Questions about the financial meltdown… (loans, real estate, foreclosure, debt)

[strawberry2]

I have some questions and apologize if these are stupid..

1. Why did the banks have such liberal lending practices? I don’t understand how sooo many people were able to get loans for homes they could not afford? Seems like they were giving mortgages to anyone who walked in off the street? And, why would companies even take such a risk?

2. Like banks with liberal lending practices for mortgages. Can the same apply to lending money to college students who can/could not repay their loans? Or, car loans? Since I make a $51,ooo a year can I get a loan for a Maserati?

3. If the CDO received a good rating, how can we be sure that other ratings are correct?

4. Why all the sudden are all the banks crashing right now (before the election)? Does it seem like it would happen sporadically?

5. Someone told me this is like the 3rd inning of the financial meltdown. The subprime mortgage were sold on 5 year bonds, what we're seeing now is the meltdown from 2002. In February the 2003 bonds comes do and it's even worse than 2002.

6. What happens if the FDIC runs out of money? They can’t just print more and we can't continue to borrow from other countries. Can we?

[Humanoid]

1. Why did the banks have such liberal lending practices? I don’t understand how sooo many people were able to get loans for homes they could not afford? Seems like they were giving mortgages to anyone who walked in off the street? And, why would companies even take such a risk?

Nothing stopped the banks from making crappy loans. Nothing stops them today. Traditionally what stopped them is that when the loan did badly they'd have to pay the price. But with debt securitization that ended. Debt securitization is when you take a loan like a mortgage and basically package it (usually with a bunch of other mortgages) into something that is essentially a bond. Investors can purchase it just like they would purchase a corporate bond. You get a particular interest rate (coupon) and it has a particular maturity date. This has been done for awhile via Frannie Mae/Freddie Mac, but over the last decade they started to do it in new and interesting ways. Regardless, when the debt is securitized in this way it means the banks don't keep the loan on their books they merely service the loan. They get upfront fees for originating the loan and then fees for servicing the loan. As a result the bank doesn't have a strong interest in whether the loan is good or not. They can take their fees and run.

3. If the CDO received a good rating, how can we be sure that other ratings are correct?

CDOs usually structure the debt in tranches. Not all tranches were given AAA ratings, only the senior notes. And really, while the real estate market was functioning normally these were high quality. The problems occurred when the real estate market collapsed nationally. It is this that they didn't predict well.

4. Why all the sudden are all the banks crashing right now (before the election)? Does it seem like it would happen sporadically?

The institutions are all tied together. A failure at one will put stress on another. Its very nature for failures to come in a wave like this.

5. Someone told me this is like the 3rd inning of the financial meltdown. The subprime mortgage were sold on 5 year bonds, what we're seeing now is the meltdown from 2002. In February the 2003 bonds comes do and it's even worse than 2002.

Actually the majority of the subprime crap will be burned off by the end of the year, with the associated foreclosures coming on the market in 2009. The mortgage related debt is already trading for under 50% of its original value. If anything, it could be under-valued. But there is no way to know until the real estate market stabilizes.

[Nor'Eastah]

I agree with Humanoid's post, as far as it goes.

This may have started with subprime mortgages, but it is no longer about mortgages, and hasn't been about subprime for quite awhile.

This is about the use of leverage to maximize returns on investments that traditionally had so-so returns. It's also about greed; banks and hedge funds are no longer happy with so-so returns. Ultimately, it's about derivatives, which are bets on which way things are going to go. Uh oh...things are not going that way any more, and the bets are going sour, the leverage is coming unwound, and there is just no way to pay back all this money that came from nowhere in the first place. You can leverage 22 cents to the moon, but that doesn't make it real money.

I'd be surprised if we were as far as the third inning. The powers are just beginning to look scared and being forced to deal with all this. There's NO WAY they can save it all. There's not enough money in the world to pay for all this. Wall Streeters want to continue the party, with Main Streeters footing the bill. Even if Main St had the money - which it doesn't - the game is over.

A lot of people are going to end up much poorer over this. And we won't know the final extent of the damage next year, or the year after, either. These things take time to unravel. Financial life as we know it, will be significantly different in a few years.