Q: Who created the whole subprime mortgage mess and why is the government bailing everyone out?
A: Ever drive through a fancy neighborhood, look at awe at the houses and wish you could buy one?
If you're like most people, the thought probably ended there. But for others, due to the zaniness of the mortgage market in the mid-2000s, the idea of buying a home you couldn't afford wasn't so outlandish.
Many lenders were willing to loan money to just about anyone with a pulse because they were selling the loans to investors, not holding onto them. So, normal standards for making loans were ignored in too many cases.
The mortgage lenders and brokers, banks, Wall Street investment banks and bond investors were all playing a game of chicken. Due to lax oversight or greed in the mortgage market, mortgage originators, who gave the money out, were able to lend money to consumers who put no money down or who provided no proof of income. They also pushed marginal borrowers into more expensive "subprime" loans at higher-than-prime interest rates.
The originators — lenders and brokers — were able to do this because they figured if the borrower defaulted, they'd just repossess the house and sell it for a profit in the red-hot housing market. Or, the originators didn't worry because they figured they would bundle the loan with dozens of others and sell the package to investors, who then were on the hook for any risk of default. Either way, they took a fee for originating the loan.
Well, the housing correction of 2006 changed everything. Housing prices were falling in many places instead of rising. That blew the mortgage lenders' first backup plan. Next, interest rates continued to rise, which not only eroded the value of outstanding mortgages but also caused many mortgage loans to reset at higher interest rates, pushing many borrowers,
both "subprime" borrowers with weak credit and housing speculators, into default.
The whole financial ballet collapsed when investors who bought these pools of loans forced some mortgage originators to take them back. Then, you guessed it, it didn't take long for the originators to go bust. But it also turns out that many large banks, investment banks and other investors owned these pools of loans. And, unable to sell them, and with values plummeting, they've been forced to write down the value of billions of dollars worth of these loans on their books.
So, the problem was caused by borrowers whose eyes were bigger than their wallets and who found opportunistic mortgage lenders and brokers willing to give them rope to hang themselves with.
Then, why is the government stepping in? The Fed, Congress and the Bush administration are all trying to stop this situation from getting so ugly that it becomes a problem that threatens the entire economy. While they are not "bailing out" lenders and investors with cash, they are doing what they can to minimize more foreclosures and keep money flowing so banks can lend to truly worthy businesses and individuals, something they have become reluctant to do because they aren't sure who is "worthy" any more.
Certainly, borrowers who bit of more than they could chew and greedy lenders concerned only about fat fees deserve to suffer the consequences of their poor decisions. At the same time, the Fed's job is to preserve financial stability, and that's a role that's sorely needed now. Some might argue they should have been stepped in a few years ago to stop the abuses.
Matt Krantz is a financial markets reporter at USA TODAY. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at firstname.lastname@example.org. Click here to see previous Ask Matt columns.