Subprime Meltdown

See: Subprime.

It was the worst of times; it was the worst of times. Yes, hit that weird movie DISSOLVE button and step into the Wayback Machine with us. It's mid-2007. Banks are desperate to show growth to shareholders. Lending laws are liberal; banks are allowed to lend many multiples of the equity they have on hand, so if anything should go awry, they will suffer greatly. It's as if you, an individual, make $100,000 a year and you have a million dollars worth of loans out there at 5% interest. You can juuuuuust make the payments, but after you do, there's not much left over for luxuries. Like, um...food.

So the banks loaned money to a lot of people who couldn't afford them. A janitor married to a substitute school teacher who together made $88,000, would get a loan for $800,000 to buy their dream home. And as they moved in (with a bad moon a-risin' in September of 2007), all seemed good and fine and just..and they hearted The American Dream.

Then the economy softened. People got fired. Jobs went away. And as one homeowner defaulted, which led to another defaulting, there was a chill in the air. The 10,983 buyers all scrambling to buy homes suddenly just...went away. And the supply of homes for sale on the market, relative to buyers, mushroomed in all kinds of psychedellic colored ways. So that $900,000 home with the $800,000 loan? Yeah, its actual market-clearing price went down, a year or so later, to be more like $576,000. And the $900,000 that the bank loaned $800,000 on lost a fortune selling it. After closing and realtor and lawyer costs, the bank kept $500,000, having to write down hundreds of thousands in losses. Now multiply this event by thousands.

But wait...it gets worse.

Subprime mortgage packages are bought and sold just like any other bundles. Drug dealer cars are bought and sold by the dozen at auctions. All kinds of trade happens in life insurance products and other financial stuff. Subprime mortgages are bought and sold the same way. They exist as a kind of unified, single financial product which trades in "packages" about the same way an ETF trades.

And stocks and ETFs can be bought with leverage, i.e. an investor can take out debt to buy an ETF, believing it will go up. It's a margin purchase of an equity, more or less. So now you have a mortgage which is, by definition, a leveraged instrument...being bought with leverage. And wow, that's a ton of gasoline on the pile of dry timber. Should anyone be smoking around here, really bad things can (and did) happen.

The explosion when housing prices went down and homeowners just gave back the front door keys to the bank, walking away from homes which the banks couldn't sell...almost bankrupted the country. Historic. We're still feeling the effects. Shakespeare's thing about being neither a borrower or lender kinda plays along in the background in the hallowed halls of banks, for better or worse.