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Washington Post: Boom, Bust & Aftermath

Sunday, June 15, 2008 | 11:20 AM

in Credit | Derivatives | Financial Press | Real Estate

Following last week's absurdity (WashPost Blames HUD for Housing/Credit Crisis), the Washington Post pays penance with a 3 part series looking at the housing and credit bubble (today, Monday and Tuesday).

Subtitled: "How homeowners, speculators and Wall Street dealmakers rode a wave of easy money with crippling consequences," it purports to explain the crisis:

"There was something very new about this particular housing boom. Much of it was driven by loans made to a new category of borrowers -- those with little savings, modest income or checkered credit histories. Such people did not qualify for the best interest rates; the riskiest of these borrowers were known as "subprime." With interest rates falling nationwide, most subprime loans gave borrowers a low "teaser" rate for the first two or three years, with the monthly payments ballooning after that.

Because subprime borrowers were assumed to be higher credit risks, lenders charged them higher interest rates. That meant that investors who bought securities based on pools of subprime mortgages would enjoy higher returns.

Credit-rating companies, which investors relied on to gauge the risk of default, gave many of the securities high grades. So Wall Street had no shortage of customers for subprime products, including pension funds and investors in places such as Asia and the Middle East, where wealth had blossomed over the past decade. Government-chartered mortgage companies Fannie Mae and Freddie Mac, encouraged by the Bush administration to expand homeownership, also bought more pools of subprime loans.

One member of the Fed watched the developments with increasing trepidation: Edward Gramlich, a former University of Michigan economist who had been nominated to the central bank by President Bill Clinton. Gramlich would later call subprime lending "a great national experiment" in expanding homeownership.

In 2003, Gramlich invited a Chicago housing advocate for a private lunch in his Washington office. Bruce Gottschall, a 30-year industry veteran, took the opportunity to pull out a map of Chicago, showing the Fed governor which communities had been exposed to large numbers of subprime loans. Homes were going into foreclosure. Gottschall said the Fed governor already "seemed to know some of the underlying problems."

Funny, nothing in Part One about Predatory Borrowing . . .

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A few factual quibbles:

1. WaPo writes "Nasdaq stock index, which had more than doubled from January 1999 to March 2000" -- actually, the Nasdaq doubled from October 1999 to March 2000 -- a six month period that included the Fed opening the monetary spigots wide in anticipation of Y2K banking problems.

2. "Then came the 2001 terrorist attacks, which brought down the twin towers, shut down the stock market for four days and plunged the economy into recession." Um, no. The 2001 recession began March 2001 and was dated as running through November 2001 according to the NBER dating committee. No credible economist believes that 9/11 was the proximate cause of the 2001 recession.

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The series is not quite Pulitzer bait, but its worth reading (at least so far).

Another fascinating aspect to it: Many of the "other resources" featured will be quite familiar to regular readers of TBP and other blogs:

• Interactive mapping tool from the Federal Reserve Bank of New York (which we featured in April), shows foreclosure and other data by county and zip code;

• Ned Gramlich, a former Federal Reserve governor who died late last year, warned of the mounting subprime crisis early and often, but his warnings many times fell on deaf ears among his colleagues at the Fed. We looked at Gramlich's book "Subprime Mortgages: America's Latest Boom and Bust" last month.

• "The Compleat UberNerd" provides more detail on how the mortgage industry works. (Mad props to Bill and Tanta at CR!)

• Two economists from the New York Fed explain in remarkable detail how mortgages get bundled and resold, along with some of the friction points in that process that led to the current crisis.

• Portfolio magazine's elegant animated illustration of how a collateralized debt obligation -- one of the bogeymen of the financial crisis -- actually works.

Source:
The Bubble
Alec Klein and Zachary A. Goldfarb
Washington Post, Sunday, June 15, 2008; Page A01 http://www.washingtonpost.com/wp-dyn/content/article/2008/06/14/AR2008061401479.html