Tuesday, February 3, 2009

The man who started the great recession

MSN Blog Money Central: The man who started the great recession


I am not certain if Mr. Douglas McIntyre is entirely serious in his blog. Regardless of the purpose of his post as sarcastic entertainment or serious scholarship to define the cause and process that led to the Great Recession, it presents a very clear and illuminating description of what happened, which led us to the mess we are in today.

It sounds like the clever mathematicians who tried to create wealth out of thin air by moving numbers around, got smacked by the intricacies of their own invention and lost control of it when the interdependent values of all the vehicles fell apart in cascading collapse faster than the banks could pull their burnt hands away. Like Warren Buffet predicted, these derivatives were weapons of mass destruction that were easy to get in, and hell to get out.

Ironically, W found his WPD on his watch, just not in Iraq.


The global recession has a "patient zero", a single person who set off the series of events which may lead the economy into its greatest downturn since The Great Depression and, by some estimates, push 50 million people around the world out of jobs this year, according to The International Labour Organisation.

"Patient zero" bought a house in Stockton, California, in 2003 after getting a subprime mortgage. He defaulted on that mortgage 39 months later.

Most economists blame the collapse of the credit markets which began the recession on a drop in US housing prices and devaluing of subprime mortgage-backed securities. The Wall Street experts who created these financial instruments failed to predict how quickly low-quality mortgages would default to some extent because the national value of housing had gone up for decades.

Someone who took out a subprime loan in 2003 is the "patient zero" who began the great recession. In financial models, he was supposed to pay his mortgage for ten years and then sell his home. When his mortgage reset in 2006, he defaulted. The flow of his payments into the mortgage pool stopped.

The differential between the real world and the Wall Street derivative model moved off center by a fraction of a millimeter. Another person within the same pool defaulted the next day, and quickly the mortgage pool lost the financial yield characteristics that it was supposed to have.

Tranches began to change in value, one by one. A small snow ball turned into an avalanche. On the day of this first unexpected default, the value of the other homes in its neighborhood ticked down a fraction. With each default that occurred, this drop accelerated.

Where was the recession's "patient zero" from and what were his financial circumstances? Based on where the real estate markets began to decline and where the most subprime loans where made, he was a client of Countrywide. He got a $250,000 mortgage five years ago. He did not have to put a nickel down to get the loan.

The value of real estate in Stockton, California, where he bought his home had been rising at 10% a year for four years. He was a good credit risk not because of his income but because the value of the asset he bought was bound to go up 100% by the end of this decade. Two months after his mortgage reset in 2006, he lost his job. He was in default less than 90 days later.

Somewhere in the Countrywide archives are his number, phone number, and most recent forwarding address. He is still looking for permanent employment.

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