Global Pool of Money Got Too Hungry

NPR's Adam Davidson and This American Life's Alex Blumberg jointly report on how rising defaults on subprime mortgages in the U.S. became a global financial crisis. This American Life host Ira Glass talks with Michele Norris about this first ever collaboration.

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IRA GLASS, Host:

From NPR News, this is ALL THINGS CONSIDERED. I'm Ira Glass.

MICHELE NORRIS, Host:

And I'm Michele Norris. And I am delighted to say hello to Ira Glass, who's visiting us from THIS AMERICAN LIFE, coming back to ALL THINGS CONSIDERED.

GLASS: Yes, and I am delighted to be here. ALL THINGS CONSIDERED was my home for over a decade. I was an ALL THINGS CONSIDERED producer before I ever went on the air myself.

NORRIS: And you come back bearing gifts with this wonderful collaboration.

GLASS: Yes. This is a collaboration designed to take advantage of the incredible expertise NPR News has when it comes to all matters of economic analysis and business analysis. And also took advantage of the documentary powers of our staff, where we can spend months tracking down people and finding people for just one story. And so we did both these things to put together this story.

NORRIS: And this story involving the subprime mortgage crisis, something that tops the news many days. But you take us much deeper into this.

GLASS: Well, we had this question, which truthfully with all the great coverage we have not understood the answer to. And basically the question had to do with these loans that banks would give out at the height of the crisis, that are at the heart of this crisis. And basically, there are these loans where you didn't have to prove you could pay them back. You didn't have to prove you had a job. You didn't have to put money down.

There's something called a NINA loan, which stands for no income, no asset. One of our producers, Alex Blumberg, talked to a guy who got a loan like this, named Clarence Nathan. And Clarence worked three part-time, not very steady jobs, made about $45,000 a year, and he took out this loan against his house that was huge, really.

CLARENCE NATHAN: Call it 540, for round figures.

GLASS: And you basically barrowed $540,000 from the bank, and they didn't check your income.

NATHAN: Right. They don't call me up and say, you know, how much money? They don't do that. I mean, it's almost like you pass a guy in the street and say, lend me $540,000. He says, well, what do you do? I got job. Okay. Essentially, that's the process.

(SOUNDBITE OF MUSIC)

GLASS: Would you have loaned you the money?

NATHAN: I wouldn't have loaned me the money, and nobody that I know would have loaned me the money. I mean, I know guys who are criminals who wouldn't lend me that money, and they'd break your kneecap.

(SOUNDBITE OF LAUGHTER)

NATHAN: So you know, yeah. I don't know why the bank did it. I'm serious, I mean, $540,000, a person with bad credit.

(SOUNDBITE OF MUSIC)

NORRIS: Ira, it's interesting to listen to this music because I feel like it should be Saturday afternoon, I'm in the car taking somebody to dance class or soccer or something like that.

(SOUNDBITE OF LAUGHTER)

GLASS: I know. This music makes any story better, doesn't it?

NORRIS: Now, Ira, your producer, Alex Blumberg, worked with NPR's Adam Davidson to put the story together.

GLASS: Yeah, the two of them went around. And they were trying to answer the question: What happened in banking? You know, what happened that the most basic rules of lending somebody money, like making sure the person who you are lending to can pay you back, what happened that made those go away? And they were also really interested in - you know, all these brokers and bankers who made these rules go away. They wanted to find out, like, what were they thinking? How did they see this? What did they think they were doing? They wanted to hear it in their words.

NORRIS: Let's hear it in their words.

ADAM DAVIDSON: When I first heard that phrase, subprime housing crisis, I thought it had all to do with the housing industry. Well, it turns out that's not exactly right. It turns out that the crisis is really about the financing and the people doing the financing.

ALEX BLUMBERG: That's right, Adam. This whole crisis really starts with what you and I have come to call the global pool of money.

(SOUNDBITE OF MUSIC)

BLUMBERG: What that is - most people don't think about it - it's the world investments - pension funds, investing for people's retirements, insurance companies investing your premiums, government central banks investing the wealth of nations.

CEYLA PAZARBASIOGLU: A lot of money; it's about 70 trillion.

BLUMBERG: That's Ceyla Pazarbasioglu of the International Monetary Fund, and let's try to figure out how much is $70 trillion. Think of all the money everyone spends on Earth every year. Everything you bought in the last year, add everything the U.S. government and the U.S. military spent money on, add all the corn in Mexico and all the money folks spent on lawyers and all the rice sold in China, all the money spent everywhere on Earth in a year; that is less than $70 trillion, less than this global pool of money.

(SOUNDBITE OF MUSIC)

DAVIDSON: So it's a lot of money, and there's this army of people, investment managers, whose job it is to watch over that money. And they're pretty nervous because they have two sort of contradictory concerns. They don't want to lose any of it, and they also want to make it grow.

So for a long time, they made it grow by investing in very safe, pretty boring investments, things like U.S. treasuries and municipal bonds.

BLUMBERG: But right before our story starts, something happened to that global pool of money; it got a lot bigger. In fact, it doubled between 2000 and 2006. In other words, several centuries to get to about 35 trillion, and then over the course of six years, it got another 35 trillion.

And there are a lot of reasons for this growth, but the main one was that a lot of countries that used to be poor, that used to have no real savings, suddenly became rich. Brazil, India, of course China started making things that the rich countries wanted. And those countries banked their profits and looked around the world for ways to invest them.

So suddenly there's twice as much money scouring the world for investments, but the world wasn't ready. There weren't twice as many good investments. And so this global money looked around and found one investment that it liked in particular - the U.S. housing market, and a special bond created by Wall Street.

MIKE FRANCIS: It was unbelievable. I mean, we almost couldn't produce enough to keep our investors happy.

BLUMBERG: Mike Francis worked at Morgan Stanley, the Wall Street investment bank. And he was producing these bonds that allowed global investors to buy into the U.S. housing market.

FRANCIS: More people wanted bonds than we could actually produce. That was our difficult task, was trying to produce enough.

BLUMBERG: Here's how Mike Francis and a lot of other people on Wall Street performed this kind of financial magic of turning mortgages into bonds. They'd buy up mortgages, thousands of them, and pool them all together. That way, they'd have this constant stream of mortgage payments coming to them every month. And they would sell shares in that stream to global investors. That's how you create a mortgage-backed security, a mortgage-backed bond.

And for a few years there, like between 2003 and 2006, almost nothing in the world was growing as fast as U.S. house prices, and these bonds were sort of a way for investors to get a piece of that action.

But there was a problem.

DAVIDSON: Right, there's always a problem.

BLUMBERG: Right. And the problem here was that to make a mortgage-backed security, you need a mortgage, and there weren't enough mortgages. By 2003, with super-low interest rates and all this money from global investors, everyone who wanted a mortgage and who had the kind of steady income and money in the bank to afford one, already had gotten a mortgage.

But that global pool of money was hungrier than ever for these mortgage backed bonds.

DAVIDSON: So Wall Street started lowering its standards. It used to be that to get a mortgage, you needed to prove that you made enough money, that you had a steady job, and that you had some assets in the bank. But starting around 2003, every month or so Wall Street would loosen things up a bit.

BLUMBERG: I talked to a guy named Mike Garner, who worked at Silver State Mortgage in Nevada, and he told me that the standards kept falling. One month Wall Street would say, borrowers don't have to prove how much they make, they can just state how much and we'll trust them.

MIKE GARNER: Then the next one came along and it was, no income-verified asset. So you don't have to tell the people what you do for a living. You don't have to tell the people what you do for work. All you have to do is show that - or state that you have a certain amount of money in your bank account.

(SOUNDBITE OF LAUGHTER)

GARNER: And then the next one that came out is just, no income, no asset. So you don't have to state anything. You just have to have a credit score and a pulse.

BLUMBERG: That pulse thing, that was also optional. Like this case in Ohio, where 23 dead people got mortgages. And even some of the living weren't exactly what you'd call a good credit risk. The name of this new loan, remember, was No Income No Asset. People in the industry called it a liar's loan. They expected people to lie.

And if that sounds crazy to you, it also sounded crazy to a lot of people in the business. Here's Mike Garner.

GARNER: My boss had been in the business for 25 years. And he hated those loans. He used to rant and just say, it makes me sick to my stomach, the kind of loans that we do. And you know, he fought the owners and the sales force tooth and neck about these guidelines. And we got the same answer every time. Nope, other people are offering it, we're going to offer it too, and we're going to get more market share this way. House prices are booming, everything is going to be good.

BLUMBERG: Think about this whole thing from the standpoint of Mike Garner's boss's boss, the owner of the company.

(SOUNDBITE OF MUSIC)

BLUMBERG: Neil Dave's(ph) Silver State Mortgage would've held on to that loan for 30 years, and so they'd make sure the borrower could pay it back. But now in the new system, they held it for a month or two, then sold it to Wall Street. All that risk was someone else's problem.

DAVIDSON: And Wall Street wasn't particularly worried, because they just passed the risk on to that global pool of money, to the investors. Now, we're not saying that Wall Street and Silver State were lying to the investors. Wall Street was constantly checking the risks of these mortgages. They had these fancy computer systems that constantly monitored the quality of the loans they bought. Morgan Stanley's Mike Francis...

FRANCIS: All the data that we had to review, to look at on loans that were years old, was positive. They performed very well.

BLUMBERG: The data told them not to worry, that mortgage foreclosure rates are low, like 1 or 2 percent. They never go above, say, 10 percent. So the mortgage-backed bonds were designed to perform well even if foreclosure rates hit some ridiculous high, like 12 percent.

We now know their numbers were way off because the data they were looking at back in 2005 and 2006, those data from the old days, back when only qualified borrowers got loans. It wasn't data from this new world of no-income, no-asset loans to people with lousy credit.

DAN NIGRO: Oh boy, there's a page I'd rather not look at very often.

BLUMBERG: Dan Nigro is one of the people who bought mortgage-backed bonds. He works for Dynamic Credit, a company that packaged those bonds into a new product called a CDO and then sold them to those global investors.

DAVIDSON: We're in his office, and he brings up a screen on his Bloomberg Terminal. It's the current statistics on one of those mortgage pools that Wall Street created, that this company bought.

NIGRO: And the statistics are pretty bad. Nearly 41 percent of the pool is more than 60 days overdue. Out of that, nearly 16.5 percent are in foreclosure.

BLUMBERG: Remember, for this bond to keep its value, the foreclosure rate has to stay below around 10 percent. It's already way over that and climbing. He says it could go past 50 percent on this bond.

And therefore, this bond will lose money, and everyone involved in this is losing something. There are more than 4 million Americans facing foreclosure, hundreds of mortgage companies are now bankrupt, hundreds of thousands of people have lost their jobs. The IMF estimates that banks and investors around the world could lose more than a trillion dollars.

And its not that everyone involved was entirely foolhardy. Dan Nigro and Dynamic Credit did not take these big risks. They refused to invest in the riskiest mortgages. They thought they were being conservative, and they lost millions.

NIGRO: In the end, there were just so many risks you couldn't avoid them all.

DAVIDSON: You thought you were being conservative?

NIGRO: I know I'm conservative, I just wasn't conservative enough.

DAVIDSON: If you were conservative enough, what would you have done?

(SOUNDBITE OF LAUGHTER)

NIGRO: Well, in retrospect, I probably should have found another line of business four years ago.

DAVIDSON Just about everyone we talked to at every step of this chain says now that they knew something weird was going on, that the deals they struck did not feel right. But none of them really questioned things and why would they? Everyone was making money right up to the day it all fell apart.

I'm Adam Davidson, NPR News.

And I'm Alex Blumberg for This American Life.

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