Your house in your hands
TESS VIGELAND: One of the country’s biggest subprime lenders, New Century, declared bankruptcy last month. Then this week, the company announced 2,000 layoffs because it can’t find a buyer . . . for its role in helping people buy homes they couldn’t afford.
This month’s Money Magazine takes a look at how this whole mortgage mess happened and what we can learn from it. Reporter Stephen Gandel is with us. And Stephen, a lot of it has to do with the secondary market for mortgages, you wanna explain.
STEPHEN GANDEL:
It used to be you go to your local bank branch, there’d be a loan officer there and he would sign you up with the mortgage that he wants you to pay for the next 30 years because that’s where the bank made its money off, you paying back the interest. Now, most banks will sell you that mortgage, but then they’ll sell it to someone else like a big Wall Street firm. They’ll package up that mortgage, your mortgage, with hundreds of other mortgages like that. And then they’ll turn around to their investors and resell that mortgage.
VIGELAND:
What does this change mean in terms of what kinds of mortgages people can get and who is actually getting those mortgages? Who they are actually lending to?
GANDEL:
It means banks are willing to lend to pretty much anyone in any way they want it, whether it’s responsible or not, because they don’t hold the risk on the mortgage anymore. They sell that mortgage often to this vast and complex financing system. So no one really has any stake in making sure that the right mortgage is sold to the right person.
VIGELAND:
How is it that investors aren’t as concerned about this as you would think they would be?
GANDEL:
Well, I think investors are concerned about it now because they bought these bonds based on a certain amount of assumptions. They relied on investment banks. They relied on rating agencies to tell them how much risk they had. And I agree. I think people took on more risk than they thought they were, but here is how the logic of it all works. These bonds that are based on mortgages are structured in a way that they pay a low interest rate to the people who get paid back first. Something a little bit better than a treasury bond because they have the assurance that the first mortgage payments that come in pay off their bonds.
GANDEL:
The people at the very bottom get a much higher interest rate. Those people are willing to take on a higher risk because they have – are gonna be paid a much higher interest rate. I’m not sure it’s gonna work out. I mean, the defaults that are happening in the mortgage market are much higher than people predicted. But the logic was, that I can take on these risky mortgages, I can buy the bonds that are backed by subprime mortgages, are backed by mortgages that may even be greater than the value of the houses. I can buy those bonds because I’m getting paid a higher interest rate. And so I’m getting compensated for the risk I’m taking.
VIGELAND:
So everyone here is taking some sort of risk. I – maybe, except the bank at this point, which is just merely selling off the mortgage. But really, most of that lies on the shoulders of the borrower who, who may not even understand that they could be getting a mortgage that they really can’t afford, but it doesn’t really matter to anybody else.
GANDEL:
That’s correct. Over the last 10 years, the mortgage market has built up a financing system that does a very good job spreading the risks among banks and mortgage brokers and investors. When you take out a mortgage with your bank, it’s fondled into this system that many people will now hold a small portion of your mortgage, and to hold a small portion of hundreds of mortgages. So any individual mortgage, they won’t really care much about what that defaults. But to the borrower, whether they are able to pay their mortgage, whether they default to their mortgage, it means, whether they have the ability – a place to live.
GANDEL:
But to the average investor, that risk has been spread out so effectively that any single mortgage can go bad and their mortgage – their portfolio isn’t hurt. The problem here is that, the system for financiers, for investors works better than it’s ever worked before. Even with all the defaults we’re hearing about. There probably won’t be a major financial catastrophe. There probably won’t be an S&L crisis. There probably won’t be any kind of major money center bank going bankrupt because the system is very good right now at spreading out the risk for the financial players.
GANDEL:
But for the actual homeowners, there’s no way to spread the risk of you not being able to pay the mortgage. If you can’t pay your mortgage, you lose your house. But for the financial players, your house is only a small fraction of the portfolio they own. And even if they bought the bond, there are complex financial instruments these days, that allow them to lay the risk off of whether you pay it or not.
VIGELAND:
Well, what can consumers, homebuyers do to protect themselves at this point given the system operates, how it operates now?
GANDEL:
You really need to try to understand the mortgage you’re getting. Because there are so many different options out there, and a mortgage broker will sell you any mortgage, even if it’s not right for you. So you need to try to understand what it is. Understand what the maximum rate you might have to pay. You should shop around. Most people believe that mortgage brokers have a duty to be on your side. In fact, they don’t. Mortgage brokers work for the bank. You need to do your own shopping around. The third thing you should do is hire your own appraiser. You may be paying for the appraiser, but the appraiser works for the bank.
VIGELAND:
All right. Stephen Gandel is a senior writer with Money Magazine. Thanks for coming in and helping us sort this through.
GANDEL:
Thanks for having me.
VIGELAND:
This is Marketplace Money from American Public Media.
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