The collapse of "inflated credit" ... in 1929

A quote attributed to Winston Churchill, in Ann Petifor's article, 1929 once more?, The Guardian (UK), April 12, 2008:

The year 1929 reached almost the end... under the promise and appearance of increasing prosperity, particularly in the United States. But in October a sudden and violent tempest swept over Wall Street......... The whole wealth so swiftly gathered in the paper values of previous years vanished. The prosperity of millions of American homes had grown up a gigantic structure of inflated credit, now suddenly proved phantom. Apart from the nation-wide speculation in shares which even the most famous banks had encouraged by easy loans, a vast system of purchase by instalment of houses, furniture, cars and numberless kinds of household conveniences and indulgences had grown up. All now fell together.

Plus ça change, plus c'est la même chose. The more things change, the more they stay the same.

(This quote is from Churchill's 1948 retrospective, The Gathering Storm.)


The collapse of a credit-fueled housing bubble ... in 1837

From the website of the Chicago Public Library:

In early years, Chicago's economy was fueled mostly by real estate speculation. In the 1830 to 1837 period town lots were sold at ever increasing prices--sometimes doubling in a day. Financing was provided by: Easterners eager to speculate in Western Lands, banknotes of doubtful value issued by distant banks, and a variety of public and private debt loosely secured by Chicago real estate.

In 1837 a nation-wide financial panic resulted in a dramatic bust of Chicago real estate values. Easterners stopped speculating, attempts to redeem the notes of the distant banks proved that many of the banknotes were indeed valueless, Chicago real estate became impossible to sell and the debt secured by it worthless. ... the economy went into a nose dive for the next four years.
Plus ça change, plus c'est la même chose. The more things change, the more they stay the same.


Steered to subprime

Tanta in her Calculated Risk blog post, Ranieri on the MBS Market: It's Broke, of April 28, 2007, quotes Lewis Ranieri, who pointed out that as much as half of the high-interest rate subprime loans that homebuyers were steered into by mortgage lenders and brokers during late 2005 through late 2006 could instead have been issued as government- or agency-insured loans, or as agency-purchased loans, at much lower interest rates:
... we had a two-day conference in Washington yesterday, which was called the Housing Round Table. It's all the participants in housing and we get together three times a year and at that there was an argument from a number of the economists in the room [... that] looking at the production, the subprime production, in those five or six quarters that as much as 50 percent of that production could have gone to the agencies, meaning, Fannie [Mae], Freddie [Mac] and FHA. That's a pretty profound statement because a subprime loan is, at best, [an] eight plus coupon.

And usually, there's a second mortgage with a 12 coupon, so you're talking about an average coupon, a little bit over nine and you know, an agency piece of paper would've been a 6.5, so if you translate that into what he said, in another way, he was arguing that half these loans, the homeowner could have been put into a coupon at 6.5 versus 9.5 [percent].
At those lower rates, one might surmise that fewer - perhaps significantly fewer - subprime homebuyers would now be defaulting on their mortgage loans.

Tanta notes that Ranieri "is generally given a large art of the credit for creating the private MBS [mortgage-backed securities] market, and would have to be considered, by anyone’s standards, a highly-informed participant in the mortgage credit markets."

We've now just seen an allegation that this practice regularly occurred at the nation's largest mortgage lender. Gretchen Morgenson reported in her article, Inside the Countrywide Lending Spree in the New York Times' Sunday edition of August 26, 2007, that salespeople at Countrywide Financial Corporation routinely steered homebuyers into high interest rate, high fee subprime loans even when they were eligible for lower cost prime loans or loans backed by the Federal Housing Administration:
... potential borrowers were often led to high-cost and sometimes unfavorable loans that resulted in richer commissions for Countrywide’s smooth-talking sales force, outsize fees to company affiliates providing services on the loans, and a roaring stock price that made Countrywide executives among the highest paid in America.

Countrywide’s entire operation, from its computer system to its incentive pay structure and financing arrangements, is intended to wring maximum profits out of the mortgage lending boom no matter what it costs borrowers, according to interviews with former employees and brokers who worked in different units of the company and internal documents they provided. ...

According to [a] former sales representative, Countrywide’s big subprime unit also avoided offering borrowers Federal Housing Administration loans, which are backed by the United States government and are less risky. But these loans, well suited to low-income or first-time home buyers, do not generate the high fees that Countrywide encouraged its sales force to pursue.

The monthly payment on [a representative] F.H.A. loan [at 7% interest with 0.125 points] would have been $1,829, while Countrywide’s subprime loan [at 9.875% interest with 3 points] generated a $2,387 monthly payment. That amounts to a difference of $558 a month, or $6,696 a year — no small sum for a low-income homeowner. ...

As of June 30 [2007], almost one in four subprime loans that Countrywide services was delinquent, up from 15 percent in the same period last year, according to company filings.

Updated January 2, 2008
Powered by ScribeFire.