HLS, maybe we don’t disagree. I suppose I am really just expressing my opinions about who should bear blame. Please excuse me while I rant!
I think professionals who made a living out of packaging and moving loans to the final investor consciously chose unsustainable levels of immediate personal gain over long term prudence and any sense of duty to the investors. In this group I would count the mortgage brokers, loan originators, the banks creating derivatives (like the MBSs and CDOs), the hedge fund and some other money managers, some law firms, rating agencies, monolines, and so on.
I think the final investors had a duty to do their own due diligence, and were provided adequate warning of the need for this in the form of their own expectation of returns higher than risk-free rates. They failed utterly.
So I hope the investors get no bailout, nor any generous settlements from the professionals (per the caveat emptor principle.) I hope the professionals suffer an appropriate loss of reputation, and penalties for any (presumably limited) fraud or conspiracy to commit fraud. And many borrowers who are now defaulting were not poor innocent victims, but instead greedy co-conspirators in a fraudulent scheme to engage in a one-sided transaction, using fraudulent loan applications. It was a one-sided transaction because they planned to keep most of the profits if home prices appreciated, and leave most of the losses with the lenders if home prices went down.
Thanks for recounting elements of loan securitization. I was familiar with only the very broad outlines of this. Yes, the loan originators bore a (tiny) portion of the risk because early defaults went back to them, and later fraudulent ones are supposed to also. But they won’t be actually paying most of the losses – they don’t have enough money, and the later losses will be much bigger. Although their share of the pain has grown big enough to sink many of them, that sharing of the risk was too tiny to incent them to underwrite the loans carefully in the first place. The investors are holding well over 90% of the risk.
Yes, lenders providing the riskier loans were supposed to be compensated for the risk by higher interest rates. But I think the risk premiums charged were completely inappropriate to the level of risk. When 2/3 of new loans are in a form like stated income, or little money down, or super-low early payments, and the money being borrowed for each home is 4 times what is was 10 years ago, and incomes are only 50% higher, then it’s obvious that historical calculations of the loan risk premium are just not relevant. Unfortunately, I suspect the people who effectively decided the risk premiums were not true agents of the investors, but rather people who made money shoveling more loans through the system. It’s still ultimately the investors’ fault for accepting risk at lousy prices. I hope they’ve learned their lesson.
