Are we convinced that talking to Johnny about the Stock Market Game helps his parents understand the traps in an option ARM mortgage?He also notes the necessary evil of mortgages different from the 20% down, 30 year fixed.
[A]s long as we try to push homeownership for the poor -- which confuses the correlation of homeownership and financial stability with a causal link from homeownership to financial stability -- we will face the problem that the poor will take advantage of riskier mortgage vehicles. We will encourage them to have higher leverage in their houses. (Yes, sir, nobody put a gun to their heads. We just put dreams in them, encouraged with itemized tax deductions. Yes, it's still their fault in the end. Yes, but what would you like to do now?)There's also a knock-on effect to the return on investment in housing, but I'm too tired to work through it tonight.
Robert Reich notes that the holders of those riskier assets weren't paying attention.
With everyone believing the underlying assets would appreciate, there was no reason to care, that is, until the appreciation stopped.
The sub-prime mortgage mess triggered it, but the problem lies much deeper. Financial markets trade in promises -- that assets have a certain value, that numbers on a balance sheet are accurate, that a loan carries a limited risk. If investors stop trusting the promises, Wall Street can't function.
But it's turned out that many promises like these weren't worth the paper they were written on.
That's because, when the market was roaring a few years back, many financial players had no idea what they were buying or selling. Worse, they didn't care. Derivatives on derivatives, SIVs, credit default swaps (watch this one!), and of course securities backed by home loans. There seemed no limit to the leverage, the off-balance sheet liabilities, and what credit rating agencies would approve by issuers who paid them to.
Two years ago I asked a hedge fund manager to describe the assets in his fund. He laughed and said he had no idea.
Mark Thoma links to much, much more.