Like a bunch of present-day George Baileys, ethical subprime lenders evaluate applications carefully, don't pay brokers big fees to rope customers into high-interest loans, and mostly hold onto the loans they make rather than reselling them. They focus less on quantity than on quality.Those ratings agencies aren't the biggest issue, but some of the stuff that is now known about their risk assessments defies belief (from this excellent article by Michael Lewis):
He [Eisman] called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.And when S&P wouldn't give them a good (AAA) rating on something, just ask another rating agency! (Bill Ackman on Charlie Rose):
ROSE: One person after another has come to this table and just cast huge criticism at the ratings agencies. ACKMAN: Yes. ROSE: It’s all deserved? ACKMAN: It’s deserved. ROSE: How did it come to that? ACKMAN: [...] There was a lot of rating shopping. An investment bank would walk into Moody’s and say, look, here is a risk. We’re looking for a Triple-A rating. It would be analyzed by Moody’s and they’d say, OK, it’s Triple-A. The investment bank would say, what, if I throw this in, is it still Triple-A? They would say, looks Triple-A to us. What if I threw in a few more bad mortgages, is it still Triple A? At some point Moody’s would say, it’s no longer Triple-A. They’d say OK. Then they’d walk across the street to S&P. They’d take a look at it, and if they said yes, they’d get paid a 600,000 dollar fee. Yes, it’s Triple-A. If they said no, they wouldn’t make any money.These bad loans were the basis for bad insurance policies. They called them credit default swaps because if you actually called them insurance you would need money to back them up (thanks Phil Graham and the congress who voted for that little exception in 1999). Of course, if you can get insurance on something, you tend to perceive the risk to be less, so you take out more loans. There is a reason why insurance companies need to have the money to back up their policies - natural disasters would otherwise constantly be giving the economy a full bodyslam. These default swaps made what probably would have been isolated losses of billion into trillions that are now poised to hammer every part of the economy, and be potentially the start of a second great worldwide depression. A good portion of my family or friends aren't being hit by this yet. We work in tech jobs and often for government(ish) agencies. It doesn't feel like we are actually in a recession, but I think we are just starting the lovely cycle they call a liquidity trap. The song goes something like this:
Reduced demand -> cut production, jobs -> fired people don't buy things -> reduced demand -> next verse, same as the firstMany believe that this is happening right now. That is why we've been hurling money at financial institutions and they've basically stuffed it in a mattress rather than loaning it. They are terrified of the next Lehman Brothers-like company crashing and taking them along, so they horde money for that rainy day. Give that money to just about anyone right now - automakers, consumers, dogs - they aren't going to spend it. And not because of rampant dog-as-customer discrimination. Ask yourself this: how willing are you right now to buy a new car? Maybe a little less than a year ago? The fix is finding some sector of the economy that will always spend more, then give them the means to do so. In the last sentence, if you started mouthing "the Congress of the United States," other people have the same idea. Even people who previously thought this was bad idea - Secretary of the Treasury Paulson is a good example - are now doing it one way or another (buying control of banks rather than just making loanshark-style loans to them). Some economists are skeptical of the existence of liquidity traps. One thing that is generally agreed on: it isn't always obvious to an a given person they are in such a trap, because different industries/job sectors go from step 1 to step 2 at different times. If it hasn't affected you yet, and it continues, you might just need to wait a little while.