Housing conundrum (part 4)

I'll now explain to you why from 2000 to 2005 we had very low defaults on mortgages let's say that let's say that I you know I buy a house for a million dollars I buy a million dollar house so let's say the bank gives me a million dollars and then I'm willing to pay a percentage on it so this is from the bank this is me and I use that to buy a house I don't know if these diagrams help you but you get the general idea and the bank does that and let's say I don't know a year later I lose my job I just can't pay this mortgage anymore so I have a couple of options I can either sell the house sell house and pay off the debt or or I guess I could just you know tell the bank well I can't do anything and I'm gonna foreclose and that would ruin my credit it would hurt my credit and I would lose all my down payment so what are the circumstances that I can sell the house well if I borrowed a million dollars as long as and let's say I did put no money down just for simplicity if I can sell the house for 1.1 million dollars well I would do it right listen let me sell for 1.1 million if I sell for 1.1 million I pay the bank let me switch colors I pay the bank a million pay 1 million and I net a hundred thousand dollars and everyone's happy the bank got their money back so they didn't lose many money on the transaction I made $100,000 and so the whole reason why this worked out even though maybe I was a credit risk is because the housing prices went up so when you have rising housing prices you'll have you'll practically the banks will not lose money lending you lending you because if you can't pay you just give back the house the bank can sell or you won't even give back the house you'll sell the house and you'll pay it off even though you can't pay the mortgage anymore the only situation where I would foreclose is if the market price of the house goes less than my loan and that's actually a situation that we're facing now so if let's say that I can only sell this house for $900,000 well then I'm just gonna give the keys back to give the keys back to the bank that's actually called jingle mail because you just mailed the keys back and then the bank sells the house for 900,000 and then they would take a loss so when housing prices go down this is this is the situate you that's the only situation where really you should have foreclosure but when housing prices go up the person who borrowed it is just going to sell the house and pay off the loan and they are actually probably gonna make some money so there was every incentive to buy a house so let's think about this whole dynamic over the last few for the last several videos that we've been building so we said we said from 2000 to 2004 housing prices went up now let me do it like this let me let me change it a little bit so we know that from so this is all going to be we could even say from 2000 to 2006 so we know that housing prices went up housing prices up and why did why did housing prices go up well we saw the data it wasn't because people were earning more it wasn't because the unemployment rate went down it wasn't because the population increased it wasn't because the supply of houses were limited we disproved all of that we realized it was just because financing got easier the standards for getting a loan went lower and lower financing it got easier and easier and because housing prices went up what did what did that cause what we just said when housing prices go up default rates go down default rates go down alright you could give a loan to someone who's a complete deadbeat but they as long as housing prices go up and if they lose their job they can still sell that house and pay you back the loan so housing prices going up make sure there's no foreclosures so defaults go down so then the perceived risk goes down of lending the perceived let me write that perceived what's happening perceived lending risk lending risk goes down so that makes more people willing to lend more people willing to lend and you know corollary of more people willing to lend is that the actual standards go down and that's financing easier we could actually write that standards go down standards go down so you had this whole I mean I guess you could argue whether this is a negative or a positive cycle but you had this whole cycle occurring oh it from the late 90s but especially it got it really got a lot of momentum and at around 2001 2002 2003 that financing got easier despite the fact that people were earning less population wasn't increasing that fast that there were all of these new houses and that caused housing prices to go up housing prices went up then we had a lot fewer people defaulting on their loans and no one would default on their loans if they can sell it for more than the loan then people then a lot more people said well these are super safe and so you know the the ratings agency Standard & Poor's and Moody's were willing to give triple-a ratings to more and more what I would argue are risky loans so the perceived lending risk went down then more and more people like this asset classes where they said wow this is great I can get a better return than I can get in a bank or in Treasuries or in a whole set of securities even though these are very low risk or perceived low risk so I want to funnel more and more money in here and so the mortgage brokers and the investment banks is said great you know the only way we can get more volume to satisfy all these people who want to lend money the only way we can find more people to lend money to is by lowering the standards and this cycle went round and round and round and it really started because this whole process of being able to take a bunch of people's mortgages together package them up and then you know turned them into securities and then sell them to a bunch of investors this was a quote unquote innovation in the mid 90s or early 90s I forgot exactly when and it and it really started to take steam in in the early part of this decade so that's essentially why housing prices went up and and why kind of all of the silliness happened and in the next video I'll talk a little bit more about maybe who's what whose what some of these investors were and I'll tell you what a a common a hedge fund technique and it's I think it's very important not to group all hedge funds together there are some good ones but what a common hedge fund technique was to take advantage of this virtuous cycle to make the hedge fund founders very wealthy I'll see you soon