The Unmentioned Cause Behind the Big Short


Ed Driscoll points to a good short video explaining how the movie The Big Short misses the real plot of the housing bubble burst.

I’ve touched on this before, but not in as much detail.  Sometimes I wonder how much incorrect information I picked up through various media in my youth and just haven’t come across the real story.  Beginning to discover those real stories was a large part of what led me to be distrustful of what I’d been taught and (therefore) to become conservative.

  • Rhett Hardwick

    The video is correct as far as it goes. To fully understand it, one must understand madness. Let us travel back to the early 90’s, following the “Savings and loan” crisis. Fully 50% of small banks failed, usually by being absorbed by larger banks. Many were replaced by “mortgage companies” who were “sellers” to FNMA. Down payment requirements were still in effect at 20%. Numerous methods were found to circumvent this. My favorite was the “soft second”. The seller would give a second mortgage to cover all, or most, of the down payment. Immediately after closing the “soft second” would be discharged without payment. One broker I know went to jail over that one.
    In the middle 90’s 2 things happened. The down payment essentially disappeared, and the small banks which “held” their loans had disappeared. Since the big banks, and mortgage companies, had no desire to “hold” loans, they were immediately sold off to FNMA. This gave rise to the “:servicer”. The banks and mortgage companies entered agreements to “Service” the loans they sold. This was for a small percentage. If the mortgagee, got in trouble they had no financial interest in helping. Worse, the bank and mortgage companies decided to “incentivize” lending, they put “originators” on commission. Commissions varied with the rate obtained from the borrower. I knew some making $6-7,000 a week writing two mortgages. Le dernier cri became “if you can fog a mirror, I can get you a mortgage” they would “complete” the forms and bring them back to the borrower for signature.
    I haven’t even approached Lehman Bros. and their “bundling” sub-prime mortgages into multi million dollar bonds. But I have stop here. I could go on for pages. The short is prices were booming and no one cared. The gov’t assisted.

  • Rhett Hardwick

    How government regulations can effect things:

    I wonder who is behind this one? cui bono?

  • GaryM

    What normally goes unnoticed is the degree of culpability the Clinton Administration had in pushing the “start” button on what ended up being one of the greatest financial meltdowns in world history.

    Keep in mind that most of the amendments and increased enforcement of the Community Reinvestment Act, along with repeal of the Glass – Steagall Act, came under Clinton’s watch (yes, I know Phil Gramm was a Republican).

    But Clinton had a special eye on so-called housing justice, and his push for things like the 1994 Reinvention of HUD and the 1994 Moving to Opportunity 10 year HUD demonstration experiment, were predicated on the idea that all of this would lead to more social opportunity for low income families. The GAO warned of the high costs to actually implement what Clinton wanted in fair housing initiatives. But Clinton had an objective, and set the tone of regulations and enforcement.

    By the time Bush came in, housing was becoming a wealth creator under the illusion that ordinary “fog a mirror” Americans could cash in along with Wall Street.

    Alan Greenspan, said at the time: “Bubbles go up very slowly as euphoria builds. Then fear hits, and it comes down very sharply.”

    The Ponzi scheme had to start somewhere.

    • Rhett Hardwick

      Without doubt there was a Ponzi Scheme effect. I think a better analogy is the “Tulip Mania”. Everyone was making money, no one understood why, no one cared, everyone was making money.

      The idea that a house was a “home” that would be paid off and provide security in retirement was replaced with the idea that it was an “investment”. The plan was to sell it on retirement and “downsize” while pocketing ample cash.

      The house represented a very heavily leveraged “investment”, beginning with a “Starter home”. The starter home would be rolled over to an ever larger home, with greater debt. At retirement, you would sell the million dollar McMansion and move to a trailer park. In between, if you got in trouble, you could always sell at a profit. For a time in the 90’s foreclosure filings in Massachusetts averaged 700 a week, 1300 was not uncommon. In that 8 year period, 20% of workers in Massachusetts filed Bankruptcy. That caused panic, so they tightened the Bankruptcy rules to reduce the numbers.

      I remember when houses here were shooting up 15% a year, without explanation. Population was not rising and incomes were relatively flat. California had begun to rise , for reasons too lengthy to go into here. The explanation became “We are just catching up to California”. Yeah, yeah, that’s it, let’er rip.

      • GaryM

        I remember one year, I think 2004, when the fastest growing housing appreciation metropolitan areas were listed as Riverside Ca., and second, Providence RI.

        People hung on the latest Case-Shiller Home Price Indice as if it were the Dow.

        • Rhett Hardwick

          California! It may have changed, but into the 90’s California “banks” would only loan 50% of “appraised value”. It became standard that the seller would hold a second mortgage for a portion of the difference between the bank mortgage and the sale price. Sale price depended more on the buyer’s willingness to assume debt and the seller’s risk preference. Appraised value became meaningless. “Zero down” became common.

          There is an ancient stock market maxim from before the invention of mutual funds, “always go against the odd lots” (small investors). theory was that by the time info reached them, it was too late. Now that there are TV shows and free seminars on “flipping houses”, it is past time to move on. “Flipping”? The very name implies magic.

          2004, only a few years before the city was offering tax takings in the Elmwood section for a $1.00, if you would agree to occupy and rehab.

    • Jason Diaz

      You haven’t seen anything. Wait until the student loan/College bubble hits.