6 ms·

Subprime or poorly documented loans are absolutely fine and actually help people, as long as they are marked as subprime loans. The problem with 2008/2009 was t

Subprime or poorly documented loans are absolutely fine and actually help people, as long as they are marked as subprime loans. The problem with 2008/2009 was that subprime loans were being marked as AAA, because that was the fraudulent part of it. And then these subprime loans were getting packaged together with AAA loans, and caused the quality to degrade, dropping asset prices, etc. As long as the loans are marked appropriately and the proper risk is taken with interest rates and there is nothing predatory or exploitative about them, there is nothing wrong with companies lending to subprime borrowers. In fact, it helps people break the circle of poverty by investing in them, again as long as it's not predatory.

Spooky23 8y ago
How is giving someone an asset-secured loan for $600k who has no income not a predatory act? In the case of the example in the article, if she wasn't given the loan, she'd probably have $100k or more in equity in cash from the sale of the home. The entire scenario is sickening and disgusting -- using hope and taking advantage of people's ego and emotional attachment to separate them from their money.
- brianwawok 8y ago
  It's an asset secured loan. If you have a 600k house, and the bank is willing to give you a 550k loan on that house - because it's backed by the asset - let it. Just don't let the bank then resell this loan as a prime AAA loan to others, so if it bombs someone else gets the shaft. It's just like organic food. I don't think it should be illegal to sell "conventional" eggs. I only think it should be illegal to sell a tray of organic eggs - where 1-2 of the eggs are "conventional" and hope no one notices. (Especially in a case where the farmer has an inside relation with the FDA inspector that is checking for the organic nature of eggs)
  - toomuchtodo 8y ago
    I think that's where the real confusion comes from. People think the relationship between the loan originator and the borrower is where the questionable practices take place, when it's really between investors and the loan originator. Similar to how Chinese companies do reverse mergers on US stock markets to bilk investors out of their dollars.
- tmp092 8y ago
  Read to the end. She used the money to fully buy out her grandfather’s house in San Clemente, Calif. She jointly inherited it with other relatives and said she needed a loan to pay them for their shares of the property. This is a highly unusual situation. She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some. The property will continue to grow in value. If she were really in a situation where she might default, her family would help her. This is not representative of any trend. Hardly predatory. Hardly a "high risk" situation for either the bank or the borrower.
  - Spooky23 8y ago
    >This is a highly unusual situation. Agreed. >She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some. So is she a private homeowner or a business? Is it legal for her to rent? Given that the bank accepts letters from old ladies describing casual labor as proof of income, who knows. I own investment property that is mortgaged and attracts high rents. The underwriting standards for that property were higher, and required 20% money down for a similar rate premium. >The property will continue to grow in value. That has little to do with qualification for the loan. Kind of makes my point -- it's in the banks interest to write a shitty loan to repo this house on default. (ie. predatory behavior) >If she were really in a situation where she might default, her family would help her. Are they cosigners? "Wink and nod" underwriting in banking is a bad thing.
    - deleted 8y ago
      [deleted]
    - rlucas 8y ago
      Banks (almost?) never want to repo and own a property. In most situations the bank 1. spends a bunch of opex to work out / sell off the property, and 2. has to remit any excess to the borrower. There are predatory operators known colloquially as “loan to own” guys, but they are usually unregulated and operating in the business world where the collateral value is less observable. For a bank, I believe Other Real Estate Owned (OREO, the balance sheet category where foreclosure properties are carried) is always considered a black mark and a burden, dragging down ROA/ROE.
- charlesdm 8y ago
  I disagree. She got a loan secured by an asset. If I own $100k in stock and I want to get a $80k loan secured against my stocks, let me. If I can buy a $550k property for $500k (with no cash down), with the lender not risking much when it gets repossessed and sold, let me. If the collateral is there, it's fine.
  - wil421 8y ago
    She got a 600k loan as a student based on bank statements which is insane. She also took it an ARM loan at 6%. In 5 years it’s very possible it could become unaffordable. Not a good decision either. In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018.
    - jlarocco 8y ago
      > In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018. But you're speculating. If it was a good deal in this case, what makes you think it's not in other cases? Can you point to a specific case where you think it's a bad deal? As long as we don't bail them out again, I don't really care what crazy deals banks and bank customers come up with.
      - deleted 8y ago
        [deleted]
      - wil421 8y ago
        Yes I think it is a bad financial decision for a nursing student to take out a 600k loan. It’s almost predatory. I could care less if it’s a good deal for the banks.
        throwawaymath 8y ago
        You keep talking about the person being a nursing student, but you keep ignoring what people are telling you about the asset. It's not an unsecured loan. It's backed by collateral. What is your specific problem? Liquidity?
Simon_says 8y ago
You use the word "predatory" a couple times. What does that mean? These are contracts that are willingly entered into by the borrower, and the lender has a lot of incentive to ensure that the borrower can actually pay.
- ceejayoz 8y ago
  In some scenarios, the lender has more incentive to let someone make years of mostly-interest payments, then foreclose. An underhanded contract isn't going to be obvious to a borrower with a high school dropout's education level. Even your run-of-the-mill credit card contract is written to an eleventh grade reading level, on average.
- gammateam 8y ago
  It means the licensed lender has a higher standard to abide by and not take advantage of the borrowers needs Such as creating a claim on everything the borrower will ever have and turning them into a debt serf But hey maybe housing prices go up really really fast
- soVeryTired 8y ago
  The lender has incentive to ensure that the value of the debt is greater than the initial outlay. That could be via a steady stream of payments, or via a handful of repayments plus a repossession and resale of the property. If the loan originator thinks the latter is likely, I don't think it's unreasonable to call the loan predatory.
- docker_up 8y ago
  You should research what the predatory loans were during the crisis. Your assumptions are incorrect, especially during the years leading up to 2008/2009. Banks would get people who undoubtably didn't deserve loans, would handwave over the details and then send people on their way with $1M loans and the borrowers would later fail. I have a friend who worked at Washington Mutual at the time, and she would routinely reject loan applications, and her manager would overrule her. The manager was making $30,000/month in commissions from loan origination, and he didn't give a fuck who was getting the loans because he was being paid and they were getting packaged up and sold to Fannie Mae/Freddie Mac. Meanwhile, people would be getting loans that they couldn't afford, but could make payments because of the 0% interest loans that were actually increasing the principal. But they didn't realize this because the lenders didn't explain all the details to them. It's predatory to take advantage of the fact that most regular people don't have a higher-level understanding of mortgages, and by filling their heads with ideas that it doesn't matter anyway because they will sell the house in a year for a profit. The lenders didn't care because they were incentivized to originate loans even if they knew the borrowers couldn't ultimately afford them. The thought at the time was "the house price will increase in 2 years anyway, so even if you get a $800k loan on a $1M house, you can sell it in 1 year for $1.2M, and then use the $200,000 profit for a downpayment on a real home."
balabaster 8y ago
Packaging small proportions of subprime mortgages with lower risk mortgages means that the bank is spreading risk across their mortgage portfolio while still giving people the opportunity of breaking the cycle of poverty by investing in them. Packaging all high risk mortgages together with a higher interest rate increases the probability of default on that portfolio while helping to keep those in poverty there by increasing the burden of the loan on them. So on one hand you've got a bank that enjoys massive profits spreading and thus decreasing their risk while assisting those in poverty to claw their way out by allowing them the benefit of lower interest rates. On the other you've got a bank that enjoys massive profits increasing the risk of one of their portfolios while making it extremely difficult for those in poverty to keep up with interest payments. I'm not discounting the fact that packaging large volumes of those mortgages as AAA and selling them on to other companies was fraudulent, it was, but the reality is, doing so was far less predatory than the alternative if you look at it from this perspective.
- gedy 8y ago
  > "giving people the opportunity of breaking the cycle of poverty" By borrowing beyond their ability to repay? That's gambling at best or just debt slavery at worst.
  - docker_up 8y ago
    Subprime loans are not lending to people who can't repay. It's lending to people who don't have the credit history or have a poor history and giving them a chance to borrow money. If they can't afford the loan they shouldn't be getting it in the first place.
  - balabaster 8y ago
    > "By borrowing beyond their ability to repay" That's a different argument. I'm not arguing the point of allowing them to borrow more than they can afford to repay. I'm arguing the point of allowing them to borrow what they can afford to repay at rates that allow them the opportunity to do so rather than making them pay rates they can't afford for money they desperately need. Preventing them borrowing more than they can afford to repay is a different and necessary oversight. Nobody should be put into a position of debt slavery. So I agree with your point, I just don't agree with your premise.
JumpCrisscross 8y ago
> The problem with 2008/2009 was that subprime loans were being marked as AAA, because that was the fraudulent part of it Not quite. Suppose I take a million subprime mortgages and say “I’ll pay you the first dollar any of these mortgages pay”. The probability that all of those mortgages default is slim. So this particular top-of-the-stack claim is, indeed, a quality one. This is what people mean when they say “top tranche” of a CDO. The CDO is the pile. The tranche is the priority. The top tranches were rated AAA. Looking back, they pretty much all paid as expected. The problem is a AAA rating means the security will pay out. Not that it will be able to be sold like a Treasury. So due to a confluence of things, many institutions needed liquidity, and when they tried to sell these instruments found there weren’t enough buyers. The desperate fire sold, thereby requiring others to mark down their holdings, and behold: crisis. There was also fraud in origination. And fraud elsewhere largely unrelated to the proximate causes of the crisis. But the proximate element was a classic one: a liquidity crisis. (The root element was over-leveraging.)
- docker_up 8y ago
  I'm not sure what your point is. Nothing you say disagrees with my point. The credit crisis was multi-faceted, but poisoning of AAA securities with subprime was definitely one of the major fraudulent aspects of the entire thing. AAA doesn't mean that the security will pay out. It means they have the lowest risk and it means that it's the most expensive. Even AAA-rated debt can fail. What happened was that large financial institutions were paying top dollar for AAA mortgage-backed securities, but after it was revealed that all of these mortgage-backed securities were poisoned with subprime loans, the value of those securities plummeted. The value of those assets dropped, which put the holders of those assets in a bad financial situation because they didn't have as much money as they thought and they also couldn't sell them. Some companies or funds are legally required to hold only AAA securities. This caused reverberations throughout the financial industry.
  - JumpCrisscross 8y ago
    > poisoning of AAA securities with subprime was definitely one of the major fraudulent aspects of the entire thing My point is there was no “poisoning of AAA securities with subprime.” Subprime mortgages can be legitimately assembled to produce AAA securities. This happened, and those securities ultimately paid out like AAA securities. They just didn’t perform, liquidity-wise, like Treasuries. (Neither did other corporate AAA securities, for that matter. OTR Treasuries are OTR Treasuries.)
patagonia 8y ago
The problem with 2008/2009... It was a bit more complicated than that. Also, subprime and poorly documented loans (mortgages in the case of the financial crisis) with teaser rates that eventually reset to a rate unaffordable to the borrower can absolutely be predatory when coupled with brokerages incentivizing brokers to sign up financially illiterate folks for loans they will eventually not be able to afford knowing the brokerage will move the risk off their books within days or weeks.
ThrustVectoring 8y ago
The 2008 crisis wasn't caused by subprime lending. It was caused by financial mis-modeling that caused various financiers of sub-prime loans to grossly mis-estimate the risk they were taking, resulting in having an insufficient amount of capital to back the economic risk they were taking. Specifically, the models used assumed that the economic risk of a mortgage default in Connecticut was uncorrelated with the economic risk of a mortgage default in Texas. When housing prices are rising nationally, this assumption is basically true - the house can be sold by the bank for what's owed on the mortgage, refinancing is available for balloon payments, and any one borrower's cash flow situation is idiosyncratic. But when housing prices started to fall, this lack of correlation broke down, and many financial institutions became unexpectedly responsible for the losses in this asset class.
- NoodleIncident 8y ago
  This might be too tangential, but this reminds me a lot of 538's model of the 2016 presidential election. They had a much higher chance of a Trump victory just before the election (30% vs 1%), and the major difference was that they didn't treat each poll's margin of error as an independent event, they modeled it so that any error in the national poll had a large effect on _every_ state poll.
  - ThrustVectoring 8y ago
    Yeah the cases have some striking similarity. There's generally two sources of error - bias, and noise. When you combine many measurements, only bias accumulates. Noisy errors in one state poll or one mortgage-based cash flow will be offset by noisy errors in another. If you get surprised by a change from a low-bias regime to a high-bias one, your old assumptions will lead you to be overconfident in your model. For 538, this just meant publishing numbers that were way too confident. But in the financial context, overconfident modeling means you think you can use more leverage than you actually can.
    - traek 8y ago
      > For 538, this just meant publishing numbers that were way too confident. This isn't the case for the 2016 elections. 538 ended up having a much more robust forecast because they accounted for systematic polling error (bias). https://fivethirtyeight.com/features/why-fivethirtyeight-gave-trump-a-better-chance-than-almost-anyone-else/ https://fivethirtyeight.com/features/why-fivethirtyeight-gav...
ianhawes 8y ago
As an aside, I find it ironic that the sibling comments all describe a different cause of the 2008/2009 crisis. Next time someone rambles on about no one being arrested/held responsible for the financial crisis, show them this thread full of reasonably intelligent people still unsure of the cause 10 years later.
- throwawaymath 8y ago
  Yes, it's an incredibly complex topic. Most people without a strong background in finance pick up their education on the topic from oversimplified source, such as: - their family/friends' opinions, - Wikipedia, - documentaries, - movies like The Big Short To be frank, unless someone has spent a significant amount of time doing hard research on the topic or is a professional in the industry, they shouldn't assign any confidence to their opinions about what caused the crisis. They can agree it's bad and shouldn't happen again, but beyond that most message board conversation is simultaneously prescriptive, uncritical and conflicting. In this particular case, we're seeing people talk about the topic who are evidently unfamiliar with the legitimate use of risk pooling in finance. It's rather too complicated to be summarized in a few paragraphs on HN.

Spooky23 8y ago

How is giving someone an asset-secured loan for $600k who has no income not a predatory act? In the case of the example in the article, if she wasn't given the loan, she'd probably have $100k or more in equity in cash from the sale of the home. The entire scenario is sickening and disgusting -- using hope and taking advantage of people's ego and emotional attachment to separate them from their money.

brianwawok 8y ago
It's an asset secured loan. If you have a 600k house, and the bank is willing to give you a 550k loan on that house - because it's backed by the asset - let it. Just don't let the bank then resell this loan as a prime AAA loan to others, so if it bombs someone else gets the shaft. It's just like organic food. I don't think it should be illegal to sell "conventional" eggs. I only think it should be illegal to sell a tray of organic eggs - where 1-2 of the eggs are "conventional" and hope no one notices. (Especially in a case where the farmer has an inside relation with the FDA inspector that is checking for the organic nature of eggs)
- toomuchtodo 8y ago
  I think that's where the real confusion comes from. People think the relationship between the loan originator and the borrower is where the questionable practices take place, when it's really between investors and the loan originator. Similar to how Chinese companies do reverse mergers on US stock markets to bilk investors out of their dollars.
tmp092 8y ago
Read to the end. She used the money to fully buy out her grandfather’s house in San Clemente, Calif. She jointly inherited it with other relatives and said she needed a loan to pay them for their shares of the property. This is a highly unusual situation. She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some. The property will continue to grow in value. If she were really in a situation where she might default, her family would help her. This is not representative of any trend. Hardly predatory. Hardly a "high risk" situation for either the bank or the borrower.
- Spooky23 8y ago
  >This is a highly unusual situation. Agreed. >She got a great deal on prime beach front Orange County property and could easily charge high rents to cover the mortgage and then some. So is she a private homeowner or a business? Is it legal for her to rent? Given that the bank accepts letters from old ladies describing casual labor as proof of income, who knows. I own investment property that is mortgaged and attracts high rents. The underwriting standards for that property were higher, and required 20% money down for a similar rate premium. >The property will continue to grow in value. That has little to do with qualification for the loan. Kind of makes my point -- it's in the banks interest to write a shitty loan to repo this house on default. (ie. predatory behavior) >If she were really in a situation where she might default, her family would help her. Are they cosigners? "Wink and nod" underwriting in banking is a bad thing.
  - deleted 8y ago
    [deleted]
  - rlucas 8y ago
    Banks (almost?) never want to repo and own a property. In most situations the bank 1. spends a bunch of opex to work out / sell off the property, and 2. has to remit any excess to the borrower. There are predatory operators known colloquially as “loan to own” guys, but they are usually unregulated and operating in the business world where the collateral value is less observable. For a bank, I believe Other Real Estate Owned (OREO, the balance sheet category where foreclosure properties are carried) is always considered a black mark and a burden, dragging down ROA/ROE.
charlesdm 8y ago
I disagree. She got a loan secured by an asset. If I own $100k in stock and I want to get a $80k loan secured against my stocks, let me. If I can buy a $550k property for $500k (with no cash down), with the lender not risking much when it gets repossessed and sold, let me. If the collateral is there, it's fine.
- wil421 8y ago
  She got a 600k loan as a student based on bank statements which is insane. She also took it an ARM loan at 6%. In 5 years it’s very possible it could become unaffordable. Not a good decision either. In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018.
  - jlarocco 8y ago
    > In this case it may be a good deal for both parties. What about the other people? The atricle mentions these loans grew by 25% in 2018. But you're speculating. If it was a good deal in this case, what makes you think it's not in other cases? Can you point to a specific case where you think it's a bad deal? As long as we don't bail them out again, I don't really care what crazy deals banks and bank customers come up with.
    - deleted 8y ago
      [deleted]
    - wil421 8y ago
      Yes I think it is a bad financial decision for a nursing student to take out a 600k loan. It’s almost predatory. I could care less if it’s a good deal for the banks.
      - throwawaymath 8y ago
        You keep talking about the person being a nursing student, but you keep ignoring what people are telling you about the asset. It's not an unsecured loan. It's backed by collateral. What is your specific problem? Liquidity?

Simon_says 8y ago

You use the word "predatory" a couple times. What does that mean? These are contracts that are willingly entered into by the borrower, and the lender has a lot of incentive to ensure that the borrower can actually pay.

ceejayoz 8y ago
In some scenarios, the lender has more incentive to let someone make years of mostly-interest payments, then foreclose. An underhanded contract isn't going to be obvious to a borrower with a high school dropout's education level. Even your run-of-the-mill credit card contract is written to an eleventh grade reading level, on average.
gammateam 8y ago
It means the licensed lender has a higher standard to abide by and not take advantage of the borrowers needs Such as creating a claim on everything the borrower will ever have and turning them into a debt serf But hey maybe housing prices go up really really fast
soVeryTired 8y ago
The lender has incentive to ensure that the value of the debt is greater than the initial outlay. That could be via a steady stream of payments, or via a handful of repayments plus a repossession and resale of the property. If the loan originator thinks the latter is likely, I don't think it's unreasonable to call the loan predatory.
docker_up 8y ago
You should research what the predatory loans were during the crisis. Your assumptions are incorrect, especially during the years leading up to 2008/2009. Banks would get people who undoubtably didn't deserve loans, would handwave over the details and then send people on their way with $1M loans and the borrowers would later fail. I have a friend who worked at Washington Mutual at the time, and she would routinely reject loan applications, and her manager would overrule her. The manager was making $30,000/month in commissions from loan origination, and he didn't give a fuck who was getting the loans because he was being paid and they were getting packaged up and sold to Fannie Mae/Freddie Mac. Meanwhile, people would be getting loans that they couldn't afford, but could make payments because of the 0% interest loans that were actually increasing the principal. But they didn't realize this because the lenders didn't explain all the details to them. It's predatory to take advantage of the fact that most regular people don't have a higher-level understanding of mortgages, and by filling their heads with ideas that it doesn't matter anyway because they will sell the house in a year for a profit. The lenders didn't care because they were incentivized to originate loans even if they knew the borrowers couldn't ultimately afford them. The thought at the time was "the house price will increase in 2 years anyway, so even if you get a $800k loan on a $1M house, you can sell it in 1 year for $1.2M, and then use the $200,000 profit for a downpayment on a real home."

balabaster 8y ago

Packaging small proportions of subprime mortgages with lower risk mortgages means that the bank is spreading risk across their mortgage portfolio while still giving people the opportunity of breaking the cycle of poverty by investing in them. Packaging all high risk mortgages together with a higher interest rate increases the probability of default on that portfolio while helping to keep those in poverty there by increasing the burden of the loan on them. So on one hand you've got a bank that enjoys massive profits spreading and thus decreasing their risk while assisting those in poverty to claw their way out by allowing them the benefit of lower interest rates. On the other you've got a bank that enjoys massive profits increasing the risk of one of their portfolios while making it extremely difficult for those in poverty to keep up with interest payments. I'm not discounting the fact that packaging large volumes of those mortgages as AAA and selling them on to other companies was fraudulent, it was, but the reality is, doing so was far less predatory than the alternative if you look at it from this perspective.

gedy 8y ago
> "giving people the opportunity of breaking the cycle of poverty" By borrowing beyond their ability to repay? That's gambling at best or just debt slavery at worst.
- docker_up 8y ago
  Subprime loans are not lending to people who can't repay. It's lending to people who don't have the credit history or have a poor history and giving them a chance to borrow money. If they can't afford the loan they shouldn't be getting it in the first place.
- balabaster 8y ago
  > "By borrowing beyond their ability to repay" That's a different argument. I'm not arguing the point of allowing them to borrow more than they can afford to repay. I'm arguing the point of allowing them to borrow what they can afford to repay at rates that allow them the opportunity to do so rather than making them pay rates they can't afford for money they desperately need. Preventing them borrowing more than they can afford to repay is a different and necessary oversight. Nobody should be put into a position of debt slavery. So I agree with your point, I just don't agree with your premise.

JumpCrisscross 8y ago

> The problem with 2008/2009 was that subprime loans were being marked as AAA, because that was the fraudulent part of it Not quite. Suppose I take a million subprime mortgages and say “I’ll pay you the first dollar any of these mortgages pay”. The probability that all of those mortgages default is slim. So this particular top-of-the-stack claim is, indeed, a quality one. This is what people mean when they say “top tranche” of a CDO. The CDO is the pile. The tranche is the priority. The top tranches were rated AAA. Looking back, they pretty much all paid as expected. The problem is a AAA rating means the security will pay out. Not that it will be able to be sold like a Treasury. So due to a confluence of things, many institutions needed liquidity, and when they tried to sell these instruments found there weren’t enough buyers. The desperate fire sold, thereby requiring others to mark down their holdings, and behold: crisis. There was also fraud in origination. And fraud elsewhere largely unrelated to the proximate causes of the crisis. But the proximate element was a classic one: a liquidity crisis. (The root element was over-leveraging.)

docker_up 8y ago
I'm not sure what your point is. Nothing you say disagrees with my point. The credit crisis was multi-faceted, but poisoning of AAA securities with subprime was definitely one of the major fraudulent aspects of the entire thing. AAA doesn't mean that the security will pay out. It means they have the lowest risk and it means that it's the most expensive. Even AAA-rated debt can fail. What happened was that large financial institutions were paying top dollar for AAA mortgage-backed securities, but after it was revealed that all of these mortgage-backed securities were poisoned with subprime loans, the value of those securities plummeted. The value of those assets dropped, which put the holders of those assets in a bad financial situation because they didn't have as much money as they thought and they also couldn't sell them. Some companies or funds are legally required to hold only AAA securities. This caused reverberations throughout the financial industry.
- JumpCrisscross 8y ago
  > poisoning of AAA securities with subprime was definitely one of the major fraudulent aspects of the entire thing My point is there was no “poisoning of AAA securities with subprime.” Subprime mortgages can be legitimately assembled to produce AAA securities. This happened, and those securities ultimately paid out like AAA securities. They just didn’t perform, liquidity-wise, like Treasuries. (Neither did other corporate AAA securities, for that matter. OTR Treasuries are OTR Treasuries.)

patagonia 8y ago

The problem with 2008/2009... It was a bit more complicated than that. Also, subprime and poorly documented loans (mortgages in the case of the financial crisis) with teaser rates that eventually reset to a rate unaffordable to the borrower can absolutely be predatory when coupled with brokerages incentivizing brokers to sign up financially illiterate folks for loans they will eventually not be able to afford knowing the brokerage will move the risk off their books within days or weeks.

ThrustVectoring 8y ago

The 2008 crisis wasn't caused by subprime lending. It was caused by financial mis-modeling that caused various financiers of sub-prime loans to grossly mis-estimate the risk they were taking, resulting in having an insufficient amount of capital to back the economic risk they were taking. Specifically, the models used assumed that the economic risk of a mortgage default in Connecticut was uncorrelated with the economic risk of a mortgage default in Texas. When housing prices are rising nationally, this assumption is basically true - the house can be sold by the bank for what's owed on the mortgage, refinancing is available for balloon payments, and any one borrower's cash flow situation is idiosyncratic. But when housing prices started to fall, this lack of correlation broke down, and many financial institutions became unexpectedly responsible for the losses in this asset class.

NoodleIncident 8y ago
This might be too tangential, but this reminds me a lot of 538's model of the 2016 presidential election. They had a much higher chance of a Trump victory just before the election (30% vs 1%), and the major difference was that they didn't treat each poll's margin of error as an independent event, they modeled it so that any error in the national poll had a large effect on _every_ state poll.
- ThrustVectoring 8y ago
  Yeah the cases have some striking similarity. There's generally two sources of error - bias, and noise. When you combine many measurements, only bias accumulates. Noisy errors in one state poll or one mortgage-based cash flow will be offset by noisy errors in another. If you get surprised by a change from a low-bias regime to a high-bias one, your old assumptions will lead you to be overconfident in your model. For 538, this just meant publishing numbers that were way too confident. But in the financial context, overconfident modeling means you think you can use more leverage than you actually can.
  - traek 8y ago
    > For 538, this just meant publishing numbers that were way too confident. This isn't the case for the 2016 elections. 538 ended up having a much more robust forecast because they accounted for systematic polling error (bias). https://fivethirtyeight.com/features/why-fivethirtyeight-gave-trump-a-better-chance-than-almost-anyone-else/ https://fivethirtyeight.com/features/why-fivethirtyeight-gav...

ianhawes 8y ago

As an aside, I find it ironic that the sibling comments all describe a different cause of the 2008/2009 crisis. Next time someone rambles on about no one being arrested/held responsible for the financial crisis, show them this thread full of reasonably intelligent people still unsure of the cause 10 years later.

throwawaymath 8y ago
Yes, it's an incredibly complex topic. Most people without a strong background in finance pick up their education on the topic from oversimplified source, such as: - their family/friends' opinions, - Wikipedia, - documentaries, - movies like The Big Short To be frank, unless someone has spent a significant amount of time doing hard research on the topic or is a professional in the industry, they shouldn't assign any confidence to their opinions about what caused the crisis. They can agree it's bad and shouldn't happen again, but beyond that most message board conversation is simultaneously prescriptive, uncritical and conflicting. In this particular case, we're seeing people talk about the topic who are evidently unfamiliar with the legitimate use of risk pooling in finance. It's rather too complicated to be summarized in a few paragraphs on HN.