Here’s what happened, without the jargon or the bubble bath. As you see at the beginning of the movie, Lewis Ranieri, now one of the wealthiest people in the world, came up with the idea of essentially crowd-funding mortgages. He took lots and lots of mortgages, bundled them into bonds, and let big institutional investors, like pension funds, buy them.
It was a great investment for them because pension funds need a safe and secure source of income to pay retirees and these were safe and secure — much more than stocks — because people almost never defaulted on their mortgages and because so many mortgages were bundled up together that even if some did default it would have almost no impact.
These bundles of mortgages were so popular that the banks ran out of safe and secure mortgages to put into bonds. And so, they started pushing mortgage brokers to issue more mortgages, and that meant giving mortgages to people who would not otherwise have qualified. (Some people will tell you that the government was at fault for pushing home ownership on people who could not afford it. They are wrong. Most of the pressure was coming from people who wanted to buy mortgages, not people who wanted to buy houses.)
So, the formerly safe and secure bonds started filling up with less and less safe and secure mortgages. And the people responsible for differentiating the risk of the bonds, including the rating agencies, decided to just keep rating and selling the new, less secure securities as though they were exactly the same as the earlier ones. All of the “formulas” (sometimes called “algorithms” or “models”) used to justify this were bunk.
Imagine it this way: there’s a vineyard that makes superior wine that everyone wants to buy and there are strong legal and economic incentives to buy it. But you only have so many grapes, so you start watering it down, still selling it at the same price, and getting the people who rate wine to continue to give it the same rating. Then you run out of water so you start blending it with turpentine, and all of your projections show that it is just as good and will still sell just as well so you price it that way and assume there is no risk.
Here’s the important part: everyone at every part of this conveyer belt of increasingly risky securities all being treated as though they were not risky was being paid based on the number of transactions, not the quality of the transactions, a sort of very big, very expensive game of tag, where there was never any “it” until finally “it” was everyone.
Read more: http://www.beliefnet.com/columnists/moviemom/2015/12/the-big-short.html#ixzz40pSB3SdG
Read more at http://www.beliefnet.com/columnists/moviemom/2015/12/the-big-short.html#xoFEDYXxSxMff9hB.99
It was a great investment for them because pension funds need a safe and secure source of income to pay retirees and these were safe and secure — much more than stocks — because people almost never defaulted on their mortgages and because so many mortgages were bundled up together that even if some did default it would have almost no impact.
These bundles of mortgages were so popular that the banks ran out of safe and secure mortgages to put into bonds. And so, they started pushing mortgage brokers to issue more mortgages, and that meant giving mortgages to people who would not otherwise have qualified. (Some people will tell you that the government was at fault for pushing home ownership on people who could not afford it. They are wrong. Most of the pressure was coming from people who wanted to buy mortgages, not people who wanted to buy houses.)
So, the formerly safe and secure bonds started filling up with less and less safe and secure mortgages. And the people responsible for differentiating the risk of the bonds, including the rating agencies, decided to just keep rating and selling the new, less secure securities as though they were exactly the same as the earlier ones. All of the “formulas” (sometimes called “algorithms” or “models”) used to justify this were bunk.
Imagine it this way: there’s a vineyard that makes superior wine that everyone wants to buy and there are strong legal and economic incentives to buy it. But you only have so many grapes, so you start watering it down, still selling it at the same price, and getting the people who rate wine to continue to give it the same rating. Then you run out of water so you start blending it with turpentine, and all of your projections show that it is just as good and will still sell just as well so you price it that way and assume there is no risk.
Read more: http://www.beliefnet.com/columnists/moviemom/2015/12/the-big-short.html#ixzz40pSB3SdG
Read more at http://www.beliefnet.com/columnists/moviemom/2015/12/the-big-short.html#xoFEDYXxSxMff9hB.99
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