In my opinion, this entire meltdown that has been going on for the last year or so is caused by one thing: a lack of accountability. This occurs at both a personal level (people who bought houses they couldn’t afford and, hence, got mortgages they couldn’t afford), the people that sold them those houses and mortgages, the banks that underwrote them, and the bankers that cut them up and resold the paper.

Let’s step through this so that it is super clear:

1. Borrower: Some people seem to want to be sympathetic to people facing foreclosure. (And I guess I’m sorry they are losing their house.) But if you bought a $500,000 house and you make $50,000 a year: YOU ARE AN IDIOT. Yes, I know most cases aren’t that extreme, but a lot of them are. People gambled and bought houses they couldn’t afford in hopes the market would go up. This is called an investment. If you lose money in other investments (like, say, the stock market) no one feels sorry for you or offers to help you out. (Man I wish the government would make my portfolio whole on the bloodbath yesterday.) And, yes, some of the blame goes to predatory lenders (and probably overzealous realtors) who convinced people to buy more house than they could afford and to take on bigger loans than they could afford (probably in many cases without understanding the long-term costs – perhaps believing appreciation would cover it all.) Anyway, anyone that took out a loan that they couldn’t afford is a major part of the problem.
2. Mortgage Brokers: I think these slice of the pie probably deserves to see many of its members go to jail for fraud, but I doubt it will happen. There corporate masters (to the extent that they had them) also deserve some blame too. As is often the case, the root problem here (again in my opinion) is the compensation model. These guys were compensated for closing loans. So, not surprisingly, they closed as many loans as possible. This was also a sales job, so they didn’t really care (and probably didn’t even understand in most cases) whether someone could or couldn’t pay the loan. All they cared about was getting the loan closed. I’d wager there was a lot of coaching (and wink-wink conversations) where they told borrowers how to fill out the load app so it would get approved. Whoever thought of Alt-A mortgages was an idiot, because that’s the perfect model for abuse by a bunch of ravenous sales people who just want to sell as many (and as expensive) mortgages as they possible can. Especially since once the mortgage is sold there doesn’t appear to be much recourse against the broker (perhaps in the first month or two, but I don’t really know this business.) Hence: no accountability, just hyper selling – not a good combo.
3. Banks: It used to be the banks were the responsible ones. They underwrite the loans, hence they had final accountability. But those days are gone – thanks to our clever friends at investment banks and the Macs (Fannie and Freddie….). The banks could just sell their loans to an investment bank (slice it up, see below) or Fannie/Freddie. At that point they basically became just another mortgage broker – although I’d wager they made more money in the process. Perhaps they had to be prepared to buy the loan back for a longer period of time, so they had slightly higher risk. They also probably looked at the loan application slightly longer (and more carefully than the mortgage brokers – but only to make sure it conformed so they could sell it. Beyond that they didn’t care, once it was sold it was no longer their responsibility. And guess what? NO ACCOUNTABILITY.
4. Investment Banks: This is where the fun really begins. These guys are really clever. They are always looking for things to sell and, thus, make fees. This drove the creation of derivatives – which in many ways are really just a complicated way of gambling on real world things. How this is legal and online poker isn’t is a good sign of how retarded our government is. (I’m for legalizing online gambling, just to be clear.) But I digress. So the banks wanted fees, they figured they could buy up mortgages, repackage them, and sell them again in bundles with a slightly higher level of complexity (cough, cough, I mean structure… or value add, or something). They basically broke mortgages up across these instruments (or derivatives, or paper, or CDOs) – which I’m pretty sure most of them actually didn’t understand. They then sold these. It worked great – they made a lot of money on fees. They also created an entire ecosystem around them that consisted of hedging and insuring these things. That worked out great for everyone until housing prices started going down. I will say, on behalf of the investment banks, they did maintain a little accountability… mostly because they were stupid though. They kept some of these CDOs for themselves rather than selling them. Woops. More on this later.
5. Fannie Mae and Freddie Mac: I’m not going to go back to the root causes of why these organizations were ticking timebombs because that’s a long way back in history. But when the government starts encouraging people to buy houses and backing it up with these organizations who are sort of for profit and sort of for the good of the people – bad stuff is bound to happen. Of course politicians seem to have the memory and attention span of the average fruit fly, so it’s not surprising that they didn’t think this through. These organizations should have been accountable to their shareholders but they were drunk with power and the tacit “the government will save you” stamp on them which allowed them to do some really stupid stuff. Like buy really bad mortgages and encourage everyone down stream to write them. Trust me, if these clowns weren’t willing to buy subprime and alt-a loans, no one would have been writing them. (They share this with the investment banks, but I’ll grant it to the Fs because they started it. I’m pretty sure the i-banks saw the Fs making money, got jealous, and jumped in to the fray.) Anyway, these guys were backed by Congress (the ultimate no accountability organization) and hence could was their hands of any risk. Any they did.

So what’s the punchline:

1. No one in the entire chain of a mortgage transaction had any sense of responsibility for the mortgage or would be held accountable (except the buyer). Therefore, everyone just wanted to take their cut and pass it along. As long as the musical chairs of a rising real estate market kept going everyone was happy.
2. I have to believe that in this chain that the value of the mortgage in a final security had to have been stripped down to very little. At each step in this chain people were taking commissions and fees (and the loan servicer took their cut too – but I left them out). This would seem to make them a bad investment. I’m not sure how a loan can return more than it’s original interest as a return – and since so many people took money out along they way, it would seem the actual return would have to have been much less.

What I would really love to see:

The Wall Street Journal or USA Today – if any of you guys are listening (highly unlikely I know) here it is – should do a nice chart showing the flow of a mortgage through the system and how much in fees got eaten up along the way. It would be really interesting to see this. (At least to me.) I’m also pretty sure it would help people really begin to understand what was actually going on and how messed up the system got.