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The crux of the problem was the rating agencies. By law, regulated funds (insurance companies, pension funds, mutual funds) can only invest in bonds that are r

The crux of the problem was the rating agencies. By law, regulated funds (insurance companies, pension funds, mutual funds) can only invest in bonds that are rated "investment grade" by official rating agencies ( such as Moody's). The rating agencies had two problems: 1) because they were given official status by law, they became less vigilant about guarding their reputation 2) instead of using a mix of statistics and personal judgment to rate bonds, they relied solely on models. It's analogous to managing programmer performance by only counting lines of code written. The banks found a way to game the algorithm ( slicing securities into tranches) and thus were able to sell massive quantities of very risky loans to big, regulated funds. So you're right, it is the banks job to make sure the customer can afford the loan, and ordinarily a bank would never have made these subprime loans. But in this situation, the banks were able to resell these super risky loans to regulated funds that were obligated by law to invest in them. The result was disaster.

Retric 18y ago
The reason the banks had problems was the need for them to keep a fraction of these loans. Once the default rate increased they where unable to make new loans and at the same time they ended up with a lot of bad debt and because the loans where bundled they did not end up with a house which could be sold.
netcan 18y ago
I'm not going to pretend I understand the mechanics of what went on. What you say sounds like it's in line with the narratives I've heard from what seemed to me like the intelligent sources. But it doesn't really negate what I am saying: The underlying assumption is that consumers will make bad decisions when given the chance. Banks can either measure their capacity to pay or the tendency to pay (credit score). Relying only on the latter seems to make the assumption (that seems like it should be reasonable) that apart from a problematic minority, lenders will take care not to bankrupt themselves themselves. Then articles such as this one come along & explain that this is actually insane. Obviously consumers are trying to bankrupt themselves. The only remaining discussion is how to stop them: banks should, rating agencies should, governments should... I find this strange. Your explanation, while not reassuring describes why institutions will make bad investment decisions.

Retric 18y ago

The reason the banks had problems was the need for them to keep a fraction of these loans. Once the default rate increased they where unable to make new loans and at the same time they ended up with a lot of bad debt and because the loans where bundled they did not end up with a house which could be sold.

netcan 18y ago

I'm not going to pretend I understand the mechanics of what went on. What you say sounds like it's in line with the narratives I've heard from what seemed to me like the intelligent sources. But it doesn't really negate what I am saying: The underlying assumption is that consumers will make bad decisions when given the chance. Banks can either measure their capacity to pay or the tendency to pay (credit score). Relying only on the latter seems to make the assumption (that seems like it should be reasonable) that apart from a problematic minority, lenders will take care not to bankrupt themselves themselves. Then articles such as this one come along & explain that this is actually insane. Obviously consumers are trying to bankrupt themselves. The only remaining discussion is how to stop them: banks should, rating agencies should, governments should... I find this strange. Your explanation, while not reassuring describes why institutions will make bad investment decisions.