My inspiration for this post came from a short cartoon a client emailed to me. It was hilarious. Before I start, I also want to say I am not an economist, just a guy running a commission advance business and trying very hard to offer a service to agents as safely and responsibly as possible in this crazy market. If anyone disagrees with this summary or feels I have missed something, I invite your comments.

Subprime Mess Explanation

So what exactly is the “Subprime Mess”? Talking heads on TV give summary opinions as to what is going on but for the average person the whole thing is kind of confusing. “Subprime” has become a very generic, overused term. To understand it, we need to explore its roots…

Let’s start with Joe Buyer and Moe Mortgage Broker. It’s 2006. Joe wants a house but not just any house, Joe wants a really nice one that’s bigger and five times more expensive than his current digs. Poor Joe Buyer hasn’t actually saved any money for a down payment and he doesn’t really think he can afford the monthly payments, but he really wants that house! Can Moe Mortgage Broker help? Of course! Moe Broker is operating under the premise that house values will always go up, so lenders don’t really need down payments anymore. On top of that, Moe Broker explains he can even get Joe Buyer into the house for a really low interest rate for a few years. Raising the rate later won’t matter because Moe’s premise is totally sound: house values will always go up.

Joe Buyer is excited by this news, but there’s a tiny little wrinkle: his credit. Apparently it’s not very good. Plus Joe mentions to Moe that his boss is kind of a jerk and wouldn’t verify his employment. Not to worry…Moe’s got a special program for excellent customers just like Joe. It’s called a Liar’s Loan. Joe can verify all his own stuff. How cool is that?

Joe thinks Moe is awesome and Moe, being the modest fellow he is, explains he’s not so awesome. The real heroes are the banks who fund the loans. Moe gets a commission. Now that’s awesome.

Fast forward a few months and something’s not right at Joe Buyer’s bank. As it turns out, lots of people actually lied on their liar’s loan application and nobody’s keeping up with their payments. In an astonishing turn of events, house values are starting to decline and the “Joe Buyers” of the world are getting letters from their banks reminding them of something called balloon payments. Very strange…but not to worry, the banks have a solution. They will package up all these crummy loans and sell them to the smart guys in New York. They’ll know what to do.

A few months later the smart guys in New York are having a meeting with only one thing on the agenda: how to dump all these crummy mortgages they bought. Who on earth would buy them now? Never underestimate the inspiration of Wall Street. Here’s the genius idea…first they create a new security and use the bad mortgages as collateral. Then they sell them off to investors and promise to pay them back as the mortgages are paid off. The problem is, the mortgages are all bad, right? Well, as it turns out, bad is just a relative term. They are not all bad, just sort of, kind of all bad. But if you pool them together only some of them will actually go bad. Now that makes total sense. Besides, house values always go up.

So who is going to buy all these pooled mortgages ranging in category from bad to kind of bad to not so bad? Let’s review: insurance companies, banks, school boards…anyone looking for a high-quality safe investment, right? I guess at this point in the story, we all know how it ends up, but where we go from here is anyone’s guess.

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This entry was posted on Thursday, March 13th, 2008 at 9:56 am and is filed under Real Estate News, Real Estate Trends. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.