How did the US get itself into the housing crisis?

I frequently hear the question "How did the US get itself into the housing crisis?"

The best answer I've heard was produced in a special program about the housing crisis produced in a special collaboration with NPR News. What does the housing crisis have to do with the turmoil on Wall Street? Why did banks make half-million dollar loans to people without jobs or income? And why is everyone talking so much about the 1930s? It all comes back to the Globalt Pool of Money.

In a nutshell - up unto the year of 2000 - all the assets in the world - all the planes, trains and cars purchased, all the money saved and spent, all the rice, wheat and products produced in the world, pension funds, etc - had a value of about 36 trillion dollars. It had taken all of history to build to that number.

And along with all that money came an army of very nervous men and women charged with investing that money responsibly. So, for most of modern history, they bought really, really safe, really boring investments: things called treasuries and municipal bonds. Boring things. But then, something changed, something happened to that global pool of money.

From 2000 until 2006 that number nearly doubled to 72 trillion dollars. So, it took several hundred years for the world to get to 36 trillion. Then, in six years, to get another 36 trillion.

How's the world get twice as much money to invest? Lots of things happened, but the main headline is all sorts of poor countries became kind of rich making TVs and selling us oil: China, India, Abu Dhabi, Saudi Arabia. Made a lot of money and banked it. China, for example, has over a trillion dollars in its central bank, and there are office buildings in Beijing filled with math geniuses-real math geniuses-looking for a place to invest it. And the world was not ready for all this money. There's twice as much money looking for investments, but there are not twice as many good investments. They all wanted the same thing: a nice low risk investment that paid some return.

At that same point - Alan Greenspan made a decision to make that army's favorite investments a lot less attractive by keeping the Fed Funds rate at the absurdly low level of one percent. It tells every investor in the world: you are not going to make any money at all on US treasury bonds for a very long time. Go somewhere else. We can't help you.

And so the global pool of money looked around for some low-risk, high-return investment. And among the many things they put their money into, there was one thing they fell in love with - the US housing market.

There are problems. Individual mortgages are too big a hassle for the global pool of money. So picture the whole chain. You have the homeowner, he gets a mortgage from a broker. The broker sells the mortgage to a small bank, the small bank sells the mortgage to a guy at a big investment firm on Wall Street. Then that guy takes a few thousand mortgages he's bought this way, he puts them in one big pile. Now he's got thousands of mortgage checks coming to him every month. It's a huge monthly stream of money, which is expected to come in for the next thirty years, the life of a mortgage. And he then sells shares of that monthly income to investors. Those shares are called mortgage backed securities.

So - so many mortgages were made that there came a point in 2003 where just about everybody who wanted a mortgage and was qualified to get one .... had gotten one. But the pool of money had just gotten started. They wanted more mortgage backed securities. So Wall Street had to find more people to take out mortgages. Which meant lending to people who never would've qualified before. And so the guidelines were getting a little looser. Something called a stated income, verified asset loan came out, stated income, stated asset . . .

And we quickly got to the point that 23 dead people in Ohio were approved for mortgages.

It was all good as long as real estate continued to appreciate. But somewhere in the summer of 2005 the real estate market stalled and started to fall.

And the foreclosure data that was used for speculating risk was flawed.

As we now know, they were actually using the wrong data. They looked at the recent history of mortgages and saw that foreclosure rate is generally below 2 percent. So they figured, absolute worst-case scenario, the foreclosure rate may go to 8 or 10 or 12 percent. But the problem with is there were all these new kinds of mortgages, given out to people who never would have gotten them before. So the historical data was irrelevant. Some mortgage pools, today, are expected to go beyond 50 percent foreclosure rates.

Here is the entire program - about an hour. 

http://www.thisamericanlife.org/Radio_Episode.aspx?sched=1242