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Good explanation, thanks. I thing along these lines I've always wondered:
My impression is that a substantial amount of the financial shenanigans that led to the crisis were based on all of the various actors who make up the pipeline of financing mortgages trying to figure out some way to themselves not lose their shirts in the environment of all of these sketchy mortgages the banks were forced to make. Where "forced" is not in the sense of "you will go to jail if you don't do this", but a more subtle indication that "we will audit and regulate your bank out of existence unless you do this". So essentially, deep down everybody knows it's going to collapse somehow eventually, and they're all trying to arrange things such that they're not the ones holding the bag when it does, which involves never acknowledging that to anyone else. Do you think this is accurate, or off-base?
It's hard to say, there's probably a few million pages of congressional testimony in which various people might or might not hint at this obliquely, I actually have no idea. I don't think there was any major effort by the majority of loan originators in middle america to limit their exposure to the subprime mortgage market. There were some smart people who did, especially from 2006 onwards, just like there were some smart hedge funds who made the same play, and just as Goldman eventually realized it themselves (as fictionalized in Margin Call). Obviously there were people who predicted the housing bubble bursting more generally, but we're 400 years on from Tulip Mania and there are always Cassandras preaching about imminent doom. It's very hard to tell who got lucky and was neurotic at the right time (like the hypochondriac who finally catches a terrible disease very early) and who knew the whole thing was really a sham.
I'll say that my impression from old hands in investment banking rather than trading is that most did not expect a crash in 2007. The market had barely recovered to dotcom levels, it had only been 6 years since the last crash and 4 since the trough of the 2001-2003 recession, M&A activity was hot but not shockingly so, the housing market was the only red-light indicator, if it even was.
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Peter Wallison says that (1) Fannie Mae and Freddie Mac misleadingly categorized mortgages as subprime only if they were issued by a small category of "subprime lenders" (rather than the more typical definition of any mortgage made to a person with FICO score worse than 660), so (2) the banks never even knew that the situation was in the toilet.
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