Why did the mortgage mess occur when it did? The topic is prompted by a Fortune Magazine article which proposes a very naive reason:
"As margins shrank in traditional businesses like underwriting and brokerage, Wall Street looked for new places to make money," says Louis Pizante, a former investment banker at Goldman Sachs and Nomura .... In the process the firms took imprudent risks to make big profits."
Look, Wall Street can make foolish mistakes even when its profits are roaring away. In fact, profits in one area are more likely to lead to the idea that they can do no wrong. And when things are bad, companies (including Wall Street firms) tend to draw in their horns across the board, taking as little risk as possible.
If it wasn't thin margins in other areas, what caused the mortgage mess?
In this five-part series, I explain how this mortgage mess came to be. The key elements are
- The Great Moderation and the benign housing cycle of the 2001 recession, which made real estate appear to be safe
- Securitization, which changed the funders from lenders to investors, while making the products too complex for most anyone to understand.
- With these two factors in place, the mortgage crisis evolved from the last recession.
- With this understood, we can see what to expect next time round.