Anatomy Of The Subprime Meltdown

The Wall Street Journal has an excellent article that explains the interdependency between subprime borrowers and wealthy, high-risk investors:

Three years ago, Colorado truck driver Roger Rodriguez was in the market for a new mortgage loan. With radio and Internet ads trumpeting easy approvals, he picked up the phone.

That call set into motion Mr. Rodriguez’s descent into the subprime mortgage mess. Over the next several months, his adjustable-rate loan passed through many hands. These included a local Denver broker, Livingston, N.J., finance company CIT Group Inc. and a Greenwich, Conn., unit of Royal Bank of Scotland Group PLC. Eventually, a piece of Mr. Rodriguez’s loan landed in mutual funds run by a Tennessee investor named James C. Kelsoe Jr.

Little good has come to any party that touched the loan. Mr. Rodriguez, now 61 years old, has lost both his job and his home. All the middlemen, from the broker to CIT to RBS, have either shuttered their mortgage businesses or are struggling. Mr. Kelsoe, once a star mutual-fund manager, has hit a career low as defaults on subprime mortgages decreased the value of his investments.

The paper trail from Mr. Rodriguez to Mr. Kelsoe illustrates how the mortgage market meltdown scalded millions of homeowners and investors. It also foreshadows how the domino effect stands to continue.

Behind Subprime Woes, A Cascade of Bad Bets [Wall Street Journal]
(Photo:stirwise)

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  1. zentec says:

    And now you know why you see people like Jim Cramer are parading around the Today show wanting a government bailout. They want someone to cover their bad bets.

  2. Crymson_77 says:

    If anything, we should shoot all the twits that caused this mess because they knew better. People that don’t have the money to buy a house, shouldn’t. How many people have been ruined by these predatory practices? Far too many as one is more than enough to me.

  3. mcjake says:

    And yet real estate agents and financiers are still pushing ARM loans!

  4. brookeln says:

    What a sad story.

  5. mac-phisto says:

    the problem now is different from the problem 6 months ago & people in government & the industry need to realize & react to that. a little bit has already been done, but if they don’t start pumping some more money into the system, this is going to effect a whole lot of people that normally would’ve been fine.

    yes, it all started b/c a bunch of bad loans that people couldn’t afford slipped thru the cracks. but now, a bunch of people that have been paying their loans on time are gonna end up screwed if they don’t get the opportunity to convert their loans.

    some might call that a bailout, but it’s not really. people are still paying their loans, investors are still making their money & it doesn’t really require the gov’t to pony up any money that they wouldn’t get back.

    or we can sit back & watch the fireworks in all their glory, but personally i’ve grown too accustomed to the 15% return in my 401(k) just for the fun of seeing our market collapse.

  6. JohnMc says:

    Cry me a river. I have sympathy for Mr. Rodriguez. But even he has a responsibility to know that with an ARM he must be capable of paying the higher rates. All those ‘professionals’ I have no sympathy for. They sliced and diced in attempts for higher yields and threw the risk factors out the window. That’s their choice now they can pay for their folly.

  7. rodeobob says:

    @mac-phisto: Close, but not cigar.

    It didn’t start because of “bad loans” that “slipped through the cracks”; it started with a financial vehicle (the mortgage-backed security) that rewarded large dollar lending over good risk management, and allowed lenders to pass off the risk of default on to others while getting paid to do so!

    You’re also close (but wrong) that “a bunch of people …are gonna end up screwed” if the feds and industry “don’t start pumping some more money into the system”. Yes, folks who are on Interest-Only or ARMs will be getting hit with high payments and probable default if they can’t refinance, and yes, the high default rates in place are making credit tight. But that’s only half the problem. Even if credit wasn’t tight, and folks were ‘pumping more money’ into the system, a lot of folks still wouldn’t be able to refinance their loans, because house prices are falling!

    The pitch many homeowners got in the last five years was pretty straightforward:
    1.) “The housing market is hot! It’s growing faster than ever before! If you buy a house now, in five years you’ll be able to sell it for a 5-15% gain that you can use to move into a bigger house!”
    2.) “If you don’t get into the housing market now, it’ll cost a lot more later!”
    3.) “You can’t afford traditional monthly mortgage payments in this hot, hot, hot housing market? Then just take an interest-only mortgage/ARM/Balloon mortgage. You’ll have a low mortgage payment which expires in 5 years, but by then the house is worth more, so you can either sell for big profits, or refinance at the higher value!”

    There’s a side to this meltdown that you’re completely missing, and that’s the declining housing market. If you have a $200,000 mortgage on a condo that’s only got a current market value of $150,000 it doesn’t matter how good your credit is, or how tight or loose the credit markets are, a bank will not refinance your mortage above the value of the asset.

    So yes, “a bunch of people that have been paying their loans are going to wind up screwed”, but no amount of “pumping some more money into the system” will help.

    The real heartache for me is that some of the folks who will wind up in forclosure will be hard working, first-time home-buyers. (a recent study showed ethic minorities were offered ARMs and other exotic lending packages at a higher rate than whites) Along with those folks will be a fair number of middle- and upper-middle class folks who were speculating in the market, looking to buy a second property to use for rental for a few years and then sell on that hot-hot-hot market. The problem with any bailout is aiding the first group (for whom the American Dream of Home Ownership is being promoted by our government) and the second group. (who speculated in a commodity market, possibly irresponsibly, and should not necessarily be protected from their losses)

  8. CumaeanSibyl says:

    @JohnMc: Dude, the man lost his job. Good luck covering any mortgage payment when you’re unemployed.

    Or are we going to blame him for lack of foresight now? “He should never have bought a house because he should’ve known he might possibly get laid off in the next ten years!”

  9. mac-phisto says:

    @rodeobob: i was actually ignoring a WHOLE LOT of the equation for the sake of brevity, but if you want, i can elaborate…

    house prices are falling b/c banks just cut their qualified applicant pool by about 80%. even before the only requirement for a loan was a pulse, you used to only need 2 out of 3 requirements: good credit, down payment & proof of income. now if you don’t have all 3, most banks are telling you to take a hike. & they’ve even tightened restrictions within those requirements – 680 used to be good enough for a loan – many banks have bumped to 700 or above.

    i live in a part of the country where housing values haven’t really fallen at all (aside from homes in the $500,000+ range), which is why i didn’t really address that part of the problem.

    regardless, a government program that allowed homebuyers the ability to refinance their existing loan balance at their current rate would stave a large portion of the problem. maybe only finance up to 100% & tell the folks that took a 125% they’re f-ed, or split off the amount above value as unsecured & create a program that mirrors consolidation under bankruptcy. either way, it would increase the amount of money available for new financing, which should increase the number of buyers & at lease keep values from resetting to 1993.

    i’m not really concerned about real estate speculators at all – & uncle sam shouldn’t be either – b/c any half-wit speculator would be smart enough to insulate himself from financial disaster by corporating his projects. if you’re speculating w/o at least an llc, than you deserve whatever financial wrath is heading your way. & if you’re corporated, you just fold the business & move on – no harm, no foul. didn’t the 80′s teach us anything?

    i find it funny that a whole lot of people think that this only effects low-income, 1st-time homebuyers or speculators though. i live in a pretty affluent part of the country & i cannot count on all my fingers & toes the number of people i know personally that have been “riding the refi” since the late 90′s. they live in 2500+ sq. ft. houses, 2 $50,000+ suvs in the garage, kids in private school – & their arm is probably resetting early next year.

    now, i know my personal experience is no indicator of problems elsewhere, but in connecticut, this meltdown is going to affect french-manicured soccer moms just as much as the low-income folks. which is to say, it’s going to affect everybody.

  10. katherinepiz says:

    Although I feel terrible about Mr. Rodriguez’s painful experience, I did not encounter this situation when seeking my own sub-prime mortgage loan. In my opinion, you need to work with a credible mortgage company and you need to be picky when selecting who to work with. I also realize this is a do or die market and mortgage companies can sometimes take advantage of you. As a consumer who was new to the whole mortgage world, I was slightly intimidated when using the Internet to find someone to help me. I came upon this site, quotematch.com, that referred me to multiple lenders, and did so quickly. I got quoted for free and eventually went through one of these lenders for my mortgage. Made me believe that there are still honest, competent mortgage brokers out there.