Housing price conundrum (part 3)

so just a bit of review what happened from 2000 to 2004 so from 2000 and actually I should really say from 2000 to 2006 because that really was when the housing bubble happened well financing got easier so financing easier financing got easier or they essentially they lowered their standards and it got progressively easier and easier and easier every year we went so then that allowed more people more people to bid on homes so increase the demand artificially in in certain ways because we saw from that New York Times article that people in come forward increasing and that the population wasn't increasing anywhere near as fast to to soak up the supply so all it did is allow people to who are renting before and who couldn't save the money for the down payment now to participate so now you had more people bidding for the same house to bid up houses to bid up houses but that led to the obvious question why did financing get easier and easier so let's go back to the good old days like the early 90s and and and or actually let's go even before that let's go to kind of the classic you know what what happens to get a housing loan well traditionally if I wanted to go alone get a loan I would go to my bank I would go to my bank and that loan officer at the bank he's going to be giving the bank's money for your house right like he's going you he gives you money and you're going to pay him interest right this is me and so that loan officer at the bank he really cares that they're not going to lose money on the transaction if he's going to give you a million dollars he wants to make sure that no matter what happens if you lose your job if you get arrested if you skip town that he's still going to be able to get his million dollars back and if you go back to our our equity and balance sheet presentations that's why back in the day they made sure that you put 20-25 percent down payment on your house and you had a good credit rating that you had a good steady income because that that banker that loan officer was going to be in trouble and his bonus was based on how good the loans he gave held up so that was the traditional model what happened that was started to happen in the mid 90s especially in California and then nationwide in in about 2001 2002 is you had what we call a securitization of the mortgage market and and this in all fairness this actually happened a while before with things like Fannie Mae and Freddie Mac and I'll do a completely separate video on those but Fannie Mae and Freddie Mac essentially had the same standards they had the standards of we call them conforming loans that yet I think the number you have 20% down you have to have a certain credit score assert certain steady income so Fannie Mae and Freddie Mac were these entities that might buy the loan from your local banker but their standards were just as high as the local bankers and they were based there I think they were actually you know they had oversight by Congress so that they had a that there they weren't giving away loans for free but I'll do a whole other presentation on Fannie Mae Freddie Mac but what you had happened in the late 90s and especially in the early part of this decade is you had a whole industry outside of the government-sponsored entities the government-sponsored entities are Freddie Mac Fannie Mae and Freddie Mac and this is essentially instead of you going to your local bank for a loan this is me again I would go to my local mortgage broker countrywide is the most famous of them I think they're CFC that's their talk is the stock ticker they're not bankrupt yet so I would go to countrywide and essentially you know I would get a million dollars from them a home loan I'll get a million dollars from them and I'd agree to pay interest to countrywide but then countrywide would do this like a million times so times a million right they'll do they'll give a home loans to a million people put them all together and then they'll sell the loans they'll sell the loans to like let's say Bear Sterns so that's an investment bank let's call it Bear Sterns hope none of these people sue me I guess they have bigger troubles now than wondering about my YouTube videos they sell to Bear Stearns and then Bear Stearns will package a bunch of these mortgages together essentially io u--'s from people and then they would sell those to investors right they would sell these to an investor so essentially instead of instead of countrywide Assent being responsible for my loan the look my payments now go to these investors and you could watch the that says investors I know my my penmanship's horrible but you should watch the videos on mortgage-backed securities and collateralized debt obligations if you want to get to understand a better understanding of exactly how the money flows go but the bottom line is because of this process what's happening countrywide is just kind of just being a transaction transactional they're just doing the paperwork from my loan they're temporarily holding the loan and and and and they're doing a little bit of due diligence and in return for that my that that countrywide mortgage broker will get you know will just get a fixed fee for for doing that transaction maybe they'll get like $5,000 for just doing the paperwork for my mortgage right and then Bear Stearns will package a bunch of these mortgages up and you know now it's going to be in the billions and and and then you know repackage them and sell them to investors and the pot process Bear Stearns gets a cut and you know wrestlers are doing this for millions of mortgages at a time so maybe Bear Stearns it's in you know it's in the billions of dollars that Bear Stearns gets a cut so Bear Stearns essentially just gets a fee like the mortgage broker of course it'll it's a huge fee and then the investors are going to get my interest payments right and let's say if the interest rates if I'm paying 7% of the other million people are paying 7% the investors are going to get 7% on their money and that seems like a pretty reasonable proposition and you know of course the investors would care that that the money that they're essentially giving because they're giving money to the investment bankers we're giving money to countrywide and that's where my million dollars is essentially coming from the only reason why the investors would give their money is if they have a lot of confidence that these are really really good loans well the investors they don't know who I am they don't know what my job is how likely I am to pay the loan so the investors have to rely on someone to tell them that these are good loans and that's where the ratings a the rating agencies come rating ratings agencies and these are standard & poor's and moody's and and they rate these these assets these these these mortgage-backed securities and what they say is well they'll look at this big you know package of mortgages these million mortgages that Bear Stearns has packaged together and they'll look at the historical default rate and they'll say well you know these these mortgages really haven't been defaulting and you can think about why they haven't because housing price has been going up so these mortgages really haven't been defaulting there's a very high chance you're going to be able to get all your money back so we're going to give these what they call you know let's say they say triple-a rating so this investor who knows what could be the Central Bank of China it could be a hedge fund it could be a whole set of people it might be the investment banks themselves sometimes they actually bought these just to make some extra money these investors they don't know who actually borrowed the money or what kind of credit rating they had or anything but they just took a leap of faith they said well Standard & Poor's or Moody's did the work they're telling me that this is triple-a triple-a which means the highest level of debt or you know whatever they told him maybe it was single a or I forget all of the the different qualities of debt but they just took their word for it and they got their 7% interest on their money whatever was 6% money and that worked out pretty well and this and so these guys they liked the fact that they were getting the 7% they say this is good asset class so then they H funneled even more money so then there are even more investors there are even more investors that wanted to do this so like this is great this is like you know with very little risk I'm getting a pretty good return on their money that's better than putting in the bank that's better than buying Treasury bills right so then even more money flowed in well more money wanted to invest in people's mortgages but countrywide would say well we're already giving mortgages to all of the people who qualify so in order to actually find more people who want mortgages from us we'll just have to lower the standards a little bit right and we can't lower the standards because we find even when we do lower the standards no one's defaulting on their mortgages and all in the next video I'll maybe give a little bit more color Y so countrywide will issue even more mortgages and give them to these investors with even lower standards and of course countrywide the mortgage brokers at countrywide they love it because every time they do a transaction they just get some money and then they give the mortgage to the investment banker which packages them up and then sells them to investors so they get it off of you know their hands and they just got the fee so they just collect big cash the investment banks love it right they just love doing the transactions because they get more and more money every time they do the transactions and for the moment the investor seemed pretty happy because they keep giving money into this system so to speak even though you know they might be reading the newspaper and seeing that the standards are going down but they're consistently getting their return and because the the defaults were very low over theirs time period and I'll explain in the next video why the defaults were very low they felt that they were in they were getting a good return maybe 6 or 7 percent on investments that had very very low risk so in the next video I'll explain why the defaults were very low in that time period see you soon