caused the savings and loan banks to lose almost all their mortgages, and they could only watch the investment banks make huge profits by selling mortgage bonds with mortgages as the core. Investment banks need to obtain loans from savings and loan banks as raw materials for mortgage bonds. Under the two-way rush, some banks started each other's business. In 1998, the commercial bank Citigroup merged with the traveler group with the nature of investment bank, and the Banking Law of 1933 existed in name only. In 1999, Clinton passed the Financial Services Modernization Act, which completely lifted the shackles of commercial banks, and commercial banks represented by Citigroup could engage in investment banking aboveboard. Therefore, Citigroup can handle the mortgage, package and securitize the mortgage, and sell, hold and trade mortgage bonds, and every link can earn huge profits by charging handling fees. Some investment banks, such as Lehman Brothers and Bear Stearns, bought savings and loan banks and turned themselves into universal banks. These universal banks on Wall Street have made a lot of money by taking advantage of the east wind of the American real estate market in the early 21st century. Richard fuld, CEO of Lehman Brothers, received a total of $484.8 billion in salary and dividends from 2 to 28. In 26, new york's financial practitioners received a dividend of $6 billion, which means that senior staff of investment banks can get tens of millions of dollars.
On December 16th, 23, George W. Bush signed the American Downpayment Act, and launched an annual down payment assistance plan of $2 million, which will provide down payment assistance of $1, or 6% of the purchase price for low-and middle-income families, which basically means zero down payment for many low-and middle-income families. After that, Congress made two regulations on Fannie and Freddie. First, Fannie and Freddie should expand the mortgage payment to low-and middle-income people and ethnic minorities. Second, they should limit the scale of assets and liabilities of Fannie and Freddie, which also limited the scale of mortgage payment, and handed over the potential mortgage customers of Fannie and Freddie to private banks. After the high-quality mortgage market of private banks was saturated, they turned their attention to subprime loans. It is a loan for people with low income and poor qualifications, and the repayment risk of this kind of loan is extremely high. Seeing this, you may have doubts. Why do banks have to handle subprime loans with high repayment risks?
in p>26, 29% of subprime mortgage bonds were bought by European investors, which laid the groundwork for a more destructive crisis. Sub-prime mortgage buyers also joined the team of refinancing, and they had no income at all, and they owned the 2345 houses with empty hands. Their refinancing has made subprime mortgage companies and investment banks earn huge fees, and investors all over the world have bought bonds with high returns. When you are good, I am good and everyone is good, the real estate bubble and the financial bubble have formed an organic integration and began to spiral to heaven.
In p>24, Federal Reserve Chairman Alan Greenspan attended a luncheon of the Banking Association, at which some people expressed concern about balloon loans and housing prices. Greenspan replied: Floating rate loans (balloon loans) are very beneficial to borrowers. I don't think the real estate market will collapse because there is no sign that house prices will fall. Greenspan's answer represents that the US government, Wall Street and the American people are immersed in the economic prosperity brought by the real estate speculation feast and financial carnival. None of these people are worried about balloon loans. Once the mortgage interest rate rises several times, will these low-income or even non-income buyers continue to pay the mortgage?
Chapter III Empty God Arrives
At the beginning of p>24, Michael Berry, a stockbroker, discovered the truth about subprime mortgage. He saw that the interest rate of some subprime loans was only 5.85% at the beginning of 24, and it would rise to 17.84% by the end of 24 and 25.34% by the end of 25. Michael continued to dig deeper, and he discovered the mechanism of the subprime mortgage bond market and mortgage-backed certificates. He instantly understood that if these subprime home buyers don't repay their mortgages when the interest rate rises to 25%, then the risky part of the subprime mortgage bonds will have problems and the subprime mortgage market will collapse. Michael began to make up his mind to short the housing market, but the problem was that subprime mortgage bonds could only be bought and could not be short, so he found a customized credit default swap-CDS from Deutsche Bank.
CDS can be understood as a kind of insurance. On May 19th, 25, Michael bought $6 million CDS for six sub-prime mortgage bonds. If the value of sub-prime mortgage bonds declines due to the mortgage default, the bank will pay Michael huge compensation. If there is nothing wrong with the subprime mortgage bonds, Michael needs to pay the insurance premium every year. His premium rates are .2% for 3A, .5% for A and 2% for 3B respectively. You will find that CDS is a good short selling tool. Traditional short selling requires you to buy short objects, but CDS does not. If you buy a stock to short him, but he goes up by 5%, then you lose 5%, but CDS won't. No matter how much the short object goes up, the premium will not change. You may think that this transaction is a sure bet for Michael, why is Deutsche Bank stupid enough to sign a contract with Michael? However, in the era of soaring housing prices in the United States, most people did not believe that housing prices and subprime loans would go wrong. They just thought that Michael was crazy and gave them a premium every year for nothing. As Michael went from bank to bank to customize CDS, the joke that "a madman is betting on falling house prices" spread on Wall Street.
Michael's CDS is good, but it's not perfect, because it's not tradable. The person who solved this problem is Greg Lipman. Lippmann is a top subprime bond salesman at Deutsche Bank. In 25, the supply of mortgage bonds was in short supply, and investors all over the world were scrambling for these bonds. The United States had completed almost all the subprime loans that it could do, and it could not meet the buying needs of investors. Lippmann wanted to develop another bond to satisfy investors, so his team developed a tradable CDS. The difference between this CDS and Michael's CDS is that the price of this CDS changes with the price of subprime bonds. If the value of subprime mortgage bonds rises, the value of this CDS will decline, and those who are bullish on the housing market will sell it, while those who are bearish on the housing market will buy it. If house prices fall and subprime loans default, many people will rush to buy this kind of CDS in order to obtain huge premiums, and the price of this kind of CDS will skyrocket. Lippmann didn't know that the CDS he designed became the last straw to crush American finance.
Michael's story caught lippman's attention. He didn't expect that someone was actually shorting the housing market. He asked the team to study the real estate market, and then they got an amazing result: since 2, the probability of people whose house value has increased by 1%-5% is four times that of people whose house value has increased by more than 1%. This means that housing prices don't even need to fall. As long as they don't keep rising at a high speed, a large number of Americans will stop repaying loans. He also found that from August 26 to August 29, the interest rate of balloon loans of $738 billion will rise from 5% to 1%-1.5%. The Federal Reserve has started to raise interest rates at this time, and these interest rates will become higher. Lippmann turned from empty to empty, and he also joined the empty god camp and began to buy CDS developed by himself to short the housing market. When colleagues laughed at him for being crazy, Lipman calmly replied, I will short your house.
In the process of selling mortgage bonds, there are always some high-risk bonds with the lowest rating that can't be sold. Investment banks don't want to hold these high-risk bonds, so they repackage these high-risk bonds and a small number of security bonds to form a new investment product, which is collateralized debt obligation-CDO, which will have a large number of B grades.