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Subprime or poorly documented loans are absolutely fine and actually help people, as long as they are marked as subprime loans. The problem with 2008/2009 was that subprime loans were being marked as AAA, because that was the fraudulent part of it. And then these subprime loans were getting packaged together with AAA loans, and caused the quality to degrade, dropping asset prices, etc.

As long as the loans are marked appropriately and the proper risk is taken with interest rates and there is nothing predatory or exploitative about them, there is nothing wrong with companies lending to subprime borrowers. In fact, it helps people break the circle of poverty by investing in them, again as long as it's not predatory.

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The 2008 crisis wasn't caused by subprime lending. It was caused by financial mis-modeling that caused various financiers of sub-prime loans to grossly mis-estimate the risk they were taking, resulting in having an insufficient amount of capital to back the economic risk they were taking.

Specifically, the models used assumed that the economic risk of a mortgage default in Connecticut was uncorrelated with the economic risk of a mortgage default in Texas. When housing prices are rising nationally, this assumption is basically true - the house can be sold by the bank for what's owed on the mortgage, refinancing is available for balloon payments, and any one borrower's cash flow situation is idiosyncratic. But when housing prices started to fall, this lack of correlation broke down, and many financial institutions became unexpectedly responsible for the losses in this asset class.

This might be too tangential, but this reminds me a lot of 538's model of the 2016 presidential election. They had a much higher chance of a Trump victory just before the election (30% vs 1%), and the major difference was that they didn't treat each poll's margin of error as an independent event, they modeled it so that any error in the national poll had a large effect on _every_ state poll.

Yeah the cases have some striking similarity. There's generally two sources of error - bias, and noise. When you combine many measurements, only bias accumulates. Noisy errors in one state poll or one mortgage-based cash flow will be offset by noisy errors in another.

If you get surprised by a change from a low-bias regime to a high-bias one, your old assumptions will lead you to be overconfident in your model. For 538, this just meant publishing numbers that were way too confident. But in the financial context, overconfident modeling means you think you can use more leverage than you actually can.

> For 538, this just meant publishing numbers that were way too confident.

This isn't the case for the 2016 elections. 538 ended up having a much more robust forecast because they accounted for systematic polling error (bias).

https://fivethirtyeight.com/features/why-fivethirtyeight-gav...

>For 538, this just meant publishing numbers that were way too confident.

538 was just about the only polling aggregrator that WASN'T guilty of this during 2016 and were relatively bullish on Trump.

Their mistake during 2016 was releasing a series of editorials not really based on data at all that predicted Trump would eventually peak in support and the remaining voters would rally behind a sensible seeming conservative establishment choice like Marco Rubio. Their theory was plausible and completely wrong. Yet their numbers consistently predicted Trump victory in the primsries as he was an eternal frontrunner for virtually the entire primary.

The problem with the risk model was is that all historical data showed nationwide price decline as impossible/never having happened....

Whenever historical growth rates have always been positive, markets react in shock at the "black swan" event when a 30, 50 or 100 year pattern is all of a sudden broken.

Really? House prices never fell before across the whole US? Not even in the 1930s or various recessions in the 60s/70s?

People don't dump houses when the market drops. Few people sell their house when they're underwater. People tend to live in them until prices come back up. Prices don't drop. Demand drops.

Unfortunately, the balloon payments made this impossible for most.

How is giving someone an asset-secured loan for $600k who has no income not a predatory act?

In the case of the example in the article, if she wasn't given the loan, she'd probably have $100k or more in equity in cash from the sale of the home. The entire scenario is sickening and disgusting -- using hope and taking advantage of people's ego and emotional attachment to separate them from their money.

It's an asset secured loan. If you have a 600k house, and the bank is willing to give you a 550k loan on that house - because it's backed by the asset - let it.

Just don't let the bank then resell this loan as a prime AAA loan to others, so if it bombs someone else gets the shaft.

It's just like organic food. I don't think it should be illegal to sell "conventional" eggs. I only think it should be illegal to sell a tray of organic eggs - where 1-2 of the eggs are "conventional" and hope no one notices. (Especially in a case where the farmer has an inside relation with the FDA inspector that is checking for the organic nature of eggs)

I think that's where the real confusion comes from. People think the relationship between the loan originator and the borrower is where the questionable practices take place, when it's really between investors and the loan originator. Similar to how Chinese companies do reverse mergers on US stock markets to bilk investors out of their dollars.

Read to the end.

She used the money to fully buy out her grandfather’s house in San Clemente, Calif. She jointly inherited it with other relatives and said she needed a loan to pay them for their shares of the property.

This is a highly unusual situation. She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some. The property will continue to grow in value. If she were really in a situation where she might default, her family would help her. This is not representative of any trend.

Hardly predatory. Hardly a "high risk" situation for either the bank or the borrower.

>This is a highly unusual situation.

Agreed.

>She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some.

So is she a private homeowner or a business? Is it legal for her to rent? Given that the bank accepts letters from old ladies describing casual labor as proof of income, who knows.

I own investment property that is mortgaged and attracts high rents. The underwriting standards for that property were higher, and required 20% money down for a similar rate premium.

>The property will continue to grow in value.

That has little to do with qualification for the loan. Kind of makes my point -- it's in the banks interest to write a shitty loan to repo this house on default. (ie. predatory behavior)

>If she were really in a situation where she might default, her family would help her.

Are they cosigners?

"Wink and nod" underwriting in banking is a bad thing.

Banks (almost?) never want to repo and own a property. In most situations the bank 1. spends a bunch of opex to work out / sell off the property, and 2. has to remit any excess to the borrower.

There are predatory operators known colloquially as “loan to own” guys, but they are usually unregulated and operating in the business world where the collateral value is less observable.

For a bank, I believe Other Real Estate Owned (OREO, the balance sheet category where foreclosure properties are carried) is always considered a black mark and a burden, dragging down ROA/ROE.

I disagree. She got a loan secured by an asset. If I own $100k in stock and I want to get a $80k loan secured against my stocks, let me.

If I can buy a $550k property for $500k (with no cash down), with the lender not risking much when it gets repossessed and sold, let me.

If the collateral is there, it's fine.

She got a 600k loan as a student based on bank statements which is insane.

She also took it an ARM loan at 6%. In 5 years it’s very possible it could become unaffordable. Not a good decision either.

In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018.

> In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018.

But you're speculating. If it was a good deal in this case, what makes you think it's not in other cases? Can you point to a specific case where you think it's a bad deal?

As long as we don't bail them out again, I don't really care what crazy deals banks and bank customers come up with.

Yes I think it is a bad financial decision for a nursing student to take out a 600k loan. It’s almost predatory.

I could care less if it’s a good deal for the banks.

You keep talking about the person being a nursing student, but you keep ignoring what people are telling you about the asset. It's not an unsecured loan. It's backed by collateral. What is your specific problem? Liquidity?

> She got a 600k loan as a student based on bank statements which is insane.

She got a 600K loan against a property she already owned a substantial share of (not a purchase money loan with nothing down) as a working home health aide who is also a nursing student.

> In 5 years it’s very possible it could become unaffordable.

In 5 years it's quite likely that higher income and lower loan to asset value will let her refinance it down, too.

> What about the other people? The atricle mentions these loans grew by 25% in 2018.

Subprime mortgages aren't generally a problem on their own, absent the kind of incentives to misrepresent their quality for sales of securities that existed in the last housing crisis. To the extent that hasn't been corrected, that's a problem, but let's not target subprime lending as the problem (heck, in the last crisis, a lot of the problem loans weren't even subprime.)

She could get a $600k loan without statements, if she had an asset worth $700k.

Why does, and more importantly should, a lender care?

> The problem with 2008/2009 was that subprime loans were being marked as AAA, because that was the fraudulent part of it

Not quite. Suppose I take a million subprime mortgages and say “I’ll pay you the first dollar any of these mortgages pay”. The probability that all of those mortgages default is slim. So this particular top-of-the-stack claim is, indeed, a quality one.

This is what people mean when they say “top tranche” of a CDO. The CDO is the pile. The tranche is the priority. The top tranches were rated AAA. Looking back, they pretty much all paid as expected.

The problem is a AAA rating means the security will pay out. Not that it will be able to be sold like a Treasury. So due to a confluence of things, many institutions needed liquidity, and when they tried to sell these instruments found there weren’t enough buyers. The desperate fire sold, thereby requiring others to mark down their holdings, and behold: crisis.

There was also fraud in origination. And fraud elsewhere largely unrelated to the proximate causes of the crisis. But the proximate element was a classic one: a liquidity crisis. (The root element was over-leveraging.)

Here's a really nice diagram about how sub-prime mortgages were packaged into MBS (with AAA tranches), whose lower tranches were packaged into CDOs (with AAA tranches), whose lower tranches were packaged into CDO-squareds (also with AAA tranches):

https://en.wikipedia.org/wiki/Collateralized_debt_obligation...

EDIT: and what that diagram misses is that, because the originators couldn't manufacture mortgages fast enough to satisfy the demands of investors/speculators, banks started manufacturing CDOs directly (synthetic CDOs), meaning investors' total notional exposure to mortgage performance could exceed the total value of outstanding mortgages.

> Here's a really nice diagram about how sub-prime mortgages were packaged into MBS (with AAA tranches), whose lower tranches were packaged into CDOs (with AAA tranches), whose lower tranches were packaged into CDO-squareds (also with AAA tranches)

It's a helpful diagram! What it doesn't say is each of those AAA tranches actually [erfpr,ed. When you look back at how the AAA tranches of CDO-squareds circa 2005 to 2008 paid out, they pretty much all behaved like AAA securities.

Those tranches were solvent. In many cases, their junior tranches were solvent. What none of those tranches were was liquid. I can hold a security that will pay me $1,000 indefinitely, but if nobody will buy it for more than a penny, it isn't useful if my trading group is busy diving into a liquidity crisis. (Granted, ratings don't say anything about the liquidity of a thing. Just its solvency.)

How are "synthetic" financial instruments different from illegal bucket shops?

This is a good question, not just about synthetic CDOs, but about derivatives in general.

I don't know the answer. A quick Google search suggests bucket shops were made illegal in the US, but I don't know the details, or why this doesn't make derivatives illegal.

One rationale for regulation I could imagine is to protect 'investors' from counterparty risk in case the bucket shop is inadequately hedged. Presumably synthetic CDOs were manufactured from derivatives whose counterparties were big banks, which are subject to capital adequacy requirements which in theory provide some protection.

I'm not sure what your point is. Nothing you say disagrees with my point. The credit crisis was multi-faceted, but poisoning of AAA securities with subprime was definitely one of the major fraudulent aspects of the entire thing.

AAA doesn't mean that the security will pay out. It means they have the lowest risk and it means that it's the most expensive. Even AAA-rated debt can fail.

What happened was that large financial institutions were paying top dollar for AAA mortgage-backed securities, but after it was revealed that all of these mortgage-backed securities were poisoned with subprime loans, the value of those securities plummeted. The value of those assets dropped, which put the holders of those assets in a bad financial situation because they didn't have as much money as they thought and they also couldn't sell them. Some companies or funds are legally required to hold only AAA securities. This caused reverberations throughout the financial industry.

> poisoning of AAA securities with subprime was definitely one of the major fraudulent aspects of the entire thing

My point is there was no “poisoning of AAA securities with subprime.” Subprime mortgages can be legitimately assembled to produce AAA securities. This happened, and those securities ultimately paid out like AAA securities. They just didn’t perform, liquidity-wise, like Treasuries. (Neither did other corporate AAA securities, for that matter. OTR Treasuries are OTR Treasuries.)

The problem with 2008/2009...

It was a bit more complicated than that.

Also, subprime and poorly documented loans (mortgages in the case of the financial crisis) with teaser rates that eventually reset to a rate unaffordable to the borrower can absolutely be predatory when coupled with brokerages incentivizing brokers to sign up financially illiterate folks for loans they will eventually not be able to afford knowing the brokerage will move the risk off their books within days or weeks.

As an aside, I find it ironic that the sibling comments all describe a different cause of the 2008/2009 crisis.

Next time someone rambles on about no one being arrested/held responsible for the financial crisis, show them this thread full of reasonably intelligent people still unsure of the cause 10 years later.

Yes, it's an incredibly complex topic. Most people without a strong background in finance pick up their education on the topic from oversimplified source, such as:

- their family/friends' opinions,

- Wikipedia,

- documentaries,

- movies like The Big Short

To be frank, unless someone has spent a significant amount of time doing hard research on the topic or is a professional in the industry, they shouldn't assign any confidence to their opinions about what caused the crisis. They can agree it's bad and shouldn't happen again, but beyond that most message board conversation is simultaneously prescriptive, uncritical and conflicting.

In this particular case, we're seeing people talk about the topic who are evidently unfamiliar with the legitimate use of risk pooling in finance. It's rather too complicated to be summarized in a few paragraphs on HN.

Packaging small proportions of subprime mortgages with lower risk mortgages means that the bank is spreading risk across their mortgage portfolio while still giving people the opportunity of breaking the cycle of poverty by investing in them. Packaging all high risk mortgages together with a higher interest rate increases the probability of default on that portfolio while helping to keep those in poverty there by increasing the burden of the loan on them.

So on one hand you've got a bank that enjoys massive profits spreading and thus decreasing their risk while assisting those in poverty to claw their way out by allowing them the benefit of lower interest rates.

On the other you've got a bank that enjoys massive profits increasing the risk of one of their portfolios while making it extremely difficult for those in poverty to keep up with interest payments.

I'm not discounting the fact that packaging large volumes of those mortgages as AAA and selling them on to other companies was fraudulent, it was, but the reality is, doing so was far less predatory than the alternative if you look at it from this perspective.

The practice of securitizing mortgages is one of the main root causes of the financial crisis. Continuing the practice, which tends to increase risk, should be done only with extreme caution and sufficient financial regulation.

A small snippet for context, although insufficient to explain a very complex problem:

"In many ways, the practices employed by SIVs (Structured Investment Vehicles) and underwriters to structure MBS [Mortgage-Backed Securities] ... tended to magnify rather than reduce risk in the financial system. A key risk-enhancing design feature of MBS was the practice of tranching, whereby several categories of securities were created in each securitization issue ... the senior tranche would have sold at its nominal value and would have been rated risk-free [despite comprising 85% of the entire MBS]."

- "Banking: A Very Short Introduction" by John Goddard and John O. S. Wilson (pg 43-53)

Kroll Ratings has free reports on securitizations and the credit rating process. Check out the securitized aviation ratings.

I agree it should be done with caution and even more regulation. I disagree that securitizing mortgages was the absolute cause of the financial crisis.

I do think that the manner in which it was done and the disregard with which it was executed was the cause of the financial crisis. With banks offloading risky debt as if it were AAA to other institutions, all passing the buck to someone else making it someone else's problem until the bubble imploded and everything fell to pieces - like a giant Ponzi scheme.

I'm not saying that mislabeling wasn't fraudulent, it was. What I'm saying is that spreading the risk among your portfolio allowing those who need it to leverage lower interest rates is less predatory than forcing them to make interest payments they can't afford, thus keeping them in debt slavery longer.

You spend less time in debt slavery if you don't have exorbitant interest rates making up the bulk of your loan repayments... this is why countless times, I end up buying a new car rather than used, because when the interest payments and restrictive loan terms are taken into account, the monthly payments for a new truck aren't significantly different than those for a previously owned. Sure, the used truck at 9% will be paid off 2 years quicker, but more of my money is paid back towards the privilege of having the loan instead of paying for the cost of the truck.

I'm already paying that amount every month and I'm used to making those payments, would I rather pay off a used truck that I had to compromise on a whole bunch of features, or would I rather have the brand new truck with exactly the featureset I want at the same monthly rate, but for an extra couple of years?

I don't mind the extra couple of years payment to have the one I really want - especially given that my monthly payments for both well within my budget. I don't want to pay for the loan. I want to pay for the truck.

So that's the difference. Forcing someone to pay the higher interest rate means they can't have what they really need because they're paying more for the loan than they are for what they need. They could pay the same amount for a larger mortgage with lower interest rates and have the nicer home.

I guess this is a long winded way of saying that despite the mortgage lender's fraudulent and underhanded execution, there is a perspective here that's valid.

> "giving people the opportunity of breaking the cycle of poverty"

By borrowing beyond their ability to repay? That's gambling at best or just debt slavery at worst.

Subprime loans are not lending to people who can't repay. It's lending to people who don't have the credit history or have a poor history and giving them a chance to borrow money. If they can't afford the loan they shouldn't be getting it in the first place.

> "By borrowing beyond their ability to repay"

That's a different argument. I'm not arguing the point of allowing them to borrow more than they can afford to repay. I'm arguing the point of allowing them to borrow what they can afford to repay at rates that allow them the opportunity to do so rather than making them pay rates they can't afford for money they desperately need.

Preventing them borrowing more than they can afford to repay is a different and necessary oversight. Nobody should be put into a position of debt slavery. So I agree with your point, I just don't agree with your premise.

You use the word "predatory" a couple times. What does that mean? These are contracts that are willingly entered into by the borrower, and the lender has a lot of incentive to ensure that the borrower can actually pay.

You should research what the predatory loans were during the crisis. Your assumptions are incorrect, especially during the years leading up to 2008/2009.

Banks would get people who undoubtably didn't deserve loans, would handwave over the details and then send people on their way with $1M loans and the borrowers would later fail. I have a friend who worked at Washington Mutual at the time, and she would routinely reject loan applications, and her manager would overrule her. The manager was making $30,000/month in commissions from loan origination, and he didn't give a fuck who was getting the loans because he was being paid and they were getting packaged up and sold to Fannie Mae/Freddie Mac.

Meanwhile, people would be getting loans that they couldn't afford, but could make payments because of the 0% interest loans that were actually increasing the principal. But they didn't realize this because the lenders didn't explain all the details to them. It's predatory to take advantage of the fact that most regular people don't have a higher-level understanding of mortgages, and by filling their heads with ideas that it doesn't matter anyway because they will sell the house in a year for a profit.

The lenders didn't care because they were incentivized to originate loans even if they knew the borrowers couldn't ultimately afford them. The thought at the time was "the house price will increase in 2 years anyway, so even if you get a $800k loan on a $1M house, you can sell it in 1 year for $1.2M, and then use the $200,000 profit for a downpayment on a real home."

In some scenarios, the lender has more incentive to let someone make years of mostly-interest payments, then foreclose.

An underhanded contract isn't going to be obvious to a borrower with a high school dropout's education level. Even your run-of-the-mill credit card contract is written to an eleventh grade reading level, on average.

The lender has incentive to ensure that the value of the debt is greater than the initial outlay. That could be via a steady stream of payments, or via a handful of repayments plus a repossession and resale of the property.

If the loan originator thinks the latter is likely, I don't think it's unreasonable to call the loan predatory.

The problem seems to come when the incentive to ensure that the borrower can actually pay goes away.

IE: My understanding of the 2008/9 problem where banks were more interested in their banky uses of loans than just "Hey, an investment with good returns."

Not entirely because if the lender can bundle these bad mortgages together and sell them it's not really their problem if the borrower can't pay because they've already extracted a lot of value from the loan by selling it. Being able to sell the debt off to another party removes a lot of the issues a lender faces with bad loans.

Now in theory they still want to make all good loans but actually evaluating all the loans in a package is hard to impossible. This can incentivize lenders fudging the numbers on loans because a few bad loans failing is fine (so long as lenders as a whole aren't systematically issuing bad loans of course).

Typically it means someone has an advantage over the other (usually an information advantage) that they use to extract a more favorable outcome for themselves than they would have gotten in a fair market.

In the mortgage market specifically they are loans that are initiated by someone who is planning to offload them ASAP and doesn't care if the borrower has any capability to pay. They may outright lie to the borrower about the situation in order to close the deal. Then they lie to the investors about the quality of the loan in order to offload them as quickly as possible for a large profit.

It means the licensed lender has a higher standard to abide by and not take advantage of the borrowers needs

Such as creating a claim on everything the borrower will ever have and turning them into a debt serf

But hey maybe housing prices go up really really fast

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